<PAGE>
 
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                      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 February 1, 1997
 
                                      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 NO. 0-7264
 
                           PAUL HARRIS STORES, INC.
            (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
 
                INDIANA                              35-0907402
    (STATE OR OTHER JURISDICTION OF               (I.R.S. EMPLOYER
    INCORPORATION OR ORGANIZATION)               IDENTIFICATION NO.)
 
   6003 GUION RD., INDIANAPOLIS, IN                     46254
    (ADDRESS OF PRINCIPAL EXECUTIVE                  (ZIP CODE)
               OFFICES)
 
                                (317) 293-3900
             (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
 
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
 
                        COMMON STOCK WITHOUT PAR VALUE
                               (TITLE OF CLASS)
 
  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 if disclosure of the 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. [_]
 
  Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by sections 12, 13, or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court.  Yes  X  No
 
  As of April 8, 1997, 10,119,403 common shares were outstanding (including
3,013,039 shares of non-voting common stock). The aggregate market value of
the common shares held by non-affiliates (based upon the closing price on
April 8, 1997 on the Nasdaq National Market System of $16.25 per share) was
approximately $160,306,000. For the purposes of such calculation, all
outstanding shares of common stock have been considered held by non-
affiliates, other than the 254,446 shares owned by directors and executive
officers of the registrant. In making such calculation the registrant does not
determine the affiliate or non-affiliate status of any shares for any other
purpose.
 
  The information required by Part III (Items 10, 11, 12, and 13) is
incorporated herein by reference from the registrant's definitive Proxy
Statement for the Annual Meeting of the Shareholders to be filed with the
Commission pursuant to Regulation 14A.
 
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<PAGE>
 
                                    PART I
 
ITEM 1. BUSINESS
 
  Paul Harris Stores, Inc. (the "Company"), incorporated under the laws of
Indiana in 1952, is a specialty retailer of moderately-priced sportswear and
accessories sold under the Paul Harris Design, Paul Harris Denim and PHD brand
names. At February 1, 1997 the Company operated 223 stores in 26 states and
the District of Columbia.
 
  The Company's fiscal year ends on the Saturday closest to January 31.
References in this report to a fiscal year refers to the calendar year in
which the fiscal year began. For example, fiscal 1996 refers to the fiscal
year which began on February 4, 1996 and ended on February 1, 1997.
 
  The Company operated retail stores in the following jurisdictions on the
dates indicated:
 
<TABLE>
<CAPTION>
                  NUMBER OF STORES AS OF
                  -----------------------
                  FEBRUARY 3, FEBRUARY 1,
                     1996        1997
                  ----------- -----------
<S>               <C>         <C>
Arkansas.........       2           2
Delaware.........       1           1
District of
 Columbia........       1           1
Florida..........       5           6
Georgia..........       8           7
Illinois.........      27          29
Indiana..........      44          35
Iowa.............       7           7
Kentucky.........       7           6
Louisiana........       3           2
Maryland.........       8           8
Massachusetts....       1           1
Michigan.........       2           2
Mississippi......       2           2
</TABLE>
<TABLE>
<CAPTION>
                  NUMBER OF STORES AS OF
                  -----------------------
                  FEBRUARY 3, FEBRUARY 1,
                     1996        1997
                  ----------- -----------
<S>               <C>         <C>
Missouri.........       6          10
Nebraska.........       2           1
New Jersey.......       5           5
New York.........       2           2
North Carolina...      12          12
Ohio.............      32          26
Pennsylvania.....      23          23
South Carolina...       5           5
South Dakota.....       1           1
Tennessee........      11          11
Texas............       7           6
Virginia.........       8           7
Wisconsin........       3           5
                      ---         ---
Total Stores.....     235         223
                      ===         ===
</TABLE>
 
  Of the Company's 223 stores at February 1, 1997, 181 are located in regional
enclosed shopping malls.
 
  The Company sells quality merchandise and emphasizes casual clothing
coordinated by color, style and fabric. Approximately 89% of all products sold
by Paul Harris Stores consists of apparel, with the balance being accessories.
 
  Merchandise is available from a large number of domestic and foreign
suppliers under a variety of trade terms and conditions. During fiscal 1996,
40 third party manufacturers supplied 68% of the Company's merchandise
purchases; however no manufacturer provided more than 7% of the Company's
merchandise. Approximately 63% of all merchandise was purchased from foreign
suppliers in fiscal 1996. Virtually all merchandise purchased is private brand
merchandise which is manufactured specifically for the Company. Importing
operations are subject to normal merchandise quota restrictions imposed by the
country of origin, but the Company anticipates no events which would
significantly limit its supply of imported merchandise in the near future. All
merchandise is distributed to the Company's retail stores from the Company's
distribution center in Indianapolis.
 
  The Company stresses testing of styles, colors and pricing to better
identify consumer demand and typically contracts for manufacture of products
to respond to such consumer demand.
 
 
                                       1
<PAGE>
 
  The Company uses various trademarks such as "Paul Harris", "Pasta" (a
trademark used on 5 stores and a line of sportswear) and other trademarks of
lesser importance. The Company has no patents, licenses, franchises or other
concessions which are considered important to its operations.
 
  Characteristic of the women's retail apparel industry, the Company realizes
its highest sales during the month of December. This sales pattern requires
higher inventory levels during the fourth quarter of the fiscal year. Various
promotional efforts, including markdowns, are used to promote rapid turnover of
inventory. In line with the characteristics of the industry, no single customer
or group of customers significantly affects the Company's business, and there
are no backorders.
 
  The Company accepts major national credit cards as an incentive to increase
sales. Credit card sales are converted to cash on a daily basis. The Paul
Harris Fashion Card ("PHFC"), a private label credit card, was introduced in
all Paul Harris Stores effective August 1994 and accounted for approximately
10.8% of the total Company sales during fiscal 1996.
 
  During fiscal 1996, the average sale per PHFC transaction was $60, compared
to an average sale per transaction of $29 for all other forms of payment. The
Company assumes no credit risk for the PHFC, but pays a percentage of sales as
a service fee to an unaffiliated third party. In fiscal 1996 approximately
47.6% of the Company's sales were for cash (including checks) and approximately
41.6% were from major national credit cards in fiscal 1996.
 
  The retail sale of women's apparel is a highly competitive business. The
Company competes with other women's fashion apparel chain stores, department
stores, individual stores and discount stores. The manner of competition
relates to style, selection, quality, display and price of merchandise, as well
as customer service, store design and location. Many of the Company's
competitors have greater financial resources and sales than the Company. The
Company is unable to rank itself with regards to number of stores and gross
sales, but believes it is one of many similar moderate-sized competitors in an
industry which includes a small number of better known larger competitors.
 
  The Company had approximately 2,500 permanent employees (full and part-time)
as of February 1, 1997. During the 1996 holiday peak shopping season, the
Company hired approximately 1,400 temporary employees.
 
  This report contains statements that constitute "forward-looking statements"
within the meaning of Section 27A of the Securities Act (and Section 21E of the
Exchange Act). The words "expect," "estimate," "anticipate," "predict,"
"believe," and similar expressions and variations thereof are intended to
identify forward-looking statements. Such statements appear in a number of
places in this report and include statements regarding the intent, belief or
current expectations of the Company, its directors or its officers with respect
to, among other things: (i) trends affecting the Company's financial condition
or results of operations; (ii) the Company's plans; (iii) the Company's
business and growth strategies; and (iv) the declaration and payment of
dividends. Prospective investors are cautioned that any such forward-looking
statements are not guarantees of future performance and involve risks and
uncertainties, and that actual results may differ materially from those
projected in the forward-looking statements as a result of various factors.
Such factors include, among others (i) changes in general economic and business
conditions; (ii) adverse weather during the Christmas selling season; (iii)
unanticipated changes in fashion; and (iv) governmental actions or other
developments that adversely affect sources of imported merchandise.
 
ITEM 2. PROPERTIES
 
  The Company owns its headquarters and distribution center in Indianapolis,
Indiana. Situated on 19.5 acres of land, the headquarters and distribution
center have a total area of 435,000 square feet of space. The Company utilizes
approximately 85% of this facility, and leases the remaining space to an
unaffiliated party for a term
 
                                       2
<PAGE>
 
expiring in 1997 with a 4-year option, ending in 2001. Either party may
terminate the lease on six months' prior notice. The Company believes that the
facility is sufficient to accommodate planned future business volume. The
property is subject to a term loan (mortgage) described in "Note 2. Long-Term
Debt and Credit Arrangements" of the "Notes To Consolidated Financial
Statements".
 
  The Company leases all of its stores. In general, the store leases have an
initial term of 3 to 10 years, with some having one or more 5-year options to
extend. Some leases have incorporated a "kick-out" clause if sales have not
reached an acceptable level after a certain number of years of operation,
which normally permits either party to terminate if the appropriate sales
levels are not achieved.
 
ITEM 3. LEGAL PROCEEDINGS
 
  The Company is involved from time to time in legal proceedings arising in
the ordinary course of its business. In the opinion of management, no pending
proceedings will have a material adverse effect on the Company's financial
condition, results of operations or cash flows.
 
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
  There were no matters submitted to a vote of security holders during the
fourth quarter of fiscal 1996.
 
EXECUTIVE OFFICERS OF THE REGISTRANT
 
  Officers are elected by the Board of Directors and serve at the discretion
of the Board. The following sets forth the name, age, position(s) and business
experience of the executive officers of the Company.
 
<TABLE>
<CAPTION>
                    NAME                AGE                 TITLE
                    ----                ---                 -----
      <S>                               <C> <C>
      Charlotte G. Fischer.............  47 Chairman of the Board, President and
                                            Chief Executive Officer
      Ana P. Porter....................  32 Executive Vice President--
                                            Merchandising and
                                            Planning/Distribution
      John H. Boyers...................  52 Senior Vice President--Finance and
                                            Treasurer
</TABLE>
 
  Ms. Fischer became Chairman of the Board, President and Chief Executive
Officer of the Company in January 1995. From April 1994 until January 1995,
Ms. Fischer was Vice Chairman and Chief Executive Officer Designate. She was a
consultant to the Company from September 1993, when she first joined the
board, until April 1994. From October 1991 to March 1994, Ms. Fischer was an
independent retail consultant. In addition, she was the President of C.G.F.,
Inc., a specialty company, which she founded in November 1992. Ms. Fischer was
employed by Claire's Boutiques, Inc., a specialty retailer of costume jewelry,
from 1986 to 1991, serving as its president and chief operating officer from
October 1986 to September 1989 and its president and Chief executive officer
thereafter. She was also a director of its parent corporation, Claire's
Stores, Inc. Ms.  Fischer is a director of Trans World Entertainment Corp.,
Inc.
 
