##### Table of Contents









UNITED STATES SECURITIES AND EXCHANGE
COMMISSION

Washington, D.C. 20549




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FORM 10-K

Annual Report Pursuant to Section 13 or 15(d)

of the Securities Exchange Act of 1934


|                                   |  |                                 
|---------------------------------- |  | --------------------------------
|For the Fiscal Year Ended 12/27/03 |  | Commission File Number 001-31309



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Phoenix Footwear Group, Inc.

(Name of Registrant as Specified in its
Charter)


|                                                                                                  |  |                                         
|------------------------------------------------------------------------------------------------- |  | ----------------------------------------
|Delaware                                                                                          |  | 15-0327010                              
|(State or Other Jurisdiction of
    Incorporation or Organization)                                |  | (IRS Employer
    Identification Number)
|                                                                                                 
|5759 Fleet Street, Suite 220
    Carlsbad, California(Address of Principal Executive
    Offices) |  | 92008(Zip Code)                         

(Registrants Telephone
Number, Including Area Code)

(760) 602-9688


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

|                                       |  |                                          
|-------------------------------------- |  | -----------------------------------------
|Title of Each Class                    |  | Name of Each Exchange On Which Registered
|                                       |  |                                          
|Common Stock, $.01 Par Value Per Share |  | American Stock Exchange                  

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

None


Indicate by check
mark whether the registrant: (1) has filed all reports
required to be filed by section 13 or 15(d) of the Exchange
Act of 1934 during the past 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 þ          No o

Indicate by check
mark if disclosure of delinquent filers in response to
Item 405 of Regulation S-K (§229.405 of this
Chapter) 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. o

Check whether the
registrant is an accelerated filer (as defined in Rule 12b-2 of
the Act). 

Yes o          No þ

State the aggregate
market value of the voting and non-voting common equity held by
non-affiliates computed by reference to the price at which the
common equity was last sold, or the average bid and asked price
of such common equity, as of the last business day of the
registrants most recently completed second quarter.
(June 28, 2003) $11,250,415.

Indicate the number
of shares outstanding of each of the registrants classes
of common Stock, as of the latest practical date: CLASS
ISSUED & OUTSTANDING AT MARCH 5, 2004, COMMON
STOCK, $.01 PAR VALUE 5,098,297 SHARES

List hereunder the
following documents, if incorporated by reference, and the part
of the Form 10-K into which the document is incorporated:
Proxy Statement for Annual Meeting of Stockholders to be held in
2004 (incorporated into Part III of Form 10-K).



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TABLE OF CONTENTS



|                                                            |  |  |  |  |  |  |  | 
|----------------------------------------------------------- |  |  |  |  |  |  |  | 
|PART I                                                     
|CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING INFORMATION
|PART II                                                    
|PART III                                                   
|PART IV                                                    
|SCHEDULE II CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS 
|SIGNATURES                                                 
|INDEPENDENT AUDITORS REPORT                               
|CONSOLIDATED BALANCE SHEETS                                
|CONSOLIDATED STATEMENTS OF OPERATIONS                      
|CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY            
|CONSOLIDATED STATEMENTS OF CASH FLOWS                      
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|EXHIBIT 10.3                                               
|EXHIBIT 10.4                                               
|EXHIBIT 10.6                                               
|EXHIBIT 10.8                                               
|EXHIBIT 10.9                                               
|EXHIBIT 10.12                                              
|EXHIBIT 10.16                                              
|EXHIBIT 10.17                                              
|EXHIBIT 14                                                 
|EXHIBIT 21.1                                               
|EXHIBIT 23.1                                               
|EXHIBIT 24                                                 
|EXHIBIT 31.1                                               
|EXHIBIT 31.2                                               
|EXHIBIT 32.1                                               



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##### Table of Contents






PART I



|        |         
|------- | --------
|Item 1. | Business

General

We are a mens and womens footwear and
apparel company. We design, develop and market dress and casual
footwear and apparel with an emphasis on traditional style,
quality and fit. We target the moderate to premium-priced
categories of the footwear and apparel markets in order to
pursue our strategy of maintaining strong gross margins. Our
current brands include Trotters®, Soft-Walk®,
SoftWalkTM, H.S. Trask®, StrolTM, and
Royal Robbins®. We also design and market a line of
mens casual footwear through a licensing agreement with
Ducks Unlimited, Inc., the worlds largest wetlands
and waterfowl conservation organization.

In 1999, in line with industry trends, we made a
corporate decision to outsource entirely the production of our
footwear products. We decided to shut down our domestic
production facilities and utilize manufacturing operations
offshore. Our foreign footwear manufacturing partners are
primarily located in Brazil and our apparel products are
primarily sourced from Asia and South America. We believe this
decision allowed us to remain cost competitive while maintaining
the high quality of our products.

We sell over 80 different styles of footwear and
over 250 different styles of apparel products. By emphasizing
traditional style, quality and fit, we believe we can better
maintain a loyal consumer following that is less susceptible to
fluctuations due to changing fashions and changes in consumer
preferences. Our design and product development teams seek to
create and introduce new products and styles that complement
these longstanding core products, are consistent with our brand
images and meet our high standards.

We intend to continue to pursue acquisitions of
sustainable niche brands in the footwear and apparel industry
that we feel could complement or expand our business, augment
our market coverage, provide us with important relationships or
otherwise offer us growth opportunities. Although we are
actively seeking acquisitions that will expand our existing
brands, as of the date of this report we have no agreements with
respect to any such acquisitions and there can be no assurance
that we will be able to identify and acquire such businesses or
obtain necessary financing on favorable terms.

History

We have been engaged in the manufacture or
importation and sale of quality footwear since 1882. Prior to
1996, we were predominantly a manufacturer and seller of
womens slippers based in Dolgeville, New York. In
1996, James Riedman and Riedman Corporation acquired a 35%
ownership position in our common stock, and Mr. Riedman
became our Chairman and Chief Executive Officer. Under
Mr. Riedmans leadership, we began to streamline our
operations and focus on our core competencies of brand specific
sales, design and customer service support. We developed a
strategy to enhance profitability and growth through recruiting
strong management, reducing costs and overhead and acquiring
complementary brands. As part of this strategy, in 1998, we
hired Greg Tunney as President and Chief Operating Officer.
Mr. Tunney had extensive experience in the footwear
industry. In June 1999, we completed the transition to
outsourcing the entire production of our footwear operations to
foreign sources and discontinued our domestic manufacturing
operations.

Also, as part of our transformation, we entered
into other areas of the footwear business. In early 2000 we
entered the mens slipper business with the acquisition of
brands from the L.B. Evans Company. Also in early 2000, we
entered the womens footwear market by acquiring the
Penobscot Shoe Company and its Trotters brand of traditional
footwear. Later that year we also introduced our new SoftWalk
brand of womens comfort footwear. We also moved our
headquarters and distribution operations to the Penobscot
facilities in Old Town, Maine.

In 2001, in the course of consolidating these new
elements of our footwear business, we elected to focus our
efforts on the two product lines which were experiencing growth,
namely the Trotters and SoftWalk brands. As a result, in
December 2001 we sold the mens and womens slipper
business, which included the trademarks Daniel
Green, L.B. Evans and Woolrich and
the inventory related thereto.

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During the second quarter of fiscal 2003, we
relocated our corporate offices from Old Town, Maine to
Carlsbad, California. We believe this relocation assists us in
attracting and retaining key personnel and provides us with
greater access to our major customers and markets.

On August 7, 2003, we entered the mens
dress and casual footwear business through our acquisition of
the H.S. Trask brand and its license rights to the Ducks
Unlimited footwear brand. This product line is based on a
romantic western image. The H.S. Trask styles
emphasize bison, longhorn and elk leather materials and rugged
construction. We believe this brand fit our acquisition criteria
due to its strongly developed niche, its potential for
consistent cash flow, its potential for growth and its
reasonable price.