  Ms. Porter was named Executive Vice President--Merchandising and
Planning/Distribution in February 1997. From December 1996 to February 1997,
Ms. Porter was an independent retail consultant. Ms. Porter was Vice
President--Merchandising, Marketing and Planning/Allocation for Cotton Ginny
Ltd. of Canada, a women's apparel retailer, from January 1993 until January
1996 and Merchandise Manager of Cotton Ginny Ltd. of Canada, from January 1991
until January 1993. Ms. Porter also served on the board of directors of Cotton
Ginny Ltd. from 1993 to 1995.
 
  Mr. Boyers was named Senior Vice President--Finance and Treasurer in March
1995. From January 1995 to March 1995, he acted as a consultant to the
Company. Mr. Boyers was self-employed as a consultant for the period of July
1994 to January 1995. From 1990 through July 1994, he was director of
financial reporting for The Wackenhut Corporation, a provider of security
personnel, in Coral Gables, Florida and also served as controller of Wackenhut
Corrections Corporation, a subsidiary of The Wackenhut Corporation.
 
                                       3
<PAGE>
 
                                    PART II
 
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
 
  The Company's common stock is traded on the Nasdaq National Market System.
The following table sets forth for the past eight fiscal quarters, the range
of high and low closing sales prices for the Company's common stock as
reported by the Nasdaq National Market System.
 
<TABLE>
<CAPTION>
                                         MARKET PRICE OF COMMON STOCK
                               -------------------------------------------------
                                FISCAL 1995 QUARTERS     FISCAL 1996 QUARTERS
                               ----------------------- -------------------------
                                1ST   2ND   3RD   4TH   1ST   2ND   3RD    4TH
                               ----- ----- ----- ----- ----- ----- ------ ------
<S>                            <C>   <C>   <C>   <C>   <C>   <C>   <C>    <C>
High.......................... $3.13 $2.63 $2.50 $2.63 $5.13 $8.50 $13.25 $22.50
Low........................... $1.25 $1.38 $1.25 $1.06 $1.75 $4.00 $ 6.25 $11.25
</TABLE>
 
  There were approximately 1,600 registered holders of record of common stock
at February 1, 1997 and 1 holder of non-voting common stock. The shares of
non-voting common stock are convertible to common stock upon sale or certain
other conditions described in the Company's Amended and Restated Articles of
Incorporation.
 
  The Company has not declared or paid any cash dividends on the Common Stock
since fiscal 1978. The Company's Board of Directors presently intends to
continue a policy of retaining earnings to finance the development and
expansion of the Company's business. Future cash dividends, if any, will be at
the discretion of the Company's Board of Directors and will depend upon the
Company's earnings, capital requirements, financial condition, contractual
restrictions, if any, and other factors considered relevant by the Company's
Board of Directors.
 
  During the period covered by this report, the Company did not sell any
equity securities in a transaction that was exempt from the registration
provisions of the Securities Act of 1933, as amended.
 
ITEM 6. SELECTED FINANCIAL DATA
 
  The selected consolidated financial data set forth below should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the Consolidated Financial Statements and Notes
thereto included in this report.
 
<TABLE>
<CAPTION>
                          TWENTY-SIX WEEKS ENDED                  FISCAL YEAR
                          --------------------------  -----------------------------------
                          AUGUST 2,     JANUARY 30,
                           1992 (1)       1993 (1)      1993     1994     1995     1996
                          -----------   ------------  -------- -------- -------- --------
                                 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                       <C>           <C>           <C>      <C>      <C>      <C>
INCOME STATEMENT DATA:
Net sales...............   $    60,606    $    84,968 $154,309 $167,778 $167,523 $190,288
Cost of sales, including
 occupancy expenses
 exclusive of
 depreciation (2).......        40,905         52,892   99,556  111,397  112,297  118,066
                           -----------    ----------- -------- -------- -------- --------
Gross income............        19,701         32,076   54,753   56,381   55,226   72,222
Selling, general and
 administrative expenses
 (3)....................        17,443         19,749   38,905   45,539   47,081   53,300
Depreciation and
 amortization...........         2,200          2,005    3,496    3,330    3,472    3,270
                           -----------    ----------- -------- -------- -------- --------
Operating income........            58         10,322   12,352    7,512    4,673   15,652
Interest expense, net...           259          1,200    3,051    2,539    2,034    1,235
                           -----------    ----------- -------- -------- -------- --------
Income (loss) before
 taxes, reorganization
 items and extraordinary
 items..................          (201)         9,122    9,301    4,973    2,639   14,417
Reorganization items....           507            --       --       --       --       --
Provision for income
 taxes..................           --           3,401    3,530    1,895    1,010    5,598
Extraordinary items.....         6,484            --       --       --       --       --
                           -----------    ----------- -------- -------- -------- --------
Net income..............   $     6,790    $     5,721 $  5,771 $  3,078 $  1,629 $  8,819
                           ===========    =========== ======== ======== ======== ========
Net income per share
 (4)....................   $       --     $      0.61 $   0.59 $   0.31 $   0.16 $   0.83
                           ===========    =========== ======== ======== ======== ========
Weighted average common
 and common equivalent
 shares outstanding.....           --           9,445    9,822    9,981   10,067   10,616
</TABLE>
 
                                       4
<PAGE>
 
<TABLE>
<CAPTION>
                          TWENTY-SIX WEEKS ENDED                 FISCAL YEAR
                          --------------------------   ----------------------------------
                          AUGUST 2,     JANUARY 30,
                           1992 (1)       1993 (1)      1993      1994     1995    1996
                          -----------   ------------   -------   -------  ------- -------
                               (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                       <C>           <C>            <C>       <C>      <C>     <C>
OPERATING DATA:
Gross income %..........          35.5%          33.6%    33.0%     38.0%
Operating income %......           8.0%           4.5%     2.8%      8.2%
Stores open at beginning
 of period..............           201            211      239       235
Stores opened during
 period.................            22             40       19        19
Stores closed during
 period.................           (12)           (12)     (23)      (31)
                           -----------    -----------  -------   -------
Stores open at end of
 period.................           211            239      235       223
                           ===========    ===========  =======   =======
Weighted average sales
 per store..............   $       748    $       740  $   683   $   845
Comparable store sales
 increase (decrease)
 (5)....................             3%             0%      (7%)      20%
Inventory turnover......           4.9x           4.6x     4.7x      5.1x
BALANCE SHEET DATA (AT
 END OF PERIOD):
Working capital.........   $     7,906    $    15,750  $24,603   $24,446  $24,481 $21,457
Total assets............        67,000         53,684   58,553    63,454   57,850  57,319
Long-term debt..........        29,670         27,025   26,290    21,970   17,640   1,930
Shareholders' equity....         1,575          7,296   15,096    19,890   22,904  36,911
</TABLE>
--------
(1) From February 1991 until the third quarter of fiscal 1992, the Company
    operated under Chapter 11 of the Bankruptcy Code. The Company emerged from
    bankruptcy upon the confirmation of its Plan of Reorganization (the
    "Plan"). In accordance with AICPA guidelines, the Company restated its
    balance sheet with the adoption of "fresh start" accounting to reflect the
    impact of the Plan as of August 2, 1992. A "black line" has been drawn
    between the pre- and post-emergence financial information delineating
    their non-comparability.
(2) Occupancy expenses include store level base rent, percentage rent and real
    estate taxes.
(3) Includes all other store level occupancy expenses not included in cost of
    sales.
(4) Net income per share and share data are not disclosed for the period prior
    to the twenty-six weeks ended January 30, 1993, due to significant changes
    in the capital structure as part of the Plan.
(5) Calculated using net sales of stores opened for at least a 12 month
    period.
 
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
 
  The following discussion should be read in conjunction with the Selected
Financial Data and the Consolidated Financial Statements and Notes thereto
appearing elsewhere herein.
 
OVERVIEW
 
  The Company was founded in 1952 and currently operates 221 stores in 26
states and the District of Columbia. Substantially all of the Company's stores
are operated under the Paul Harris name ("Paul Harris Stores"). Primarily as a
result of a very weak fourth quarter in fiscal 1990, the Company disposed of
slow-moving inventory at substantial markdowns, resulting in substantial
losses in both fiscal 1990 and fiscal 1991 and defaults under the Company's
debt agreements. On February 27, 1991, the Company and two subsidiaries filed
for protection from their creditors under Chapter 11 of the Bankruptcy Code.
The Company's Chapter 11 Plan was confirmed on August 31, 1992. Under the
Plan, liabilities subject to compromise were settled through initial and
deferred payments of cash, shares of Common Stock and $24.0 million aggregate
principal amount of 11.375% Notes due January 31, 2000 (the "11.375% Notes")
issued by the Company.
 
 
                                       5
<PAGE>
 
  In January 1995, the Board of Directors appointed Charlotte G. Fischer as
Chief Executive Officer. Ms. Fischer assembled a new senior management team
and took action to improve the Company's revenues and profitability. These
actions included: (i) remerchandising and expanding the product assortment to
better serve the Company's target customer; (ii) upgrading stores through new
fixtures and leasehold improvements; (iii) closing the Company's discount
store division, which had operated under "The $5-$10-$15-$20 Place" name (the
"$5-$20 Stores") and marketed off-priced apparel and close-out merchandise;
(iv) expanding sourcing to be more cost-effective and efficient; and (v)
improving inventory management.
 
  During fiscal 1995, the implementation of these new actions, particularly
the reduction of excess inventories and the phasing out of the $5-$20 Stores,
adversely affected operating results. Beginning in the third quarter of fiscal
1995, the Company's operating results began to recover as these actions began
to take effect. The Company reported record operating income for fiscal 1996.
In addition, the Company reduced its financial leverage by repaying $4.2
million of its 11.375% Notes in fiscal 1995 and the remaining $19.8 million in
fiscal 1996, three years ahead of schedule.
 