On October 31, 2003, we entered the apparel
business through our acquisition of the Royal Robbins apparel
brand. The Royal Robbins brand consists of an authentic outdoor
and travel clothing line for men and women emphasizing comfort,
rugged style, and specialty fabrics. This product line includes
over 250 styles of womens and mens outdoor
sportswear and travel apparel. We believe this brand also fit
our acquisition criteria due to its strongly developed niche,
its potential for consistent cash flow, its potential for growth
and its reasonable purchase price.

We sell our footwear products primarily to
department stores, national and regional chain stores,
independent retailers and third party catalog companies. We
distribute our apparel products primarily to specialty
retailers, and directly to consumers at our retail outlet stores
in Berkeley and Modesto, California. We also distribute our
products directly to consumers over our Internet websites and
through our own direct mail catalogs. Our largest customers
include Nordstrom and Dillards department stores.

Our Brands

Through a series of acquisitions, we have built a
portfolio of niche brands that we believe exhibit consistent
cash flow and brand growth potential. We intend to continue to
build our portfolio of brands through acquisitions of footwear
and apparel companies and product lines that we believe
complement or expand our business or augment our market
coverage, provide us with important relationships or otherwise
offer us growth opportunities. We may also acquire businesses
that we feel could provide us with important relationships or
otherwise offer us growth opportunities. Our current brands
include Trotters, SoftWalk, Strol, H.S. Trask and Royal Robbins.
We also design and market a line of mens casual footwear
through an exclusive footwear licensing agreement with Ducks
Unlimited, Inc., the worlds largest wetlands and
waterfowl conservation organization.

Trotters.The
Trotters brand primarily competes in the womens
traditional footwear classification at key price
points between $59 and $99. The footwear niche that we target
with this product line is a wide array of sizes and widths for
the female customer. This line emphasizes quality and fit with
continuity of style from season to season.

SoftWalk.SoftWalk
competes in the comfort footwear niche. Key price
points are between $89 and $129. All of our SoftWalk products
utilize our patented footbed technology, which provides the
consumer with exceptional comfort without compromising style.
This product line has exhibited strong growth since its launch
in fiscal 2000. We believe SoftWalks popularity is
attributable to its unique combination of comfort and
contemporary styling.

Strol.We are
currently in the process of launching our newly developed Strol
brand. Strol is a premium tailored and casual mens line
with contemporary styling based upon our patented footbed
technology used in our SoftWalk product line. Key price points
for the Strol brand are between $89 and $129.

H.S. Trask.H.S.
Trask has historically been a mens footwear brand based on
a romantic western image. Our H.S. Trask styles
emphasize bison, longhorn and elk leather materials and rugged
construction. Key price points are between $99 and $199. Our
H.S. Trask womens line is a brand extension of our H.S.
Trask brand with key price points between $99 and $139. We
believe the H.S. Trask brand has significant growth potential
due to its strong brand image. This growth could result from
brand extensions such as the H.S. Trask womens line,
introduction of apparel, luggage and other accessories, as well
as from a broader product assortment in the traditional
mens target market.

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Royal Robbins.Our
Royal Robbins product line includes over 250 styles of
womens and mens outdoor sportswear and travel
apparel emphasizing comfort, rugged style and specialty fabrics.
Key price points are between $39 and $120. This brand was
originally created by Royal Robbins, an internationally
acclaimed climber and traveler who, with his wife, founded their
outdoor clothing company over 30 years ago to meet the
specialty clothing needs of outdoor enthusiasts. Our Royal
Robbins brand has strong customer loyalty and is recognized as a
core, authentic brand within its retail channel.

Business Strategy

Our operations are based on a decentralized,
brand focused strategy. Each brand manager is responsible for
the product development, marketing, sales growth and
profitability of his or her brand. Our approach enables us to
address individual production and marketing requirements of our
brands and respond to changing market dynamics in a timely
manner. At the same time, our corporate infrastructure allows us
to achieve economies of scale through sharing warehousing,
finance functions and information systems in the operations of
each of our brands. Our focus is on extending existing brands
through our investment in design and product development. We
also seek to expand our brand portfolio through creation of
additional brands, licensing and acquisitions.

We have developed core strengths that we believe
have been significant contributors to our growth to date and
will help support future growth. These strengths include:

Portfolio of Current
Brands.Through product design,
innovation, quality and fit, our brands have built a high degree
of consumer and retailer loyalty. We believe our portfolio
approach reduces business risk by creating greater diversity and
consistency to our revenue and cash flow. We believe this
portfolio of brands also provides us with access to a broader
array of retailers than could be achieved by the brands on a
standalone basis. We continue to seek brand acquisition
opportunities that complement our existing brands and meet
minimum operational, growth and cash flow investment criteria.

Manufacturing
Relationships.We believe that one of
the key factors in our recent growth has been our strong
relationship with overseas manufacturers that are capable of
meeting our requirements for quality and price in a timely
fashion. We source our footwear products primarily from Brazil,
and our apparel products primarily from Asia and South America.

Emphasis on Moderate- to Premium-Priced
Categories of the Footwear and Apparel
Markets.Our portfolio of current
brands is sold through independent retailers, specialty
retailers and better department stores. This distribution
strategy distinguishes us from footwear and apparel companies
that supply the discount or mass merchant channel. We believe
our emphasis on providing high-quality premium products allows
us to maintain stronger gross profit margins.

Pre-Season Sales
Approach.We attempt to reduce the
inventory risk resulting from changing trends and product
acceptance by obtaining orders for at least 50% of our products
before each season. We believe that this approach mitigates the
risks of carrying obsolete inventory and poor retail
sell-through.

Customer
Relationships.We support our footwear
retailers and, to a lesser extent, our apparel retailers, by
maintaining a limited in-stock inventory position for selected
styles, which minimizes the time necessary to fill in
season customers orders. In addition, we provide our
wholesale customers with brand specific sales forces, EDI
capability, co-op advertising, point-of-sale displays and
assistance in evaluating which products are likely to appeal to
their retail customer base.

Seasoned Management
Team.We believe our management team,
who each possess on average 20 years of footwear and
apparel experience in the areas of design, product development,
sourcing and distribution, represents a significant competitive
advantage. We also believe that the strength of our management
team, our portfolio of brands and our focused business strategy
improve our ability to attract and retain key industry personnel.

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Growth Strategies

Our growth will depend upon our broadening of the
products offered under each brand, expanding distribution of our
products and developing or acquiring new brands. Specifically,
our growth strategies include:

Growth of Existing
Brands.We seek to increase sales of
products under each of our existing brands by increasing the
assortment of products and through brand extensions, such as our
newly introduced H.S. Trask womens product line. We
believe that certain areas of our brands are underdeveloped and
will benefit from broader product assortment and additional
investment in the brands such as further developing the Fall
product offerings for Royal Robbins. We also seek to further
expand our existing retail opportunities in current channels,
such as our recent introduction of the Royal Robbins
womens line into Dillards department stores.

Growth with New
Brands.We believe that creating or
licensing additional brands from third parties will enable us to
increase our sales volumes and satisfy the needs of a wider
range of customers. We believe we are well-positioned to
continue pursuing this strategy due to the strength of our
operating cash flow and management team and our brand
development track record. As an example, the new Strol brand of
mens comfort style footwear is an outgrowth of the
patented footbed technology developed in our SoftWalk brand.

Growth Through
Acquisitions.We plan to pursue
acquisitions that have consistent historical cash flow and brand
growth potential and can be purchased at a reasonable price. We
believe that brand acquisition opportunities currently exist in
the footwear and apparel market place that would allow us to
expand our product offerings and improve our market segment
participation. We may also acquire businesses that do not meet
our exact investment criteria but which we feel could provide us
with important relationships or otherwise offer us growth
opportunities.

Expand Our Internet and Catalog
Operations.We currently sell our
products through direct consumer catalog solicitation and our
own Internet websites. Although these sales comprise only a
small portion of our net sales, we intend to expand these sales
to take advantage of their low overhead opportunity for growth.
Our catalog and Internet sales also provide opportunities to
renew contact with existing consumers of our products, and to
acquaint them with our new styles and brands, which enhance our
growth.

Recent Acquisitions

During 2003 we completed two acquisitions of
niche brands that we believed had sustainable cash flows. On
August 7, 2003 we acquired the H.S. Trask footwear brands
and rights to the Ducks Unlimited footwear brand through the
purchase of all the outstanding shares of H.S. Trask &
Co, a Bozeman, Montana based mens footwear company, for an
aggregate purchase price of $6.4 million, consisting of
$2.9 million in cash, 699,980 shares of common stock
valued at $3.2 million and $300,000 in acquisition related
expenses.

On October 31, 2003 we acquired the Royal
Robbins apparel brand through the purchase of all the
outstanding shares of Royal Robbins, Inc., a Modesto,
California based apparel company, for an aggregate purchase
price of $6.8 million, including $6.0 million in cash,
71,889 shares of common stock valued at $500,000 and
$300,000 in acquisition related expenses, plus potential
contingent earnout cash payments. The potential contingent
earnout payments equal 25% of the Royal Robbins product
lines gross profit over the 12 month periods ended
May 31, 2004 and 2005, respectively, so long as minimum
gross profit thresholds are achieved.

With these acquisitions we added to our portfolio
of brands and diversified our product offerings, added
significant revenues, and diversified and added to our
manufacturer and customer base. We intend to continue to pursue
acquisitions of sustainable niche brands in the footwear and
apparel industry that we feel could complement or expand our
business, augment our market coverage, provide us with important
relationships or otherwise offer us growth opportunities.
Although we are actively seeking acquisitions that will expand
our existing brands, as of the date of this Annual Report on
Form 10-K we have no agreements with respect to any such
acquisitions and there can be no assurance that we will be able
to identify and acquire such businesses or obtain necessary
financing on favorable terms.

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| |              
| | -------------
| | Product Lines

Our current product lines consist of womens
dress and casual footwear sold under the Trotters and SoftWalk
brand names, mens dress and casual footwear sold under the
Strol, H.S. Trask and Ducks Unlimited brand names, and outdoor
sportswear and travel apparel for both men and women sold under
the Royal Robbins brand name. Our products emphasize quality,
fit and traditional and authentic styles. Our products emphasize
the moderate to premium-priced categories of the footwear and
apparel markets. Many of our products include our patented
footbed technology and other patented materials, including
performance fabrics made with Gore Tex®, Lycra
Spandex®, Cordura® nylon and Dri-X-TremeTM
wicking finish and Vibram® soles. The following table
summarizes our product lines:

|                                      |  |                                    |               |                                                                                                                                   |  |                                                                                                                                            |         |   |         | 
|------------------------------------- |  | ---------------------------------- | ------------- | --------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------ | ------- | - | ------- | 
|                                      |  |                                    |               |                                                                                                                                   |  | Suggested                                                                                                                                 
|Product Line                          |  | Brands                             |               | Target Market                                                                                                                     |  | Retail Price                                                                                                                              
|                                      |  |                                    |               |                                                                                                                                   |  |                                                                                                                                           
|Womens Dress and Casual Footwear     |  | Trotters, SoftWalk,H.S. Trask      |               | Female Consumer  Ages 35-60.
    Medium income, prefers quality and value over price. Comfort and
    fit are of key importance. |  | $                                                                                                                                          | 59-$139 |  
|Mens Dress and Casual Footwear       |  | H.S. Trask, Ducks Unlimited, Strol |               | Male Consumer  Ages 40-60.
    Medium income, professional, wants and demands the highest
    quality in products purchased.     |  | $                                                                                                                                          | 69-$199 |  
|Outdoor Sportswear and Travel Apparel |  |                                    | Royal Robbins |                                                                                                                                   |  | Male and Female Consumer 
    Ages 25-55.
    Outdoor enthusiast, looks for performance features in their
    casual and outdoor apparel. |         | $ | 39-$120 | 

Womens Dress and Casual
Footwear.Womens dress and
casual footwear is our largest product line. Our womens
dress and casual footwear consists of the Trotters and SoftWalk
brands and the newly-introduced H.S. Trask womens brands.

The Trotters brand primarily competes in the
womens traditional footwear classification at
key price points between $59 and $99. The broad selection of
sizes and widths for the Trotters brand fills an important niche
for our female customers. This line emphasizes quality and fit
with continuity of style from season to season.

SoftWalk competes in the comfort
footwear niche. Key price points are between $89 and $129. All
of our SoftWalk products utilize our patented footbed
technology, which provides the consumer with exceptional comfort
without compromising style. This product line has exhibited
strong growth since its launch in fiscal 2000. We believe
SoftWalks popularity is attributable to its unique
combination of comfort and contemporary styling which fills a
niche of comfort footwear for our retail customer base.

Our H.S. Trask womens line is a brand
extension of our H.S. Trask brand, which historically addressed
the mens footwear market, and is positioned in the
premium footwear classification. Key price points
are between $99 and $139. Key classifications include driving
moccasins, casual, tailored and slippers.

Mens Dress and Casual
Footwear.Our primary mens
footwear brand, H.S. Trask, is based on a romantic
western image. Our H.S. Trask styles emphasize bison,
longhorn and elk leather materials and rugged construction. Our
special tanning techniques and the combination of softness and
durability found in these leathers enable us to ensure high
standards of quality and comfort. Key price points are between
$99 and $199. We believe this brand has significant growth
potential due to its strong brand image. This growth could
result from brand extensions such as the H.S. Trask womens
line, introduction of apparel, luggage and other accessories, as
well as from a broader product assortment in the traditional
mens target market.

We are developing the Ducks Unlimited active
outdoor footwear product line through an exclusive licensing
agreement with Ducks Unlimited, Inc., the worlds
largest wetlands and waterfowl conservation organization. Key
price points for the Ducks Unlimited brand are between $69 and
$99. Currently, sales of this brand represent a relatively small
percentage of our total net sales.

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We are currently in the process of launching our
newly developed Strol brand. Strol is intended to be a premium
tailored and casual mens line with contemporary style
based upon our patented footbed technology used in our SoftWalk
product line. Key price points for the Strol brand are between
$89 and $129.

Outdoor Sportswear and Travel
Apparel.We are in the outdoor
sportswear and travel market with our Royal Robbins brand. This
product line includes over 250 styles of womens and
mens outdoor sportswear and travel apparel emphasizing
comfort, rugged style, and specialty fabrics. Key price points
are between $39 and $120.

This brand was originally created by Royal
Robbins, an internationally acclaimed climber and traveler who,
with his wife, founded their outdoor clothing company over
30 years ago to meet the specialty clothing needs of
outdoor enthusiasts.

The Royal Robbins brand has strong customer
loyalty and is recognized as a core or authentic brand within
its retail channel. In 2003, Royal Robbins was nominated to
compete in the Vendor of the Year competition by its
largest customer, REI. This honor was bestowed on only 10 out of
a total of 800 vendors. We believe that this strong brand
heritage provides us with several promising growth
opportunities, including:



| |   |                                                                                                                                                                         
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Increasing sales within the mens product
    offering (currently womens products account for
    approximately 60% of the brands offerings);                         
|
| |  | Increasing the sales of the brands Fall
    offering (currently the Fall season accounts for approximately
    33% of the brands sales);                               
|
| |  | Introducing a line of Royal Robbins
    footwear; and                                                                                                                   
|
| |  | Broadening our distribution channel for this
    product line, including the recent introduction of the Royal
    Robbins Womens line into Dillards department stores.