  In fiscal 1996, the Company opened 19 stores of which 18 were opened in the
second half of the year. The Company also opened a new format store in April
1996 and is currently operating seven new format stores. The new format stores
incorporate the latest version of the Company's store layout and fixture
package, larger dressing rooms, an expanded accessory department and, in some
cases, seating and children's play areas. The Company anticipates opening 30
net new stores in fiscal 1997 and 45 to 50 net new stores in fiscal 1998.
Approximately one-third of the stores to be opened in fiscal 1997 are expected
to be new format stores. The Company is also remodeling stores based largely
on the positive customer feedback and financial performance of its new format
stores. The Company remodeled 15 stores in fiscal 1996. The Company expects to
remodel 30 to 35 stores in fiscal 1997 and 80 to 100 stores in the three
fiscal years thereafter.
 
RESULTS OF OPERATIONS
 
  The following table sets forth certain income statement items and operating
data as a percentage of net sales.
 
<TABLE>
<CAPTION>
                                                              FISCAL YEAR
                                                           -------------------
                                                           1994   1995   1996
                                                           -----  -----  -----
   <S>                                                     <C>    <C>    <C>
   Net sales.............................................. 100.0% 100.0% 100.0%
   Cost of sales, including occupancy expenses exclusive
    of depreciation (1)...................................  66.4   67.0   62.0
                                                           -----  -----  -----
     Gross income.........................................  33.6   33.0   38.0
   Selling, general and administrative expenses (2).......  27.1   28.1   28.0
   Depreciation and amortization..........................   2.0    2.1    1.8
                                                           -----  -----  -----
     Operating income.....................................   4.5    2.8    8.2
   Interest expense, net..................................   1.5    1.2    0.7
                                                           -----  -----  -----
     Income before income taxes...........................   3.0    1.6    7.5
     Provision for income taxes...........................   1.2    0.6    2.9
                                                           -----  -----  -----
   Net income.............................................   1.8%   1.0%   4.6%
                                                           =====  =====  =====
</TABLE>
--------
(1) Occupancy expenses include store level base rent, percentage rent and real
    estate taxes.
(2) Includes all store level occupancy expenses not included in cost of sales.
 
 
                                       6
<PAGE>
 
FISCAL 1996 COMPARED TO FISCAL 1995
 
  The Company's net sales increased to $190.3 million in fiscal 1996 from
$167.5 million in fiscal 1995, an increase of $22.8 million or 13.6%. The
increase in net sales was primarily attributable to a 20% increase in
comparable store sales, which was partially offset by a decrease in the
average number of stores open during fiscal 1996. The increase in comparable
store sales in fiscal 1996 was primarily a result of an increase in consumer
demand generally and wider acceptance of the Company's product offering, as
reflected by a 22.5% increase in average customer transactions per store. The
Company experienced positive comparable store sales for each month of fiscal
1996, with increases of 10% or more in each of the last 11 months, including a
23% increase for December 1996. The Company operated 223 stores on February 1,
1997, compared to 235 stores on February 3, 1996. During fiscal 1996, the
Company opened 19 stores and closed 31 stores (excluding three $5-$20 Stores
converted to Paul Harris Stores).
 
  Gross income increased to $72.2 million in fiscal 1996 from $55.2 million in
fiscal 1995, an increase of $17.0 million or 30.8%. As a percentage of net
sales, gross income increased to 38.0% in fiscal 1996 from 33.0% in fiscal
1995. Gross income increased primarily due to the increase in net sales. Gross
income as a percentage of net sales increased as a result of a higher
percentage of lower cost merchandise from overseas sources and a growth in net
sales of accessories, which generally have higher gross margins than apparel.
 
  Selling, general and administrative expenses increased to $53.3 million in
fiscal 1996 from $47.1 million in fiscal 1995, an increase of $6.2 million or
13.2%. As a percentage of net sales, selling, general and administrative
expenses decreased to 28.0% in fiscal 1996 from 28.1% in fiscal 1995. Of the
$6.2 million increase, $3.7 million was attributable to increased incentive
compensation payable as a result of the Company's attainment of performance
targets set by the Board of Directors for net sales (for field personnel) and
pretax income (for headquarters personnel). The remaining $2.5 million
resulted from increases in payroll, credit card and other expenses.
 
  Depreciation and amortization decreased to $3.3 million in fiscal 1996 from
$3.5 million in fiscal 1995, a decrease of $202,000 or 5.8%. As a percentage
of net sales, depreciation and amortization decreased to 1.8% in fiscal 1996
from 2.1% in fiscal 1995.
 
  Operating income increased to $15.7 million in fiscal 1996 from $4.7 million
in fiscal 1995, an increase of $11.0 million or 234.9%. As a percentage of net
sales, operating income increased to 8.2% in fiscal 1996 from 2.8% in fiscal
1995.
 
  Interest expense, net, decreased to $1.2 million in fiscal 1996 from $2.0
million in fiscal 1995, a decrease of $799,000 or 39.3%. The decrease resulted
primarily from repayment of the 11.375% Notes.
 
  Provision for income taxes increased to $5.6 million in fiscal 1996 from
$1.0 million in fiscal 1995, an increase of $4.6 million, or 454.3%, primarily
because of the increase in income before income taxes. The Company's effective
income tax rate increased to 38.8% in fiscal 1996 from 38.3% in fiscal 1995.
The Company had approximately $3.4 million of federal income tax loss
carryforwards remaining available after the provision for income taxes for
fiscal 1996. Due to the utilization of federal and state income tax loss
carryforwards, the Company benefited in fiscal 1996 from a reduction of income
taxes payable (reflected as a credit to additional paid-in capital) of $5.0
million.
 
  As a result of all the above factors, the Company's net income increased to
$8.8 million in fiscal 1996 from $1.6 million in fiscal 1995, an increase of
$7.2 million, or 441.4%.
 
                                       7
<PAGE>
 
FISCAL 1995 COMPARED TO FISCAL 1994
 
  The Company's net sales decreased to $167.5 million in fiscal 1995 from
$167.8 million in fiscal 1994, a decrease of $255,000 or less than 1.0%. The
decrease in net sales was primarily attributable to a 7% decline in total
comparable store sales, which was partially offset by an increase in the
average number of stores open during fiscal 1995. The fiscal 1995 decline in
comparable store sales included a (i) 6% decline in comparable store sales for
the Paul Harris Stores due to fewer customers, fewer units sold per
transaction and a lower price per unit sold and (ii) an 18% decline in
comparable store sales for the $5-$20 Stores due to fewer customers and a
lower price per unit sold, partially offset by an increase in units sold per
transaction. The Company operated 235 stores on February 3, 1996, compared to
239 stores on January 28, 1995. During fiscal 1995, the Company opened 19
stores and closed 23 stores (excluding 15 $5-$20 Stores that were converted to
Paul Harris Stores).
 
  Gross income decreased to $55.2 million in fiscal 1995 from $56.4 million in
fiscal 1994, a decrease of $1.2 million or 2.0%. As a percentage of net sales,
gross income decreased to 33.0% in fiscal 1995 from 33.6% in fiscal 1994.
Gross income decreased due to the decrease in net sales, which was partially
offset by negotiated lower pricing on increased amounts of merchandise sourced
overseas.
 
  Selling, general, and administrative expenses increased to $47.1 million in
fiscal 1995 from $45.5 million in fiscal 1994, an increase of $1.6 million or
3.4%. As a percentage of net sales, selling, general and administrative
expenses increased to 28.1% in fiscal 1995 from 27.1% in fiscal 1994. Higher
common area maintenance and utility charges resulted in increased selling,
general and administrative expenses. Further, fiscal 1994 expenses were
reduced (relative to fiscal 1995) by a one-time curtailment gain, net of
current pension expense, of $428,000 that resulted from the Company's decision
to freeze its defined benefit pension plan.
 
  Depreciation and amortization increased to $3.5 million in fiscal 1995 from
$3.3 million in fiscal 1994, an increase of $142,000 or 4.3%. As a percentage
of net sales, depreciation and amortization increased to 2.1% in fiscal 1995
from 2.0% in fiscal 1994.
 
  Operating income decreased to $4.7 million in fiscal 1995 from $7.5 million
in fiscal 1994, a decrease of $2.8 million or 37.8%. As a percentage of net
sales, operating income decreased to 2.8% in fiscal 1995 from 4.5% in fiscal
1994.
 
  Interest expense, net, decreased to $2.0 million in fiscal 1995 from $2.5
million in fiscal 1994, a decrease of $505,000 or 19.9%. The decrease resulted
primarily from payment on the 11.375% Notes and interest income earned on
higher cash balances during fiscal 1995.
 
  Provision for income taxes decreased to $1.0 million in fiscal 1995 from
$1.9 million in fiscal 1994, a decrease of $885,000 or 46.7%, primarily
because of the decrease in income before income taxes. The Company's effective
income tax rate for fiscal 1995 was 38.3% as compared to 38.1% for fiscal
1994. The Company had approximately $18.2 million of federal income tax loss
carryforwards remaining available after the provision for income taxes for
fiscal 1995. Due to the utilization of federal and state income tax loss
carryforwards and recognition of prior and current years' state tax loss
carryforwards, the Company benefited in fiscal 1995 from a reduction of
federal income taxes payable (reflected as a credit to additional paid-in
capital) of $1.4 million (including $440,000 for recognition of current and
prior years' state tax loss carryforwards).
 
  As a result of all the above factors, the Company's net income decreased to
$1.6 million for fiscal 1995 from $3.1 million in fiscal 1994, a decrease of
$1.5 million or 47.1%.
 
SEASONALITY AND QUARTERLY RESULTS
 
  The Company's business, like that of most retailers, is subject to seasonal
influences. A significant portion of the Company's net sales and profits are
realized during the Company's fourth fiscal quarter, which includes the
holiday selling season. Results for any quarter are not necessarily indicative
of the results that may be achieved for a full fiscal year. Quarterly results
may fluctuate materially depending upon, among other things, the timing of new
store openings, net sales and profitability contributed by new stores,
increases or decreases in comparable store sales, adverse weather conditions,
shifts in the timing of certain holidays and promotions, and changes in the
Company's merchandise mix.
 
                                       8
<PAGE>
 
  The following table sets forth certain unaudited quarterly income statement
information for fiscal 1996 and fiscal 1995. The unaudited quarterly
information includes all normal recurring adjustments that management
considers necessary for a fair presentation of the information shown.
 