Product Design and Development

We employ separate design and development teams
for each of our product lines. Our management believes this
approach results in a more responsive design and product
development process, which reduces new product introduction lead
times. Our sales management and marketing departments also
actively participate in the design and product development
process by collaborating on opportunities related to new styles,
patterns, design improvements and the incorporation of new
materials.

We have also developed a patented technology
utilized in our SoftWalk and Strol brands. We believe this
technology enhances our competitive position. The patented
technology claims an insole construction for footwear comprising
an intermediate member having raised cushioning elements of a
height, size and spacing so as to be self-adjusting to the foot.
These elements combine to create a shoe with comfort and support
that acts like a mattress for the foot.

We incurred design and product development costs
incurred for the last three fiscal years of approximately
$556,000 in 2003, $315,000 in 2002 and $229,000 in 2001.

Sales and Distribution

Our footwear products are primarily sold to
retailers and catalog companies through our own employee sales
force that covers much of the United States. The Trotters and
SoftWalk brands are sold primarily through independent retailers
and department stores. Our H.S. Trask line is sold predominantly
through independent retailers and catalog sales. We also sell
footwear products in Canada and the Caribbean through
independent distributors.

Our apparel products are sold in the United
States primarily through specialty retailers utilizing an
independent sales force and two retail stores. We also plan to
distribute our apparel products through department stores and
have recently begun selling our womens line of Royal
Robbins through Dillards department stores. Sales to
Dillards department stores represented 11%, 12% and 11% of
our net sales in 2003, 2002 and 2001, respectively, and no other
customers exceeded 10% of our net sales. In Canada, the

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United Kingdom, Japan and Germany, our apparel
products are sold under licensing agreements with third parties.


Approximately 6,000 stores in the United States
carry our products, including many major department stores, mail
order companies, and specialty footwear and apparel retailers.
Sales to any one customer in fiscal 2003, 2002 and 2001 did not
exceed 12% of our net sales. Ten major customers represented
approximately 39% of our net sales in fiscal 2003. Most of these
same customers represented approximately 34% of our net sales in
fiscal 2002 and 38% of our net sales in fiscal 2001. We sell
private label products to a small number of customers that
represent an insignificant portion of our total net sales. See
Risk Factors  We make a large portion of our
sales to a relatively small group of customers with whom we do
not have long-term purchase orders, so the loss of any one or
more of these customers could adversely affect our
business.

Consumer Direct

We offer direct sales to consumers through our
own www.SoftWalkshoes.com, www.trotters.com, www.hstrask.comand www.royalrobbins.comwebsites. We also distribute
print catalogs for H.S. Trask, Trotters and SoftWalk. During
fiscal 2003, catalog sales represented approximately 30% of net
sales of H.S. Trask. During 2004, we began to offer catalog
sales for our Trotters and SoftWalk brands.

We believe our catalogs and e-commerce websites
offer a significant growth potential while simultaneously
complementing our existing wholesale business by increasing
consumer awareness of our brands. Sales through our Internet
websites and print catalogs represented approximately 4% of our
net sales for fiscal 2003. The products marketed through
consumer direct channels are sold at the manufacturers
suggested retail price, enabling us to maintain full retail
margins.

Marketing and Advertising

We advertise and promote our various brands
through a variety of methods, including product packaging, print
advertising in trade publications, co-op advertising with our
retail customers, and direct consumer marketing. Additionally,
we attend numerous tradeshows that are generally well-attended
by our retail customers and provide a platform for the unveiling
of new products and an important source of pre-season sales
orders. We avoid granting restricted or exclusive product sale
arrangements because we believe that a profitable distribution
of our product lines requires the greatest number of outlets.

Manufacturing and Sourcing

We source our products entirely through
independent foreign third-party manufacturing facilities. We
provide the independent manufacturers with detailed
specifications and quality control standards. We maintain a
staff in Brazil to monitor the production process to ensure high
quality standards and timely delivery. We also engage foreign
agencies to assist in product fulfillment, quality control and
inspection, customs and product delivery logistics. We source
our current footwear products primarily from Brazil and, to a
lesser extent, China, and source our apparel products through
Asia and South America. We do not maintain long-term purchase
commitments with our manufacturers, but rather use individual
purchase orders. We use multiple sources for our foreign sourced
products in an effort to reduce the risk of reliance on any one
manufacturing facility or company. We believe that the various
raw materials and components used in the manufacture of our
products are generally available from multiple sources at
competitive prices. See Risk Factors  Our
reliance on independent manufacturers, with whom we do not have
long-term written agreements, could cause delay and damage to
customer relationships.

Seasonality and Weather

Our product lines are sold during two distinct
selling seasons, Spring/ Summer and Fall/ Winter. We attempt to
design and develop our new product introductions to coincide
with this seasonal trend. Trotters and SoftWalk sales are
approximately evenly split between these two seasons, while
Royal Robbins products are purchased and used predominantly
during the spring and summer months. Conversely, our H.S. Trask
and

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Ducks Unlimited mens dress and casual
footwear lines are purchased and used by consumers predominantly
in the fall and winter months.


Backlog

We typically enter a selling season four to six
months in advance of the orders being shipped. For our footwear
business, approximately 50% of our sales are based on orders
placed in advance of the selling season and the remaining sales
are on an at once basis during the selling season. For our
apparel products, our preorder business represents approximately
80% to 85% of our total sales, with the remaining sales being
made on an at once basis during the selling season. We have
backlog orders for our Spring business in December of the
preceding year and for our Fall business in June of the same
year. We had firm backlog orders as of December 27, 2003 of
approximately $17.9 million, compared with approximately
$8.3 million and $8.7 million as of December 31,
2002 and 2001, respectively. The increase of approximately
$9.6 million in 2003 over 2002 is due to the acquisition of
the Royal Robbins and H.S. Trask brands in 2003. We anticipate
the majority of our backlog orders as of December 27, 2003
will be filled during fiscal 2004.

Employees

We enjoy a good relationship with our
approximately 130 employees, most of whom are full-time. The
majority of our employees are employed in our Old Town, Maine
and Modesto, California distribution facilities. Our executive
and administrative office, which was relocated to Carlsbad,
California in April 2003, employs approximately 30 individuals.
We also employ 23 outside sales staff whom reside in various
states throughout the United States. No employee is represented
by a labor union, and we have never suffered an interruption of
business caused by labor disputes.

Patents and Trademarks

We regard our proprietary rights as valuable
assets and as important to our competitive advantage. Our
trademarks include Trotters, SoftWalk, H.S. Trask, and Royal
Robbins, which we have registered in the United States and many
foreign countries. We also have rights to use the Ducks
Unlimited and Audubon trademarks. In addition, we have applied
for trademark registration of the Strol logo in the United
States, Canada and Israel.

Our SoftWalk and Strol brands contain a patented
technology in the footbed of the shoe, for which we own patents
in the United States. We vigorously protect our intellectual
property against infringement. We cannot be sure, however, that
our activities do not, and will not, infringe on the proprietary
rights of others. See Risk Factors  Our ability
to compete could be jeopardized if we are unable to protect our
intellectual property rights or if we are sued for intellectual
property infringement.

Competition

We face intense competition in the footwear and
apparel industry from other companies. We compete with numerous
domestic and foreign footwear and apparel designers and
marketers.

Our Trotters footwear line primarily competes
with Naturalizer®, EasySpirit®, Munro America®
and RosHommerson® brands, as well as with retailers
private label footwear. Our SoftWalk footwear line primarily
competes with the Easy Spirit® and ECCO® brands. Our
H.S. Trask footwear line primarily competes with Cole
Haan®, ECCO® and Mephisto® brands. Our Royal
Robbins apparel lines compete primarily with Patagonia®,
The North Face® and Columbia Sportswear Company®.

Many of our competitors have greater financial,
distribution or marketing resources than we do, as well as
greater brand recognition. Our ability to compete successfully
depends on our ability to:



| |   |                                                                            
| | - | ---------------------------------------------------------------------------
| |  | anticipate and respond to changing consumer
    demands in a timely manner;
|
| |  | maintain brand reputation and authenticity;                                
|
| |  | develop high quality products that appeal to
    consumers;                

9



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| |   |                                                                     
| | - | --------------------------------------------------------------------
| |  | appropriately price our products;                                   
|
| |  | provide strong and effective marketing support
    for our products;
|
| |  | ensure product availability; and                                    
|
| |  | maintain and effectively assess our distribution
    channels.      

We believe we are well positioned to compete in
the footwear and apparel industry. By emphasizing traditional
style, quality and fit, we believe we can maintain a loyal
consumer following that is less susceptible to fluctuations due
to changing fashions and changes in consumer preferences.

Risk Factors



| |                                                                                                                                                  
| | -------------------------------------------------------------------------------------------------------------------------------------------------
| | Our acquisitions or acquisition efforts,
    which are important to our growth, may not be successful or may
    dilute our existing stockholders

Acquisitions have been an important part of our
development to date. During 2003, we acquired Royal Robbins and
H.S. Trask. As part of our business strategy, we intend to make
additional acquisitions in the footwear and apparel industry
that we feel could complement or expand our business, augment
our market coverage, provide us with important relationships or
otherwise offer us growth opportunities. If we identify an
appropriate acquisition candidate, we may not be able to
negotiate successfully the terms of or finance the acquisition.
Unsuccessful acquisition efforts, such as our attempted
acquisition of Antiqua Enterprises Inc. may result in
significant additional expenses that would not otherwise be
incurred. In fiscal year 2003, we incurred $285,000 of such
costs. In addition, we cannot assure you that we will be able to
integrate the operations of our acquisitions without
encountering difficulties, including possible unanticipated
costs, difficulty in retaining customers and supplier or
manufacturing relationships, failure to retain key employees,
the diversion of management attention or failure to integrate
our information and accounting systems. Following an
acquisition, we may not realize the revenues and cost savings
that we expect to achieve or that would justify the investment
made and we may incur costs in excess of what we anticipate.
These circumstances could adversely affect the market price of
our common stock.



| |                                                                                                                                                                                
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our future success depends on our ability
    to respond to changing consumer preferences and fashion trends
    and to develop and commercialize new products
    successfully

Our principal business is the design, development
and marketing of footwear and apparel. Although our focus is on
traditional and sustainable niche brands, our brands may still
be subject to rapidly changing consumer preferences and fashion
trends. For example, in fiscal 2002, our Trotters brand
experienced decreased retail acceptance of certain styles, which
adversely affected our net sales. Accordingly, we must identify
and interpret fashion trends and respond in a timely manner.
Demand for and market acceptance of new products, such as our
H.S. Trask womens and Strol brands, are uncertain, and
achieving market acceptance for new products generally requires
substantial product development and marketing efforts and
expenditures. Any failure on our part to regularly develop
innovative products and update core products could limit our
ability to differentiate and appropriately price our products,
adversely affect retail and consumer acceptance of our products,
and limit sales growth. Similarly, these risks could adversely
affect our results of operations or financial condition.



| |                                                                                                                                                                                                                                                    
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We face intense competition, including
    competition from companies with greater resources than ours, and
    if we are unable to compete effectively with these companies,
    our market share may decline and our business could be
    harmed

We face intense competition in the footwear and
apparel industry from other companies, such as Brown Shoe
Company, which markets the Naturalizer brand, and Columbia
Sportswear, Inc. Many of our competitors have greater
financial, distribution or marketing resources, as well as
greater brand awareness. In addition, the overall availability
of overseas manufacturing opportunities and capacity allow for
the introduction of competitors with new products. Moreover, new
companies may enter the markets in which we compete, further
increasing competition in the footwear and apparel industry.

10



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



| |                                                                                                                                                                                                                                           
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | A large portion of our sales are to a
    relatively small group of customers with whom we do not have
    long-term purchase orders, therefore the loss of any one or more
    of these customers could adversely affect our
    business

Ten major customers represented approximately 39%
of net sales in fiscal 2003; and most of these same customers
represented 34% of net sales in fiscal 2002 and 38% of net sales
in fiscal 2001. Sales to any one customer in fiscal 2003, 2002
and 2001 did not exceed 12% of our net sales. Dillards
department stores accounted for 11%, 12% and 11% of our net
sales in fiscal 2003, fiscal 2002 and fiscal 2001, respectively,
and no other customer accounted for more than 10% of our net
sales in those fiscal years. Although we have long-term
relationships with many of our customers, our customers do not
have a contractual obligation to purchase our products, and we
cannot be certain that we will be able to retain our existing
major customers. The retail industry can be uncertain due to
changing customer buying patterns and consumer preferences, and
customer financial instability. These factors could cause us to
lose one or more of these customers, which could adversely
affect our business.



| |                                                                                           
| | ------------------------------------------------------------------------------------------
| | Our business could be adversely affected by
    the financial instability of our customers

We sell our merchandise to major department
stores and specialty retailers across the United States and
extend credit based on an evaluation of each customers
financial condition, usually without requiring collateral.
However, the financial difficulties of a customer could cause us
to curtail business with that customer. We may also assume more
credit risk relating to that customers receivables due us.
Two of our customers constituted 20% of trade accounts
receivable outstanding at December 27, 2003. Our inability
to collect on our trade accounts receivable from any of our
major customers could adversely affect our business or financial
condition.



| |                                                                                                                                                                              
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our ability to compete could be jeopardized
    if we are unable to protect our intellectual property rights or
    if we are sued for intellectual property
    infringement

We believe that we derive a competitive advantage
from our ownership of the Trotters, SoftWalk, H.S. Trask and
Royal Robbins trademarks, and from our patented footbed
technology. In addition, we own and license other trademarks
that we utilize in marketing our products. We vigorously protect
our trademarks against infringement. We believe that our
trademarks are generally sufficient to permit us to carry on our
business as presently conducted. We cannot, however, know
whether we will be able to secure trademark protection for our
intellectual property in the future or that protection will be
adequate for future products. Further, we face the risk of
ineffective protection of intellectual property rights in the
countries where we source our products. We cannot be sure that
our activities do not and will not infringe on the proprietary
rights of others. If we are compelled to prosecute infringing
parties, defend our intellectual property, or defend ourselves
from intellectual property claims made by others, we may face
significant expenses and liability that could divert our
managements attention and resources and otherwise
adversely affect our business or financial condition.

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| |                                                                                                                                                                                                                                                                               
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our international manufacturing operations
    are subject to the risks of doing business abroad, which could
    affect our ability to manufacture our products in international
    markets, obtain products from foreign suppliers or control the
    costs of our products

We rely on foreign sourcing of our products. We
believe that one of the key factors in our growth has been our
strong relationships with manufacturers capable of meeting our
requirements for quality and price in a timely fashion. We
source our products primarily from independent third-party
manufacturing facilities located in Brazil, Asia and South
America. As a result, we are subject to the general risks of
doing business outside the United States, including, without
limitation, work stoppages, transportation delays and
interruptions, political instability, expropriation,
nationalization, foreign currency fluctuation, changing economic
conditions, the imposition of tariffs, import and export
controls and other non-tariff barriers, and changes in local
government administration and governmental policies, and to
factors such as the short-term and long-term effects of severe
acute respiratory syndrome, or SARS, and the outbreak of avian
influenza in China. Although a diverse domestic and
international industry exists for the kinds of merchandise
sourced by us, there can be no assurance that these factors will
not adversely affect our business, financial condition or
results of operations.



| |                                                                                                                                                              
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our reliance on independent manufacturers,
    with whom we do not have long-term written agreements, could
    cause delay and damage customer relationships

In fiscal 2003, 13 manufacturers accounted
for 100% of our footwear volume. We do not have long-term
written agreements with any of our third party manufacturers. As
a result, any of these manufacturers may unilaterally terminate
their relationships with us at any time. Establishing
relationships with new manufacturers would require a significant
amount of time and would cause us to incur delays and additional
expenses, which would also adversely affect our business and
results of operations.