<TABLE>
<CAPTION>
                                                          FISCAL QUARTER ENDED
                          ----------------------------------------------------------------------------------------
                          APRIL 29,  JULY 29,   OCTOBER 28, FEBRUARY 3, MAY 4,   AUGUST 3, NOVEMBER 2, FEBRUARY 1,
                            1995       1995        1995        1996      1996      1996       1996        1997
                          ---------  --------   ----------- ----------- -------  --------- ----------- -----------
                                           (DOLLARS IN THOUSANDS, EXCEPT FOR PER SHARE DATA)
<S>                       <C>        <C>        <C>         <C>         <C>      <C>       <C>         <C>
Net sales...............   $34,801   $36,509      $36,880     $59,333   $39,639   $36,721    $45,413     $68,515
Gross income............    10,184    11,717       11,634      21,691    12,827    12,560     18,074      28,761
Operating income (loss).    (1,468)     (767)        (442)      7,350       610       404      3,427      11,211
Income (loss) before
 income taxes...........    (1,982)   (1,283)        (996)      6,900       232       107      3,058      11,020
Net income (loss).......   $(1,215)  $  (780)     $  (612)    $ 4,236   $   138   $    64    $ 1,821     $ 6,796
Net income (loss) per
 share..................   $ (0.12)  $ (0.08)     $ (0.06)    $  0.42   $  0.01   $  0.01    $  0.17     $  0.62
AS A PERCENTAGE OF NET SALES:
Net sales...............     100.0%    100.0%       100.0%      100.0%    100.0%    100.0%     100.0%      100.0%
Gross income............      29.3      32.1         31.5        36.6      32.4      34.2       39.8        42.0
Operating income (loss).      (4.2)     (2.1)        (1.2)       12.4       1.5       1.1        7.5        16.4
Income (loss) before
 income taxes...........      (5.7)     (3.5)        (2.7)       11.6       0.6       0.3        6.7        16.1
Net income (loss).......      (3.5%)    (2.1%)       (1.7%)       7.1%      0.3%      0.2%       4.0%        9.9%
</TABLE>
 
LIQUIDITY AND CAPITAL RESOURCES
 
  The Company's primary source of working capital consists of internally
generated cash and its secured, revolving credit facility which was recently
increased to $30.0 million. While this credit facility is principally intended
for letters of credit for import merchandise, the Company may make direct
borrowings of up to the maximum amount of the credit facility. The credit
facility expires June 30, 1999. The annual interest rate on borrowings
outstanding under the credit facility is a variable rate equal to the prime
rate of the Company's lender plus 0.25%. In addition, the letters of credit
carry an initial issuance fee plus a fee of 0.25% of the face amount of such
letters of credit. The credit facility also contains certain financial
covenants which set limits on tangible net worth and cash flow from
operations. The credit facility is secured by a security interest in the
Company's inventory, equipment, fixtures, cash and an assignment of leases. At
February 1, 1997, there were outstanding letters of credit issued in favor of
the Company under the credit facility in an aggregate amount of $9.6 million.
On the same date, there were no outstanding direct borrowings under the credit
facility.
 
  The Company made capital expenditures of approximately $5.2 million in
fiscal 1996, primarily for opening new stores (approximately $1.3 million) and
remodeling existing stores and updating store fixtures (approximately $2.8
million). The Company expects to make capital expenditures in fiscal 1997 of
approximately $12.5 million, primarily for the new point-of-sale system
(approximately $4.4 million), for opening new stores (approximately $2.9
million) and for remodeling existing stores (approximately $3.7 million). The
Company anticipates opening 30 net new stores and remodeling 30 to 35 stores
during fiscal 1997.
 
  Net cash flow from operating activities was $21.0 million in fiscal 1996.
Net cash outflow for financing activities aggregated $19.7 million in fiscal
1996, including the repayment of $19.9 million of long-term debt, primarily
the 11.375% Notes, net of $214,000 received from the sale of Common Stock in
connection with the exercise of stock options.
 
  Net cash flow from operating activities was $5.1 million in fiscal 1995. The
Company's investing activities in fiscal 1995 included the investment of $2.2
million in capital improvements. Net cash outflow for financing activities
aggregated $4.3 million in fiscal 1995 and was attributable to the repayment
of $4.3 million of long-term debt, primarily the 11.375% Notes.
 
  Cash and cash equivalents decreased to $16.0 million at the end of fiscal
1996 from $19.9 million at the beginning of fiscal 1996, a decrease of $3.9
million or 19.5%.
 
  Management believes that the net proceeds to the Company from the Offering
together with cash generated from operations and borrowings under the
Company's credit facility, if any, will be sufficient to meet the Company's
working capital and capital expenditure needs in the foreseeable future.
 
                                       9
<PAGE>
 
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
 
  The information required by this item is presented under Item 14 of this
report.
 
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
 
  There have been no changes in or disagreements with the Company's independent
accountants on accounting or financial disclosures.
 
                                    PART III
 
  The information required by this Part III (Items 10, 11, 12, and 13) is
incorporated herein by reference from the registrant's definitive Proxy
Statement for the Annual Meeting of the Shareholders to be filed with the
Commission pursuant to Regulation 14A.
 
                                       10
<PAGE>
 
                                    PART IV
 
ITEM 14. FINANCIAL STATEMENTS, FINANCIAL STATEMENT SCHEDULES, EXHIBITS AND
REPORTS ON FORM 8-K
 
  (a) (1) Financial Statements
 
<TABLE>
<CAPTION>
                                                                        PAGE NO.
                                                                        --------
     <S>                                                                <C>
     Consolidated Balance Sheets--As of February 3, 1996 and February
      1, 1997.........................................................     12
     Consolidated Statements of Income--for Fiscal 1994, Fiscal 1995
      and Fiscal 1996.................................................     13
     Consolidated Statements of Cash Flows--for Fiscal 1994, Fiscal
      1995 and Fiscal 1996............................................     14
     Consolidated Statements of Shareholders' Equity--for Fiscal 1994,
      Fiscal 1995 and Fiscal 1996.....................................     15
     Notes to Financial Statements....................................     16
     Report of Independent Accountants................................     26
</TABLE>
 
  (a) (2) Financial Statement Schedules
 
    Not applicable.
 
  (a) (3) Exhibits
 
    The Exhibit Index that appears on page 28 is hereby incorporated by
  reference in response to this item.
 
  (b) Reports on Form 8-K
 
    None.
 
                                       11
<PAGE>
 
                   PAUL HARRIS STORES, INC. AND SUBSIDIARIES
 
                          CONSOLIDATED BALANCE SHEETS
 
<TABLE>
<CAPTION>
                                                        FEBRUARY 3, FEBRUARY 1,
                                                           1996        1997
                                                        ----------- -----------
                                                            (IN THOUSANDS)
<S>                                                     <C>         <C>
ASSETS
Current assets
  Cash and cash equivalents............................   $19,886     $16,001
  Merchandise inventories..............................    17,645      19,759
  Other receivables....................................       539         861
  Prepaid expenses.....................................     1,013         836
                                                          -------     -------
    Total current assets...............................    39,083      37,457
                                                          -------     -------
Property, fixtures and equipment
  Land, building and improvements......................     5,715       5,787
  Store fixtures and equipment.........................    11,575      14,067
  Leasehold improvements and other.....................    11,389      12,567
                                                          -------     -------
                                                           28,679      32,421
  Less accumulated depreciation and amortization.......   (10,785)    (13,315)
                                                          -------     -------
    Property, fixtures and equipment, net..............    17,894      19,106
Other assets...........................................       873         756
                                                          -------     -------
                                                          $57,850     $57,319
                                                          =======     =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
  Accounts payable.....................................   $ 6,012     $ 8,515
  Compensation and related taxes.......................       778       3,774
  Income taxes payable.................................        45          37
  Other accrued expenses...............................     3,447       3,554
  Current maturities of long-term debt.................     4,320         120
                                                          -------     -------
    Total current liabilities..........................    14,602      16,000
                                                          -------     -------
Long-term debt.........................................    17,640       1,930
Other non-current liabilities..........................     2,704       2,478
Commitments and contingent liabilities (see Note 5)....       --          --
Shareholders' equity
  Preferred stock (no par value)
  Authorized 1,000 shares; none issued
  Common stock (no par value)
  Authorized 20,000 shares; issued and outstanding
   10,115 and 10,019, respectively.....................     1,716       1,930
  Additional paid-in capital...........................     4,989       9,963
  Retained earnings....................................    16,199      25,018
                                                          -------     -------
    Total shareholders' equity.........................    22,904      36,911
                                                          -------     -------
                                                          $57,850     $57,319
                                                          =======     =======
</TABLE>
 
         See accompanying "Notes To Consolidated Financial Statements".
 
                                       12
<PAGE>
 
                   PAUL HARRIS STORES, INC. AND SUBSIDIARIES
 
                       CONSOLIDATED STATEMENTS OF INCOME
 
<TABLE>
<CAPTION>
                                               FOR THE     FOR THE     FOR THE
                                              FIFTY-TWO  FIFTY-THREE  FIFTY-TWO
                                             WEEKS ENDED WEEKS ENDED WEEKS ENDED
                                             JANUARY 28, FEBRUARY 3, FEBRUARY 1,
                                                1995        1996        1997
                                             ----------- ----------- -----------
                                               (IN THOUSANDS, EXCEPT PER SHARE
                                                            DATA)
<S>                                          <C>         <C>         <C>
Net sales..................................   $167,778    $167,523    $190,288
Cost of sales, including occupancy expenses
 exclusive of depreciation.................    111,397     112,297     118,066
                                              --------    --------    --------
Gross income...............................     56,381      55,226      72,222
Selling, general and administrative
 expenses..................................     45,539      47,081      53,300
Depreciation and amortization..............      3,330       3,472       3,270
Interest expense, net......................      2,539       2,034       1,235
                                              --------    --------    --------
Income before income taxes.................      4,973       2,639      14,417
Provision for income taxes.................      1,895       1,010       5,598
                                              --------    --------    --------
Net income.................................   $  3,078    $  1,629    $  8,819
                                              ========    ========    ========
Net income per common share................   $    .31    $    .16    $    .83
                                              ========    ========    ========
Weighted average number of shares and
 share equivalents outstanding.............      9,981      10,067      10,616
                                              ========    ========    ========
</TABLE>
 
 
 
 
         See accompanying "Notes To Consolidated Financial Statements".
 