In the past, a manufacturers failure to
ship products to us in a timely manner or to meet the required
quality standards has caused us to miss the delivery date
requirements of our customers for those items. This, in turn,
has caused, and may in the future cause, customers to cancel
orders, refuse to accept deliveries or demand reduced prices.
This could adversely affect our business and results of
operation.



| |                                                                                                                                                                                      
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We depend on our senior executives to
    develop and execute our strategic plan and manage our
    operations, and if we are unable to retain them, our business
    could be harmed

Our future success depends upon the continued
services of James Riedman, our Chairman of the Board and Chief
Executive Officer, who has played a key role in developing and
implementing our strategic plan. We also rely on Greg Tunney,
our President and Chief Operating Officer, to manage our overall
operations. Our loss of either of these individuals would harm
us if we are unable to employ a suitable replacement in a timely
manner. We do not maintain keyman insurance on
Messrs. Riedman or Tunney or any of our other senior
executives.



| |                                                                                                                     
| | --------------------------------------------------------------------------------------------------------------------
| | Fluctuations in the price, availability and
    quality of raw materials could adversely affect our gross
    profit

Fluctuations in the price, availability and
quality of raw materials, such as leather and bison hides, used
to manufacture our products, could adversely affect our cost of
goods or our ability to meet our customers demands.
Although we do not expect our foreign manufacturing partners to
have any difficulty in obtaining the raw materials required for
footwear production, certain sources may experience some
difficulty in obtaining raw materials. For example, in fiscal
2002, the availability of leather decreased as a result of
destruction of livestock due to concerns about mad
cow disease and hoof and mouth disease. We
generally do not enter into long-term purchase commitments. In
the event of price increases in these raw materials in the
future, we may not be able to pass all or a portion of these
higher raw materials prices on to our customers, which would
adversely affect our gross profit.

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| |                                                                                                                                                                                                                                
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | A decline in general economic conditions
    could lead to reduced consumer demand for our footwear and
    accessories and could lead to a reduction in our
    stockholders equity and thus our ability to obtain
    credit

In addition to consumer fashion preferences,
consumer spending habits are affected by, among other things,
prevailing economic conditions, levels of employment, salaries
and wage rates, consumer confidence and consumer perception of
economic conditions. In fiscal 2002 and fiscal 2003, the United
States economy, and more specifically the retail environment,
experienced a general slowdown, and adversely affected consumer
spending habits which we believe contributed to the decline in
the net sales of our Trotters brand that fiscal year. Future
slowdowns would likely cause us to delay or slow our expansion
plans and result in lower net sales than expected on a quarterly
or annual basis, which could lead to a reduction in our
stockholders equity and thus our ability to obtain credit
as and when needed.



| |                                                                                                                                                                                                                                                                
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our recent acquisitions make evaluating our
    operating results difficult given the significance of these
    acquisitions to our operations, and our historical results may
    not give you an accurate indication of how we will perform in
    the future

Our historical results of operations do not give
effect to the acquisitions of H.S. Trask and Royal Robbins for a
full fiscal year. Accordingly, the historical financial
information that we have included in this Annual Report on
Form 10-K does not necessarily reflect what our financial
position, operating results and cash flows will be in the future
as a result of these acquisitions.



| |                                                                                                                                                                                           
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The financing of any future acquisitions we
    make may result in dilution to your stock ownership and/or could
    increase our leverage and our risk of defaulting on our bank
    debt

Our business strategy is to expand into new
markets and enhance our position in existing markets through the
acquisition of complementary businesses. In order to
successfully complete targeted acquisitions or to fund our other
activities, we may issue additional equity securities that could
dilute your stock ownership. We may also incur additional debt
if we acquire another company, which could significantly
increase our leverage and hence our risk of default under our
secured credit facility.



| |                                                                                                              
| | -------------------------------------------------------------------------------------------------------------
| | Defaults under our secured credit
    arrangement could result in a foreclosure on our assets by our
    bank

We have a $24.8 million secured credit
facility with our bank. As of March 5, 2004, we had
$14.3 million of unpaid principal under this facility. In
the future, we may incur additional indebtedness in connection
with acquisitions. All of our assets are pledged as collateral
to secure our bank debt. Our credit facility includes a number
of covenants, including financial covenants. If we default under
our credit arrangement and are unable to cure the default,
obtain appropriate waivers or refinance the defaulted debt, our
bank could declare our debt to be immediately due and payable
and foreclose on our assets, which may result in a complete loss
of your investment.



| |                                                                                                                                   
| | ----------------------------------------------------------------------------------------------------------------------------------
| | We may be required to recognize impairment
    charges that could substantially affect our reported earnings in
    future periods

As of December 27, 2003, we had
$9.0 million of goodwill and unamortizable intangibles. We
expect this figure to increase with future acquisitions.
Pursuant to generally accepted accounting principles, we are
required to perform impairment tests on our intangible assets
annually or at any time when events occur that could impact the
value of our business. Our determination of whether an
impairment has occurred is based on a comparison of each of our
reporting units fair market value with its carrying value.
Significant and unanticipated changes could require a provision
for impairment in a future period that could substantially
affect our reported earnings in a period of such change.



| |                                                                                                                 
| | ----------------------------------------------------------------------------------------------------------------
| | The exercise of outstanding stock options
    would cause dilution to our stockholders ownership
    percentage

As of March 5, 2004, we had outstanding for
legal purposes 5,098,297 shares of common stock, including
478,513 unallocated shares held by our 401(k) plan, which
despite the fact they are outstanding for voting and other legal
purposes, are classified as treasury shares for financial
statement reporting purposes and not taken

13



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into account in determining earnings per share or
earnings per diluted share. The 478,513 unallocated shares will
be allocated at the rate of 120,000 shares annually until they
are fully allocated to the accounts of plan participants. After
each allocation 120,000 shares will be included in the weighted
average shares outstanding for purposes of determining earnings
per share and earnings per diluted share. In addition, as of
that date we had outstanding options to purchase an additional
1,267,057 shares at exercise prices ranging from $1.725 to
$8.91 per share. The exercise of all or part of these
options would cause our stockholders to experience a dilution in
their percentage ownership.




| |                                                                                                                                                                                    
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The charge to earnings from the
    compensation of employees under our employee retirement plan
    could negatively affect your investment value and our growth
    opportunities

As of March 5, 2004, our 401(k) plan held
478,513 unallocated shares of our common stock, which
constituted approximately 9.4% of our outstanding shares as of
that date. Under the terms of the plan, approximately 120,000 of
these shares will be allocated to plan participants in February
of each year until fully allocated. We are required to record an
expense for compensation based on the market value of the amount
allocated to employees each year. For fiscal 2002 and 2003 we
recorded expenses for this allocation of $237,000 and $402,000,
respectively, and for fiscal 2004 we expect to record $852,000
in expenses for this allocation. As our stock price increases,
we must take a higher charge for this allocation and thereby
decrease our reported earnings. This could depress our stock
price and detract from our ability to use our securities as
currency for any acquisitions we plan to make.



| |                                                                                                                                              
| | ---------------------------------------------------------------------------------------------------------------------------------------------
| | We are controlled by a principal
    stockholder who is able to exert significant control over us and
    our significant corporate decisions