                                       13
<PAGE>
 
                   PAUL HARRIS STORES, INC. AND SUBSIDIARIES
 
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
 
<TABLE>
<CAPTION>
                                             FOR THE     FOR THE     FOR THE
                                            FIFTY-TWO  FIFTY-THREE  FIFTY-TWO
                                           WEEKS ENDED WEEKS ENDED WEEKS ENDED
                                           JANUARY 28, FEBRUARY 3, FEBRUARY 1,
                                              1995        1996        1997
                                           ----------- ----------- -----------
                                                     (IN THOUSANDS)
<S>                                        <C>         <C>         <C>
Cash flow from operating activities:
Net income................................   $ 3,078     $ 1,629    $  8,819
Adjustments to reconcile earnings to cash
 provided:
  Depreciation and amortization...........     3,330       3,472       3,270
  Net loss on disposal of assets..........       328         169         560
  Utilization of net operating loss
   carryforward...........................     1,629       1,353       4,974
  (Increase) decrease in current assets:
    Merchandise inventories...............      (530)      1,922      (2,114)
    Other receivables.....................       350         410        (322)
    Prepaid expenses......................       (41)          3         177
  Increase (decrease) in current
   liabilities:
    Accounts payable......................     1,653      (1,595)      2,503
    Compensation and related taxes........       (33)       (604)      2,996
    Income taxes payable..................        25        (371)         (8)
    Other accrued expenses................      (800)     (1,718)        107
  Other...................................      (422)        412          79
                                             -------     -------    --------
Net cash flow from operating activities...     8,567       5,082      21,041
                                             -------     -------    --------
Net cash flow from investing activities:
  Additions to fixed assets...............    (3,781)     (2,247)     (5,230)
                                             -------     -------    --------
Cash flow from financing activities:
  Repayment of long-term debt.............      (737)     (4,330)    (19,910)
  Proceeds from sale of common stock......        87          32         214
                                             -------     -------    --------
Net cash flow from financing activities...      (650)     (4,298)    (19,696)
                                             -------     -------    --------
                                             $ 4,136     $(1,463)   $ (3,885)
                                             =======     =======    ========
Cash and cash equivalents
  At beginning of period..................   $17,213     $21,349    $ 19,886
  At end of period........................    21,349      19,886      16,001
                                             -------     -------    --------
                                             $ 4,136     $(1,463)   $ (3,885)
                                             =======     =======    ========
Supplemental disclosures of cash flow
 information:
  Cash paid during the period for
   interest...............................   $ 3,122     $ 4,321    $  2,188
                                             =======     =======    ========
  Cash paid during the period for income
  taxes...................................   $   119     $    11    $    632
                                             =======     =======    ========
</TABLE>
 
         See accompanying "Notes To Consolidated Financial Statements".
 
                                       14
<PAGE>
 
                   PAUL HARRIS STORES, INC. AND SUBSIDIARIES
 
                CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
 
<TABLE>
<CAPTION>
                           COMMON STOCK  ADDITIONAL
                           -------------  PAID-IN   RETAINED
                           SHARES AMOUNT  CAPITAL   EARNINGS
                           ------ ------ ---------- --------
                                    (IN THOUSANDS)
<S>                        <C>    <C>    <C>        <C>
Balance as of January 29,
 1994.....................  9,662 $1,597   $2,007   $11,492
  Issuance of stock
   grants.................    301    --       --        --
  Exercise of stock
   options................     35     87      --        --
  Benefit of net operating
   loss carryforward......    --     --     1,629       --
  Net income for fiscal
   year 1994..............    --     --       --      3,078
                           ------ ------   ------   -------
Balance as of January 28,
 1995.....................  9,998  1,684    3,636    14,570
  Exercise of stock
   options................     21     32      --        --
  Benefit of net operating
   loss carryforward......    --     --     1,353       --
  Net income for fiscal
   year 1995..............    --     --       --      1,629
                           ------ ------   ------   -------
Balance as of February 3,
 1996..................... 10,019  1,716    4,989    16,199
  Exercise of stock
   options................     96    214      --        --
  Benefit of net operating
   loss carryforward......    --     --     4,974       --
  Net income for fiscal
   year 1996..............    --     --       --      8,819
                           ------ ------   ------   -------
Balance as of February 1,
 1997..................... 10,115 $1,930   $9,963   $25,018
                           ====== ======   ======   =======
</TABLE>
 
 
 
 
         See accompanying "Notes To Consolidated Financial Statements".
 
                                       15
<PAGE>
 
                  PAUL HARRIS STORES, INC., AND SUBSIDIARIES
 
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
 Nature of Business
 
  Paul Harris Stores, Inc. (the "Company") is a specialty retailer of
moderately-priced sportswear and accessories sold under the Paul Harris
Design, Paul Harris Denim and PHD brand names. Stores are located primarily in
regional enclosed shopping malls and, to a lesser extent, strip shopping
centers, with the greatest concentration of stores in the Midwest.
 
 Definition of Fiscal Year
 
  The Company's fiscal year ends on the Saturday closest to the last day of
January. Fiscal 1995 included 53 weeks. Fiscal 1996 and 1994 were 52 weeks
each.
 
 Principles of Consolidation
 
  The consolidated financial statements include the accounts of Paul Harris
Stores, Inc. and its wholly-owned subsidiaries. All significant intercompany
balances and transactions are eliminated in consolidation. Certain amounts in
the prior year have been reclassified to conform to the current year
presentation.
 
 Management's Use of Estimates
 
  The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and the
disclosure of contingent assets and liabilities at the date of the financial
statements and reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates.
 
 Fair Value of Financial Instruments
 
  Management has estimated that the carrying value of cash and cash
equivalents, receivables, prepaid expenses and trade accounts payable
approximates their fair value due to the relatively short period of time until
expected realization. Management has estimated the fair value of long-term
debt using discounted cash flow analyses, based on the Company's current
expected borrowing rates for similar types of borrowing arrangements.
 
 Property, Fixtures and Equipment
 
  Property, fixtures and equipment are recorded at cost. Leasehold
improvements, store fixtures and equipment, net of accumulated depreciation,
are written off for closed stores. Depreciation is computed using the
straight-line method over the estimated useful lives of the assets, which are
as follows: Buildings and improvements 15-40 years; Store fixtures and
equipment 3-10 years; Leasehold improvements 1-15 years.
 
 Cash and Cash Equivalents
 
  Cash equivalents are highly liquid investments with a maturity of less than
three months (primarily money market funds). Investment income is recognized
when earned.
 
 Merchandise Inventories
 
  Inventories of merchandise on hand are valued at the lower of cost or market
as determined by the first-in, first-out ("FIFO") retail inventory method,
which approximates FIFO cost.
 
                                      16
<PAGE>
 
                  PAUL HARRIS STORES, INC., AND SUBSIDIARIES
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
 Net Income Per Share
 
  Net income per share of common stock is based on the weighted average number
of common and dilutive common equivalent shares outstanding.
 
 Income Taxes
 
  Income taxes have been provided in accordance with Statement of Financial
Accounting Standards No. 109 (SFAS 109), "Accounting for Income Taxes". SFAS
109 is an asset and liability approach which requires the recognition of
deferred tax liabilities and assets for the expected future tax consequences
of temporary differences, based on current tax rates, between the financial
reporting bases and tax bases of assets and liabilities.
 
 Stock Based Compensation
 
  The Company has elected to continue following the existing accounting rules
for stock options as contained in the Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" (APB Opinion No. 25).
 
NOTE 2. LONG-TERM DEBT AND CREDIT ARRANGEMENTS
 
  The Company has entered into an agreement with a financial institution for a
revolving credit facility. This agreement was modified as of May 8, 1996 to
increase the line of credit facility from $13.5 million to $20 million and
extend the term to June 30, 1997. The financial institution has agreed to make
revolving loans and to issue letters of credit in amounts not to exceed $20
million, with the direct borrowings limited to $10 million. The Company made
no direct borrowings during fiscal 1996. Letters of credit outstanding as of
February 1, 1997 were $9.6 million. The annual interest rate on the direct
borrowings is a variable rate equal to the prime rate of the bank plus 1
percent. The letters of credit carry an initial issuance fee plus negotiation
fees of three eighths of a percent (0.375%) of the face amount of each letter
of credit. Also, during January 1994, the Company entered into a term loan
(mortgage) with the same financial institution for $2.4 million with monthly
principal payments of $10,000 plus interest at 7.84% per annum. The balance of
this term loan (mortgage) is due in full February 1999 and is secured by the
land and buildings of the Company. The revolving credit facility contains
several covenants which set limits on indebtedness, tangible net worth, cash
balances, cash flow from operations, capital expenditures, liquid assets and
also restrict dividends. The Company is also required to maintain all of its
primary operating accounts with this institution. The revolving credit
facility is secured by the Company's inventory, equipment, fixtures, cash and
assignment of leases.
 
  On September 15, 1992 the Company issued notes in an aggregate principal
amount of $24 million bearing interest of 11.375% per annum, payable semi-
annually (the "11.375% Notes"). The principal amount of the 11.375% Notes were
required to be redeemed pro rata in eight equal installments of $2.1 million
payable on each January 31 and July 31 commencing with July 31, 1995 and
ending with January 31, 1999 and the final two installments of $3.6 million on
July 31, 1999 and January 31, 2000. The Indenture relating to the 11.375%
Notes also contained several covenants relating to certain operational and
financial requirements. The Company repaid the $19,800,000 balance outstanding
on these 11.375% Notes at February 3, 1996 (current and long-term portion) in
fiscal 1996.
 
                                      17
<PAGE>
 
                   PAUL HARRIS STORES, INC., AND SUBSIDIARIES
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  Long-term debt, exclusive of amounts maturing in one year, is summarized
below:
 
<TABLE>
<CAPTION>
                                                        FEBRUARY 3,  FEBRUARY
                                                           1996      1, 1997
                                                        ----------- ----------
      <S>                                               <C>         <C>
      Notes payable in semi-annual payments from July
       31, 1995 through January 31, 2000 plus interest
       payable at the rate of 11.375% per annum.......  $15,600,000        --
      Term loan (mortgage) on land and buildings
       payable in monthly payments through February
       1999 including interest at the fixed rate of
       7.84% per year.................................    2,040,000 $1,930,000
                                                        ----------- ----------
        Total long-term debt..........................  $17,640,000 $1,930,000
                                                        =========== ==========
</TABLE>
 
  The term loan (mortgage) has covenants restricting indebtedness, tangible net
worth, cash balances, cash flow from operations, capital expenditures, liquid
assets and also restricts dividends. The book value of assets subject to this
lien as of February 1, 1997 was $4,486,000.
 