James R. Riedman, our Chairman of the Board and
Chief Executive Officer, is the largest beneficial owner of our
stock. Through his personal holdings and shares over which he is
deemed to have beneficial ownership held by Riedman Corporation
of which he is a shareholder, our employee retirement plan, his
children, and an affiliated entity, he has beneficial ownership
of approximately 44.8% of our outstanding shares. He also has
beneficial ownership of shares underlying options which, if
exercised, would increase his percentage beneficial ownership to
approximately 49.2%, assuming no other exercises of outstanding
options. Through this beneficial ownership, Mr. Riedman can
direct our affairs and significantly influence the election or
removal of our directors and the outcome of all matters
submitted to a vote of our stockholders, including amendments to
our certificate of incorporation and bylaws and approval of
mergers or sales of substantially all of our assets. The
interest of our principal stockholder may conflict with
interests of other stockholders. This concentration of ownership
may harm the market price of our common stock by, among other
things:



| |   |                                                                                                                               
| | - | ------------------------------------------------------------------------------------------------------------------------------
| |  | delaying, deferring or preventing a change in
    control of our company;                                                     
|
| |  | impeding a merger, consolidation, takeover or
    other business combination involving our company;                           
|
| |  | causing us to enter into transactions or
    agreements that are not in the best interests of all
    stockholders; or        
|
| |  | discouraging a potential acquirer from making a
    tender offer or otherwise attempting to obtain control of our
    company.



| |                                                                                                                                                           
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our inventory levels may exceed our actual
    needs, which could adversely affect our operating results by
    requiring us to make inventory write-downs

We generally pre-sell up to 50% of each
seasons anticipated merchandise demand. This is based on
our past experience. Nonetheless, if we order more product than
we are able to sell, we could be required to write-down this
inventory, negatively affecting our margins and in turn, our
operating results. This could occur as the result of change in
customer order patterns, general sales activity, orders subject
to cancellation by customers, misforecasting and consumer
demand. Write-downs of inventory could adversely affect our
gross margins and operating results.

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| |                                                                                                                                                                                                      
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our financial results may fluctuate from
    quarter to quarter as a result of seasonality in our business,
    and if we fail to meet expectations, the price of our common
    stock may fluctuate.

The footwear and apparel industry generally, and
our business specifically, are characterized by seasonality in
net sales and results of operations. Our business is seasonal,
with the first and third quarters generally having stronger
sales and operating results than the other two quarters. These
events can cause the price of our common stock to decline
substantially.






CAUTIONARY STATEMENT


CONCERNING FORWARD-LOOKING
INFORMATION


This Annual Report on Form 10-K and the
Securities and Exchange Commission filings that are incorporated
by reference into this Annual Report on Form 10-K contain
forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, or
the Securities Act, and Section 21E of the Securities
Exchange Act of 1934, as amended, or the Exchange Act. We intend
that these forward-looking statements be subject to the safe
harbors created by those sections.

These forward-looking statements include, but are
not limited to, statements relating to our anticipated financial
performance, business prospects, new developments, new
merchandising strategies and similar matters, and/or statements
preceded by, followed by or that include the words
believes, could, expects,
anticipates, estimates,
intends, plans, projects,
seeks, or similar expressions. We have based these
forward-looking statements on our current expectations and
projections about future events, based on the information
currently available to us. These forward-looking statements are
subject to risks, uncertainties and assumptions, including those
described under the heading Risk Factors, that may
affect the operations, performance, development and results of
our business. You are cautioned not to place undue reliance on
these forward-looking statements, which speak only as of the
date stated, or if no date is stated, as of the date of this
Annual Report on Form 10-K. We undertake no obligation to
publicly update or revise any forward-looking statements,
whether as a result of new information, future events or any
other reason except as we may be required to do under applicable
law. In light of these risks, uncertainties and assumptions, the
forward-looking events discussed in this Annual Report on
Form 10-K may not occur.

Investors should also be aware that while the
Company does, from time to time, communicate with securities
analysts, it is against the Companys policy to disclose to
them any material non-public information or other confidential
commercial information. Accordingly, investors should not assume
that the Company agrees with any statement or report issued by
any analyst irrespective of the content of the statement or
report.

Furthermore, the Company has a policy against
issuing publishing financial forecasts or projections issued by
others or confirming financial forecasts, or projections issued
by others. Thus, to the extent that reports issued by securities
analysts contain any projections, forecasts or opinions, such
reports are not the responsibility of the Company.

Access to SEC Filings

Interested readers can access the Companys
Annual Reports on Form 10-K, Quarterly Reports on
Form 10-Q, current reports on Form 8-K, and any
amendments to those reports filed or furnished pursuant to
Section 13(a) or 15(d) of the Securities Exchange Act of
1934, as amended, through the U.S. Securities and Exchange
Commissions website at www.sec.gov. These reports can be
accessed free of charge.

15



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|        |           
|------- | ----------
|Item 2. | Properties

We occupy offices and facilities in various
locations in California and Maine. The following table
summarizes our properties.

|                                                |  |           |       |             |  |                  |  |  |          | 
|----------------------------------------------- |  | --------- | ----- | ----------- |  | ---------------- |  |  | -------- | 
|                                                |  |           |       |             |  | Approximate     
|Facility/Location                               |  | Own/Lease |       | Description |  | Square Footage  
|                                                |  |           |       |             |  |                 
|Corporate Headquarters
    Carlsbad, California |  |           | Lease |             |  | Office Space     |  |  | 14,000   | 
|Distribution Center
    Old Town, Maine         |  |           | Own   |             |  | Warehouse        |  |  | 75,000   | 
|Distribution Center
    Modesto, California     |  |           | Lease |             |  | Office/Warehouse |  |  | 20,000   | 
|Berkeley, California                            |  |           | Lease |             |  | Retail           |  |  | 2,400    | 
|Modesto, California                             |  |           | Lease |             |  | Retail           |  |  | 4,500    | 
|Dolgeville, New York                            |  |           | Own   |             |  | Vacant Land      |  |  | 30 acres | 

We also lease a vacant office and warehouse
facility in Bozeman, Montana under a lease that expires in April
2004. We are not renewing this lease.

We have no manufacturing facilities because all
of our products are manufactured by independent manufacturers.
We believe that our existing office, warehouse and retail space
is adequate to meet our current and foreseeable future
requirements.



|        |                   
|------- | ------------------
|Item 3. | Legal Proceedings.

From time to time we are involved with legal
proceedings, claims and litigation arising in the ordinary
course of business. As of the date of this Annual Report on
Form 10-K we are not a party to any pending material legal
proceedings.

The Company acquired Penobscot Shoe Company
(Penobscot) from Riedman Corporation, a related
party, on March 30, 2000. Riedman Corporation had acquired
Penobscot in a cash tender offer of $5.88 per share, which
was concluded on November 16, 1999. At that time, the
holders of 506,052 shares of Penobscot stock exercised
their dissenters rights under Maine law applicable to
Penobscot and demanded payment of the fair value of their
shares. On or about April 3, 2000, Penobscot filed suit in
the Superior Court in Maine, Penobscot County, to have the Court
determine the fair value of dissenter shares.

Subsequently, several dissenting shareholders
withdrew from the litigation, accepting the $5.88 per share
offered. As a result, there were only four persons remaining,
dissenting as to 296,636 shares. One of those dissenters
requested the Court to compel Penobscot to post a bond of
$2.0 million to assure payment of the fair value of his
shares once that was determined by the Court. The Court ordered
Penobscot to post a bond for approximately $1.7 million,
being the product of the number of shares held by that dissenter
and $5.88, the amount of the tender offer.

On May 30, 2003 the Company received from
the Superior Court in Penobscot County, Maine its decision
stating that the dissenting Penobscot shareholders were entitled
to $7.94 per common share, representing $2.06 more per
share than the amount the Company paid at the time of the
acquisition. Additionally, the ruling granted interest to the
dissenting shareholders bringing the total judgment to
$3.1 million. As a result, the Company recorded in Other
Expenses, Net $733,000 of litigation related legal and
settlement expenses and $376,000 of interest expense during
Fiscal 2003. The Company used $500,000 in cash on hand and
increased its note payable-line of credit in the amount of
$2.6 million to pay the settlement and was relieved of its
$1.7 million bond obligation.