  Scheduled maturities of long-term debt over the next three fiscal years are:
$120,000 in each of fiscal 1997 and 1998 and $1,810,000 in fiscal 1999.
 
  The estimated fair market value of the term loan (mortgage) was $2,012,000
and $1,915,000 as of February 3, 1996 and February 1, 1997, respectively. The
estimated fair market value of the 11.375% Notes was $15,897,000 as of February
3, 1996.
 
NOTE 3. SHAREHOLDERS' EQUITY
 
  All outstanding shares are shares of voting common stock with the exception
of 3,013,039 shares of non-voting common stock held by a single institutional
holder. This holder may request to convert the non-voting common stock to
voting common stock on a share for share basis upon the occurrence of certain
events specified in the Company's Amended and Restated Articles of
Incorporation, including the sale of shares of common stock by the Company in
an underwritten public offering.
 
  Pursuant to the Company's confirmed Plan of Reorganization (the "Plan"),
certain of the shares of Common Stock and the 11.375% Notes to be distributed
under the Plan were to be distributed upon final resolution of all claims to
the holders of allowed claims on a pro rata basis. On May 10, 1996 the Company
completed the distribution. Of the 305,723 shares of Common Stock required to
be distributed, 162,127 shares were issued as Non-voting Common Stock. All of
these shares of Common Stock to be distributed under the Plan have been
reflected in the Company's financial statements as issued and outstanding since
the confirmation of the Plan in 1992.
 
  The Company and a major shareholder are parties to a stock transfer agreement
whereby under specific guidelines, at the option of the shareholder's estate,
the Company must repurchase shares of the Company's stock from the immediate
family of the shareholder upon his death, to the extent that the Company
receives net proceeds from life insurance policies held by the Company on the
life of that shareholder. As of February 1, 1997, the Company owns and is the
beneficiary of approximately $225,000 in face amount of life insurance on the
life of the shareholder.
 
 
                                       18
<PAGE>
 
                  PAUL HARRIS STORES, INC., AND SUBSIDIARIES
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
NOTE 4. INCOME TAXES
 
  The provision for income taxes was as follows:
 
<TABLE>
<CAPTION>
                                                  FISCAL     FISCAL     FISCAL
                                                   1994       1995       1996
                                                ---------- ---------- ----------
      <S>                                       <C>        <C>        <C>
      Current tax expense:
        Federal................................ $   80,000 $   72,000 $  293,000
        State..................................     67,000     25,000    325,000
      Deferred tax expense:
        Federal................................  1,519,000    780,000  4,431,000
        State..................................    229,000    133,000    549,000
                                                ---------- ---------- ----------
      Income tax provision..................... $1,895,000 $1,010,000 $5,598,000
                                                ========== ========== ==========
</TABLE>
 
  The provision for income taxes differs from the amount of income tax
determined by applying the U.S. statutory Federal income tax rate to pretax
income from continuing operations as a result of the following differences:
 
<TABLE>
<CAPTION>
                                                FISCAL      FISCAL     FISCAL
                                                 1994        1995       1996
                                              ----------  ---------- ----------
      <S>                                     <C>         <C>        <C>
      Statutory U.S. taxes................... $1,703,000  $  897,000 $4,945,000
      State and local taxes, net
       of federal benefit....................    196,000     104,000    574,000
      Other..................................     (4,000)      9,000     79,000
                                              ----------  ---------- ----------
                                              $1,895,000  $1,010,000 $5,598,000
                                              ==========  ========== ==========
</TABLE>
 
  Deferred tax assets (liabilities) are comprised of the following:
 
<TABLE>
<CAPTION>
                                                       FEBRUARY 3,  FEBRUARY 1,
                                                          1996         1997
                                                       -----------  -----------
      <S>                                              <C>          <C>
      Deferred rent................................... $   991,000  $   943,000
      Depreciation....................................      10,000      465,000
      Minimum tax credit..............................     671,000      958,000
      Loss carryforwards..............................   6,925,000    1,292,000
      Other...........................................     181,000      162,000
                                                       -----------  -----------
        Gross deferred tax assets.....................   8,778,000    3,820,000
                                                       -----------  -----------
      Pre-paid pension................................    (162,000)    (162,000)
      Other...........................................    (193,000)    (209,000)
                                                       -----------  -----------
        Gross deferred tax liabilities................    (355,000)    (371,000)
                                                       -----------  -----------
      Valuation allowance.............................  (8,423,000)  (3,449,000)
                                                       -----------  -----------
      Net deferred taxes.............................. $       --   $       --
                                                       ===========  ===========
</TABLE>
 
  In accordance with SFAS 109, deferred tax assets are established to give
recognition to prior loss carryforwards. Additionally, deferred assets and
liabilities are established related to normal temporary differences. Due to
the seasonal nature of the Company's business (and its historical reliance on
fourth quarter results), the volatility of trends in women's apparel, and the
relatively short amount of time that has passed since the Company's emergence
from Chapter 11, the net deferred tax assets have been reduced by a valuation
allowance until realization of those assets is reasonably assured. As required
by SOP 90-7, any utilization of net operating loss carryforwards results in an
increase in additional paid-in capital. Approximately $3,404,000 of the
Company's loss carryforwards remain at February 1, 1997 which, if unused, will
expire in fiscal 2006 and 2007.
 
                                      19
<PAGE>
 
                   PAUL HARRIS STORES, INC., AND SUBSIDIARIES
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
NOTE 5. COMMITMENTS AND CONTINGENT LIABILITIES
 
  All stores are leased under operating leases which expire on various dates
through fiscal 2007. Approximately 73% of the store leases contain rent
escalation clauses. Expense related to these leases is recorded on a straight-
line basis. The Company also leases automobiles under operating leases with
terms of 24 to 36 months. Following is a summary of future minimum rental
payments required by operating leases at February 1, 1997:
 
<TABLE>
<CAPTION>
           PAYABLE
              IN                              MINIMUM RENTAL
            FISCAL                               PAYMENTS
             YEAR                            STORES AND OTHER
           -------                           ----------------
           <S>                               <C>
           1997.............................   $11,728,000
           1998.............................    10,200,000
           1999.............................     8,273,000
           2000.............................     7,495,000
           2001.............................     6,814,000
           Later Years......................    19,230,000
                                               -----------
             Total..........................   $63,740,000
                                               ===========
</TABLE>
 
  In addition to minimum lease payments, the Company may be obligated to pay
other contingent amounts: (1) Some store leases provide for additional rentals
if sales exceed specified amounts. These additional rentals approximated 2% of
rental expense for fiscal 1996, 1% for fiscal 1995, and 1% for fiscal 1994; (2)
the Company has a number of leases which are paid based on a percentage of
monthly sales dollars. Such leases accounted for 13% of rental expense in
fiscal 1996, 10% for fiscal 1995 and 6% for fiscal 1994; (3) Under certain
store leases, additional payments are required of the Company for real estate
taxes, utilities and other expenses. Rental expense under store leases for
these items aggregated $15,089,000 for fiscal 1996, $14,904,000 for fiscal 1995
and $13,026,000 for fiscal 1994.
 
  In January 1997 the Company entered into various agreements for the purchase
of new "point of sale" hardware and related software in an aggregate amount of
approximately $4,900,000.
 
  In December 1993 the Company contracted with a local printing company to
provide the Company with printing services and has agreed to purchase annual
print volume of $500,000 per year for a period of five (5) years.
 
NOTE 6. RETIREMENT PLAN
 
  The Company has a non-contributory defined benefit pension plan covering
substantially all full-time employees. The benefits are based on years of
service and the average annual compensation for the employee's five highest
consecutive years of employment with the Company. Until December 31, 1994 the
Company's funding policy was to contribute annually the maximum amount that can
be deducted for federal income tax purposes. Contributions were intended to
provide for current service and for any unfunded projected future benefit
obligation over a reasonable period.
 
  The Company ceased benefit accrual under the defined benefit plan effective
December 31, 1994. No new employees will be able to enter into the plan.
Participants will maintain benefits accrued through December 31, 1994, but will
not accrue any benefit for service or compensation in future years. As a result
of freezing the accrued benefits, a curtailment as described under Statement of
Accounting Financial Standards No. 88 (SFAS 88) "Employers' Accounting for
Settlements and Curtailments of Defined Benefit Pension Plans and for
Termination Benefits" occurred in fiscal 1994. The curtailment gain of $572,000
is included in the Company's results of operations for fiscal 1994, net of
fiscal 1994 pension expense of $144,000.
 
                                       20
<PAGE>
 
                  PAUL HARRIS STORES, INC., AND SUBSIDIARIES
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  Net pension expense (income) for fiscal 1994, 1995 and 1996 includes the
following components:
 
<TABLE>
<CAPTION>
                                              FISCAL     FISCAL     FISCAL
                                               1994       1995       1996
                                             ---------  ---------  ---------
      <S>                                    <C>        <C>        <C>
      Service expense--benefits earned
       during the year...................... $ 211,000  $     --   $     --
      Interest expense on projected benefit
       obligation...........................   156,000    106,000     91,000
      Actual loss (gain) on plan assets.....   266,000   (332,000)  (278,000)
      Net amortization and deferral.........  (489,000)   210,000    133,000
                                             ---------  ---------  ---------
      Net pension expense (income).......... $ 144,000  $ (16,000)  $(54,000)
                                             =========  =========  =========
</TABLE>
 
  The funded status of the plan is as follows:
 
<TABLE>
<CAPTION>
                                                        FEBRUARY 3, FEBRUARY 1,
                                                           1996        1997
                                                        ----------- -----------
      <S>                                               <C>         <C>
      Vested........................................... $1,201,000  $1,173,000
      Nonvested........................................     63,000      32,000
                                                        ----------  ----------
      Accumulated benefit obligation...................  1,264,000   1,205,000
      Projected impact of future salary increases......        --          --
                                                        ----------  ----------
      Projected benefit obligation.....................  1,264,000   1,205,000
      Market value of plan assets available for
       benefits........................................  1,825,000   1,869,000
                                                        ----------  ----------
      Funded position.................................. $  561,000  $  664,000
                                                        ==========  ==========
      Consisting of:
        Unrecognized loss (gain) on assets............. $  107,000  $  131,000
        Prepaid asset..................................    454,000     533,000
                                                        ----------  ----------
      Funded position.................................. $  561,000  $  664,000
                                                        ==========  ==========
</TABLE>
 
  The assets of the plan, comprised almost entirely of U.S. Government
obligations and high grade stocks and bonds, included 6,363 shares of the
Company's common stock as of January 28, 1995, February 3, 1996, and February
1, 1997.
 
  The weighted-average discount rates utilized in determining the actuarial
present value of the projected benefit obligations were 7% and 7.25% for
fiscal 1995 and 1996, respectively. The expected long-term rate of return on
assets was 8% in fiscal 1995 and 1996.
 
NOTE 7. EMPLOYEE BENEFIT PLANS
 
 Stock Option Plans
 
  The Company has options outstanding under its 1992 Non-Qualified Stock
Option Plan (the "1992 Plan") and pursuant to an agreement with its Chief
Executive Officer. In addition, the Board of Directors has approved two other
stock based compensation plans--the 1996 Stock Option and Incentive Plan (the
"1996 Plan") and the Outside Directors Stock Option Plan (the "Directors
Plan"). Both the adoption of the 1996 Plan and the Directors Plan and the
options granted under such plans are subject to shareholders approval at the
1997 annual meeting of shareholders.
 
  The Company has elected to continue following the existing accounting rules
for stock options as contained in APB Opinion No. 25 as they relate to the
recognition of compensation expense in the Statement of Operations.
Accordingly, no compensation expense has been recognized in the results of
operations of the Company.
 
                                      21
<PAGE>
 
                   PAUL HARRIS STORES, INC., AND SUBSIDIARIES
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  The 1992 Plan provides additional incentive to key employees and persons who
are not employees of the Company but whose efforts are expected to be of
substantial benefit to the Company. The 1992 Plan provides that a Committee,
appointed by the Board of Directors, may from time to time grant to employees
of the Company and to persons who are not employees of the Company, stock
options to purchase shares of common stock of the Company. The Committee is
authorized to issue options to purchase up to 900,000 shares of common stock of
the Company under the 1992 Plan. In addition, grants of options were made to
non-employee directors in 1992, 1993 and 1994. As of February 1, 1997 virtually
all options under the 1992 Plan have been granted at an exercise price ranging
from $1.31 to $17.50 per share.
 
  The 1996 Plan provides a means for attracting and retaining officers and key
employees of the Company. The 1996 Plan is to be administered by a Committee
appointed by the Board of Directors. The maximum number of shares of common
stock of the Company that may be granted under the 1996 Plan is 1,000,000
shares. Grants may be in the form of stock options, restricted stock, or stock
appreciation rights. Stock options granted under the 1996 Plan may be in the
form of non-qualified stock options or incentive stock options. As of February
1, 1997 options to purchase 76,100 shares of common stock of the Company have
been granted at an exercise price of $17.00 per share.
 
  Generally, options may be granted under the above plans at any time prior to
the tenth anniversary of their respective effective dates. Options awarded to
date generally vest in equal amounts from one to three years and expire ten
years from grant date under these plans. Generally the price of the options may
be tendered in cash or in shares of common stock valued at fair market value on
the date of exercise for each plan.
 
  The Directors Plan encourages increased common stock ownership of the Company
by members of the Board of Directors who are not employees of the Company. The
Directors Plan reserves for the issuance of 100,000 shares of common stock of
the Company. Each eligible director is automatically granted an option to
purchase 3,000 shares of stock in the month following each annual meeting of
shareholders held after June 19, 1996. In addition, an eligible director who
did not receive options under the Company's 1992 Plan is entitled to receive
options to purchase 5,000 shares of common stock in the month following the
month in which he or she is first elected as a director. As of February 1,
1997, options to purchase 15,000 shares of common stock of the Company have
been granted under this plan.
 
  Pursuant to an employment agreement by and between the Company and Ms.
Fischer the compensation committee granted a non-transferable option to
purchase 350,000 shares of the common stock of the Company at an exercise price
of $5.68 per share.
 
                                       22
<PAGE>
 
                  PAUL HARRIS STORES, INC., AND SUBSIDIARIES
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  The following table summarizes options outstanding and available for
issuance under these plans and arrangements:
 
<TABLE>
<CAPTION>
                                              FISCAL     FISCAL      FISCAL
                                               1994       1995        1996
                                             ---------  ---------  ----------
      <S>                                    <C>        <C>        <C>
      Options outstanding at beginning of
       year.................................   553,000    883,000     904,000
        Options granted.....................   572,000    385,000     444,000
        Options exercised...................   (35,000)   (21,000)    (96,000)
        Options expired.....................  (207,000)  (343,000)    (82,000)
                                             ---------  ---------  ----------
      Options outstanding at year-end.......   883,000    904,000   1,170,000
                                             =========  =========  ==========
      Options exercisable at year-end.......   429,000    684,000     657,000
                                             =========  =========  ==========
      Options available for grant at year-
       end..................................   324,000    282,000   1,020,000
                                             =========  =========  ==========
      Weighted average option prices per
       share:
        At beginning of year................ $    3.62  $    4.68  $     3.47
        Granted.............................      5.32       1.50       10.39
        Exercised...........................      2.52       1.50        2.23
        Expired.............................      3.60       4.32        2.66
        Outstanding at year-end.............      4.68       3.47        6.30
        Exercisable at year-end............. $    3.41  $    3.83  $     5.75
</TABLE>
 
  For the weighted average fair value of options granted during the year, the
fair value of each option granted is estimated on the date of the grant using
the Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants in 1995 and 1996, respectively: dividend yield of
0.0 and 0.0 percent; expected volatility of 37.8 and 41.4 percent; risk free
interest rates of 6.1 and 6.3 percent; and expected lives of 4.4 and 7.3
years.
 
<TABLE>
<CAPTION>
                                                                 FISCAL FISCAL
                                                                  1995   1996
                                                                 ------ ------
      <S>                                                        <C>    <C>
      Weighted-average fair value per option of options granted
       during the year.......................................... $0.54  $5.17
</TABLE>
 
  Had compensation expense for the Company's stock options been determined
based on the fair value at the grant dates for the awards under those plans
consistent with the method of Statement of Financial Accounting Standards No.
123, "Accounting for Stock-Based Compensation," the Company's net income and
earnings per share would have been reduced to the pro forma amounts indicated
below:
 
<TABLE>
<CAPTION>
                                                                  FISCAL FISCAL
                                                                   1995   1996
                                                                  ------ ------
      <S>                                                         <C>    <C>
      Net income (in thousands)
        As reported.............................................. $1,629 $8,819
        Pro forma................................................ $1,596 $7,863
      Net income per common share
        As reported.............................................. $  .16 $  .83
        Pro forma................................................ $  .16 $  .74
</TABLE>
 
  Compensation expense based on the fair value of options granted prior to
January 29, 1995 were not included in the preceding pro forma calculations.
Therefore, the resulting pro forma compensation expense may not be
representative of that to be expected in future years.
 
                                      23
<PAGE>
 
                  PAUL HARRIS STORES, INC., AND SUBSIDIARIES
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  The following table summarizes information about stock options outstanding
and options exercisable at February 1, 1997.
 
<TABLE>
<CAPTION>
                         OPTIONS OUTSTANDING         OPTIONS EXERCISABLE
                  --------------------------------- ---------------------
                    NUMBER     WEIGHTED-  WEIGHTED-   NUMBER    WEIGHTED-
     RANGE OF     OUTSTANDING   AVERAGE    AVERAGE  EXERCISABLE  AVERAGE
     EXERCISE     AT FEB. 1,  CONTRACTUAL EXERCISE  AT FEB. 1,  EXERCISE
      PRICES         1997        LIFE       PRICE      1997       PRICE
     --------     ----------- ----------- --------- ----------- ---------
   <S>            <C>         <C>         <C>       <C>         <C>
          $ 1.31    221,500      8.70      $ 1.31     117,900    $ 1.31
   $ 1.32-$ 3.99    243,500      8.36        1.96     157,900      2.02
   $ 4.00-$ 5.99    429,500      7.26        5.57     281,200      5.54
   $ 6.00-$12.99     61,500      9.59        9.37           0      0.00
   $13.00-$17.50    214,000      9.80      $17.24     100,000    $17.50
</TABLE>
 
 Thrift/Profit-Sharing Plan
 
  The Company has established a thrift/profit-sharing plan for substantially
all employees which allows participating employees to authorize payroll
deductions from their earnings for contribution to the plan. The Company
contributes amounts as a set percentage of employees deductions as defined in
the plan. Additionally, the Company may contribute amounts to the plan as
determined annually by the Board of Directors from Company profits.
 
NOTE 8. QUARTERLY INFORMATION (UNAUDITED)
 
<TABLE>
<CAPTION>
                                                  FISCAL 1995 QUARTERS
                                             ----------------------------------
                                               1ST      2ND      3RD      4TH
                                             -------  -------  -------  -------
                                             (IN THOUSANDS, EXCEPT PER SHARE
                                                          DATA)
<S>                                          <C>      <C>      <C>      <C>
Net sales................................... $34,801  $36,509  $36,880  $59,333
Gross income................................  10,184   11,717   11,634   21,691
Income (loss) before income taxes...........  (1,982)  (1,283)    (996)   6,900
Net income (loss)........................... $(1,215) $  (780) $  (612) $ 4,236
                                             =======  =======  =======  =======
Net income (loss) per share................. $  (.12) $  (.08) $  (.06) $   .42
                                             =======  =======  =======  =======
<CAPTION>
                                                  FISCAL 1996 QUARTERS
                                             ----------------------------------
                                               1ST      2ND      3RD      4TH
                                             -------  -------  -------  -------
                                             (IN THOUSANDS, EXCEPT PER SHARE
                                                          DATA)
<S>                                          <C>      <C>      <C>      <C>
Net sales................................... $39,639  $36,721  $45,413  $68,515
Gross income................................  12,827   12,560   18,074   28,761
Income before income taxes..................     232      107    3,058   11,020
Net income.................................. $   138  $    64  $ 1,821  $ 6,796
                                             =======  =======  =======  =======
Net income per share........................ $   .01  $   .01  $   .17  $   .62
                                             =======  =======  =======  =======
</TABLE>
 
NOTE 9. SUBSEQUENT EVENTS
 
 Bank Revolving Credit Facility
 
  On April 9, 1997, the Company and its lender agreed to modify the secured
revolving credit facility described in "Note 2. Long-Term Debt and Credit
Arrangements." The revised agreement increases the credit facility from
$20,000,000 to $30,000,000. The Company may use the entire amount of the
credit facility for letters of credit or direct borrowings.
 
                                      24
<PAGE>
 
                  PAUL HARRIS STORES, INC., AND SUBSIDIARIES
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONCLUDED)
 
The term of the credit facility has been extended to June 30, 1999. The annual
interest rate on the direct borrowings was decreased from a variable rate
equal to the prime rate of the lender plus one percent to the prime rate plus
one quarter of one percent (.250%). Issuance fees for letters of credit were
reduced to one quarter of one percent (.250%) from three eighths of one
percent (0.375%) of the face amount of each letter of credit. The advance rate
on inventory for the period of August 1 to November 30 was increased from 60%
to 70%. The previous agreement contained several covenants such as those items
relating to indebtedness, capital expenditures, dividends and cash balances.
The new agreement has eliminated many of these covenants for the credit
facility and term loan (mortgage) and modified the remaining covenants related
to tangible net worth and operating cash flow requirements.
 
 SHAREHOLDER RIGHTS PLAN
 
  On April 10, 1997 the Company adopted a shareholder rights plan. The plan is
designed to ensure that the Company's shareholders receive fair treatment in
the event of an unsolicited attempt to acquire control of the Company. Under
the plan, holders of the Company's outstanding common stock on April 25, 1997
will receive one Right for each share they hold. Initially each Right will
represent the right to purchase one one-hundredth (1/100th) of a share of the
Company's Series A Participating Cumulative Preferred Stock at an exercise
price of $90. The Company may redeem the Rights for $.01 in cash or securities
at any time prior to the acquisition by a person or group of beneficial
ownership of 15% or more of the Company's common stock or the expiration of
the Rights on April 10, 2007. The Rights are not exercisable or transferable
apart from the Company's common stock unless a person or group discloses an
intent or becomes a beneficial owner of 15% or more of the Company's
outstanding common stock. When the Rights become exercisable and transferable,
each holder of a Right (other than the person or group acquiring or attempting
to acquire 15% or more of the Company's common stock) will be entitled to
purchase at the Right's then-current exercise price, shares of the Preferred
Stock having a value of twice the Rights exercise price.
 
                                      25
<PAGE>
 
                       REPORT OF INDEPENDENT ACCOUNTANTS
 
To the Board of Directors and Shareholders of Paul Harris Stores, Inc.
 
In our opinion, the consolidated financial statements listed in the index
appearing under Item 14(a)(1) on page 11 present fairly, in all material
respects, the financial position of Paul Harris Stores, Inc. and its
subsidiaries at February 1, 1997 and February 3, 1996, and the results of
their operations and their cash flows for each of the three years in the
period ended February 1, 1997, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of
the Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
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, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
 
Price Waterhouse LLP
 
Indianapolis, Indiana
February 27, 1997, Except as to Note 9  which is as of April 10, 1997
 
                                      26
<PAGE>
 
                                  SIGNATURES
 
  PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED
ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.
 
                                          Paul Harris Stores, Inc.
 
April 9, 1997                                  /s/ Charlotte G. Fischer
                                          By: _________________________________
                                            Charlotte G. Fischer, Chairman of
                                              the Board, President and Chief
                                               Executive Officer (Principal
                                                    Executive Officer)
 
  PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS
REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE
REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.
 
<TABLE>
<CAPTION>
             SIGNATURE                           TITLE                    DATE
             ---------                           -----                    ----
 
 
<S>                                  <C>                           <C>
    /s/ Charlotte G. Fischer         Chairman of the Board,          April 9, 1997
____________________________________  President and Chief
        Charlotte G. Fischer          Executive Officer
                                      (Principal Executive
                                      Officer)
 
       /s/ John H. Boyers            Senior Vice President--         April 9, 1997
____________________________________  Finance and Treasurer
           John H. Boyers             (Principal Financial
                                      Officer)
 
    /s/ Keith L. Himmel, Jr.         Vice President--Finance,        April 9, 1997
____________________________________  Controller and
        Keith L. Himmel, Jr.          Corporate Secretary
                                      (Principal Accounting
                                      Officer)
 
 /s/ Richard A. Feinberg Ph.D.       Director                        April 9, 1997
____________________________________
     Richard A. Feinberg Ph.D.
 
                                     Director                        April  , 1997
____________________________________
             Rudy Greer
 
        /s/ Robert Logan             Director                        April 9, 1997
____________________________________
            Robert Logan
 
                                     Director                        April  , 1997
____________________________________
          James T. Morris
 
        /s/ Gerald Paul              Director and Chairman           April 9, 1997
____________________________________  Emeritus
            Gerald Paul               of the Board
 
        /s/ John E. Rau              Director                        April 9, 1997
____________________________________
            John E. Rau
 
       /s/ Sally Tassani             Director                        April 9, 1997
____________________________________
           Sally Tassani
 
</TABLE>
 
 
                                      27
<PAGE>
 
                                 EXHIBIT INDEX
 
<TABLE>
<CAPTION>
 
 <C>         <S>                                                            <C>
 (3)(a)(i)   Amended and Restated Articles of Incorporation of the Regis-
             trant dated September 8, 1992 (incorporated herein by refer-
             ence from Form 8-K dated April 11, 1997).
    (a)(ii)  Amendment to Amended and Restated Articles of Incorporation
             dated July 6, 1993 (incorporated herein by reference from
             Form 8-K dated April 11, 1997).
    (a)(iii) Amendment to Amended and Restated Articles of Incorporation
             dated April 10, 1997 (incorporated herein by reference from
             Form 8-K dated April 11, 1997).
    (b)*     Restated Bylaws of the Registrant
 (4)(a)      Indenture dated as of September 15, 1992 between the Regis-
             trant and IBJ Schroder Bank & Trust Company, as trustee, re-
             lating to the Company's 11.375% Notes due 2000 (the "Inden-
             ture") (incorporated herein by reference from Form 8-K dated
             August 31, 1992).
    (b)      First Supplemental Indenture as of October 25, 1993 between
             the Registrant and IBJ Schroder Bank & Trust Company, as
             trustee, relating to the Company's 11.375% Notes due 2000
             (the "Indenture") (incorporated herein by reference from
             Form 10-Q for the fiscal quarter ended October 30, 1993).
    (c)      Secured Credit Agreement dated as of October 28, 1993 by and
             between the Registrant and LaSalle National Bank (incorpo-
             rated herein by reference from Form 10-Q for the fiscal
             quarter ended October 30, 1993).
    (d)      Amended and Restated Secured Credit Agreement dated as of
             January 20, 1994 by and between the Registrant and LaSalle
             National Bank (incorporated herein by reference from Form
             10-Q for the fiscal quarter ended April 30, 1994).
    (e)      First Modification of Secured Credit Agreement, Notes, Mort-
             gage and Other Loan Documents dated as of October 31, 1994
             by and between the Registrant and LaSalle National Bank (in-
             corporated herein by reference from Form 10-K for the fiscal
             year ended January 28, 1995).
    (f)      Second Modification of Secured Credit Agreement, Notes,
             Mortgage and Other Loan Documents dated as of January 31,
             1995 by and between the Registrant and LaSalle National Bank
             (incorporated herein by reference from Form 10-K for the
             fiscal year ended January 28, 1995).
    (g)      Third Modification of Secured Credit Agreement, Notes, Mort-
             gage and Other Loan Documents dated as of September 28, 1995
             by and between the Registrant and LaSalle National Bank (in-
             corporated herein by reference from Form 10-Q for the fiscal
             quarter ended October 28, 1995).
    (h)      Fourth Modification of Secured Credit Agreement, Revolving
             Note, and Other Loan Documents dated as of May 8, 1996 by
             and between the Registrant and LaSalle National Bank (incor-
             porated herein by reference from Form 10-Q for the fiscal
             quarter ended May 4, 1996).
    (i)*     Fifth Modification of Secured Credit Agreement, Revolving
             Note, and Other Loan Documents dated as of April 9, 1997 by
             and between the Registrant and LaSalle National Bank.
    (j)      Rights Agreement between the Registrant and The First Na-
             tional Bank of Boston, as rights agent, dated April 10, 1997
             (incororated herein by reference from Form 8-K dated April
             11, 1997).
</TABLE>
 
 
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<PAGE>
 
<TABLE>
<CAPTION>
 
 <C>       <S>                                                              <C>
 (10)(a)   The Registrant's 1992 Non-Qualified Stock Option Plan (incor-
           porated herein by reference from Form 10-K for the fiscal year
           ended January 30, 1993).
     (b)   Amended and Restated Employment Agreement and Settlement of
           the Deferred Compensation Agreement both dated August 31, 1992
           between the Registrant and Gerald Paul (incorporated herein by
           reference from Form 10-K for the fiscal year ended January 30,
           1993).
     (c)   Stock Transfer Agreement with Gerald Paul dated September 2,
           1981 (incorporated herein by reference from Form 10-K for the
           fiscal year ended January 30, 1993).
     (d)   Supplement to the Amended and Restated Employment Agreement
           between the Registrant and Gerald Paul dated March 21, 1994
           (incorporated herein by reference from Form 10-K for the fis-
           cal year ended January 29, 1994).
     (e)   Employment Agreement between the Registrant and Charlotte G.
           Fischer dated April 28, 1994 (incorporated herein by reference
           from Form 10-Q for the fiscal quarter ended April 30, 1994).
     (f)   Stock Option Agreement dated as of April 29, 1994, between the
           Registrant and Charlotte G. Fischer (incorporated herein by
           reference from Form 10-K for the fiscal year ended January 28,
           1995).
     (g)   Letter dated March 2, 1995 to John H. Boyers describing pro-
           posed terms of employment (incorporated herein by reference
           from Form 10-K for the fiscal year ended February 3, 1996).
     (h)   Amended and Restated Employment Agreement between the Company
           and Charlotte G. Fischer dated June 17, 1996 (incorporated
           herein by reference from Form 10-Q for the fiscal quarter
           ended August 3, 1996).
     (i)*  Amended and Restated Employment Agreement between the Company
           and Charlotte G. Fischer dated November 22, 1996.
 (23)*     Consent of Price Waterhouse LLP.
 (27)*     Financial Data Schedule.
</TABLE>
 
 
 
--------
*Filed with this report.
 
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