16



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##### Table of Contents





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

During the fourth quarter of the Companys
fiscal year, no matter was submitted to a vote of stockholders.






PART II




|        |                                                                              
|------- | -----------------------------------------------------------------------------
|Item 5. | Market for the Registrants Common
    Stock and Related Stockholder Matters.

Our common stock began trading on the American
Stock Exchange on May 20, 2002 under the symbol
PXG. Prior to May 20, 2002, our common stock
was quoted on The Nasdaq SmallCap Market under the symbol
DAGR. The following table sets forth for each
calendar quarter the low and high closing sale prices per share
of our common stock as reported on the American Stock Exchange
and The Nasdaq SmallCap Market for the applicable periods. These
prices reflect our 2-for-1 stock split effective at the close of
business on June 12, 2003.

|                              |                |      |   |      |  |  |   |      | 
|----------------------------- | -------------- | ---- | - | ---- |  |  | - | ---- | 
|                              |                | High |   | Low 
|                              |                |      |   |     
|Year Ended December 31, 2002: |                |      |   |      |  |  |   |     
|                              | First Quarter  |      | $ | 4.87 |  |  | $ | 2.25 | 
|                              | Second Quarter |      | $ | 5.93 |  |  | $ | 4.45 | 
|                              | Third Quarter  |      | $ | 5.50 |  |  | $ | 3.75 | 
|                              | Fourth Quarter |      | $ | 3.93 |  |  | $ | 2.90 | 
|Year Ended December 27, 2003: |                |      |   |      |  |  |   |     
|                              | First Quarter  |      | $ | 3.63 |  |  | $ | 2.74 | 
|                              | Second Quarter |      | $ | 5.19 |  |  | $ | 3.51 | 
|                              | Third Quarter  |      | $ | 5.92 |  |  | $ | 4.80 | 
|                              | Fourth Quarter |      | $ | 7.49 |  |  | $ | 5.80 | 

At March 5, 2004, we had approximately 439
holders of record (including Cede & Co., the nominee
for the Depositary Trust Company, a registered clearing agency).
We believe that the number of beneficial owners of our common
stock on that date was substantially greater.

We do not pay cash dividends on our capital
stock. We do not anticipate paying cash dividends on our common
stock in the foreseeable future. We currently anticipate that we
will retain all of our future earnings for use in funding the
expansion of our business and general corporate purposes. In
addition, our credit agreement with our bank restricts our
ability to declare or pay dividends on our common stock without
the banks consent. Any future determination as to the
payment of dividends will be subject to applicable limitations,
will be at the discretion of our board of directors and will
depend on our results of operations, financial condition,
capital requirements and other factors deemed relevant by our
board of directors. See Managements Discussion and
Analysis of Financial Condition and Results of
Operations  Liquidity and Capital Resources.

17



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##### Table of Contents



Securities Authorized for Issuance Under
Equity Compensation Plans

Information about the Companys equity
compensation plans at December 27, 2003 is as follows:

Equity Compensation Plan Information

|                                                              |  |                      |           |                      |  |                         |      |  |  |  |         | 
|------------------------------------------------------------- |  | -------------------- | --------- | -------------------- |  | ----------------------- | ---- |  |  |  | ------- | 
|                                                              |  | Number of securities |           |                      |  | Number of securities   
|                                                              |  | to be issued upon    |           | Weighted average     |  | remaining available for
|                                                              |  | exercise of          |           | exercise price of    |  | future issuance under  
|                                                              |  | outstanding options, |           | outstanding options, |  | equity comp plans      
|Plan Category                                                 |  | warrants and rights  |           | warrants and rights  |  | (excluding (a))        
|                                                              |  |                      |           |                      |  |                        
|                                                              |  | (a)                  |           | (b)                  |  | (c)                    
|Equity compensation plans approved by
    stockholders(1)     |  |                      | 648,000   |                      |  | $                       | 4.03 |  |  |  | 434,000 | 
|Equity compensation plans not approved by
    stockholders(2) |  |                      | 398,000   |                      |  | $                       | 2.07 |  |  |  | 0       | 
|                                                              |  |                      |           |                      |  |                         |      |  |  |  |         | 
|Total                                                         |  |                      | 1,046,000 |                      |  | $                       | 3.28 |  |  |  | 434,000 | 
|                                                              |  |                      |           |                      |  |                         |      |  |  |  |         | 



---



|    |                                                                                                                                                                                                                                                                                                                                               
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Consists of the following plans: 2001 Long-Term
    Incentive Plan and the 1995 Stock Incentive Plan. No shares are
    available for grant under the 1995 Stock Incentive Plan at
    December 27, 2003. The 2001 Long-Term Incentive Plan
    permits the award of stock options, restricted stock and various
    other stock-based awards.
|   
|(2) | Consists of options granted to James R. Riedman
    and Riedman Corporation in connection with financial guaranties
    and loans granted to us. See Note 9 to our Consolidated
    Financial Statements as of December 27, 2003, contained
    herein.                                                                                       

On October 31, 2003, we issued
71,889 shares of common stock to the three holders of Royal
Robbins, Inc., common stock as partial consideration for
our acquisition of that company. No underwriters were involved.
The securities were issued in reliance upon the exemption from
registration provided under Section 4(2) of the Securities
Act, based on the fact that the common stock was sold by the
issuer in a transaction not involving a public offering.

We did not make any repurchases of our common
stock during the fourth quarter of 2003.



|        |                        
|------- | -----------------------
|Item 6. | Selected Financial Data

The historical consolidated statements of
operations data for the years ended December 31, 2001 and
2002 and December 27, 2003, and the historical consolidated
balance sheet data as of December 31, 2002 and
December 27, 2003, have been derived from our historical
consolidated financial statements which consolidated financial
statements and independent auditors report are included
elsewhere in this Annual Report on Form 10-K. The
historical consolidated statements of operations data for the
years ended December 31, 1999 and 2000, and the historical
balance sheet data as of December 31, 1999, 2000 and 2001,
have been derived from our audited historical consolidated
financial statements that are not included in this Annual Report
on Form 10-K.

The financial data in the following table was
impacted by our 2000 acquisition of the Penobscot Shoe Company
and its Trotters brand, our 2001 sale of our slipper brands and
our 2003 acquisition of H.S. Trask and Royal Robbins. As a
result of the slipper brands divestiture, we recognized a
$1.2 million gain in fiscal 2001 and experienced lower net
sales in fiscal 2002. For our two acquisitions in fiscal 2003,
we paid a total purchase price of $9.5 million in cash,
issued 771,889 shares of common stock and agreed to pay
Royal Robbins stockholders a potential earnout if certain
financial thresholds are achieved.

Historical results are not necessarily indicative
of future results, The following information should be read in
conjunction with our consolidated financial statements and the
related notes and Managements

18



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##### Table of Contents



Discussion and Analysis of Financial Condition
and Results of Operations, which are included elsewhere in
this Annual Report on Form 10-K.


|                                               |                                            |                                                              |                          |             |           |              |   |              |           |              |   |        |           |        |   |        |           |        |   |        |           |        | 
|---------------------------------------------- | ------------------------------------------ | ------------------------------------------------------------ | ------------------------ | ----------- | --------- | ------------ | - | ------------ | --------- | ------------ | - | ------ | --------- | ------ | - | ------ | --------- | ------ | - | ------ | --------- | ------ | 
|                                               |                                            |                                                             
|                                               |                                            | Fiscal Years Ended                                          
|                                               |                                            |                                                             
|                                               |                                            | December 31,                                                 |                          | December 31 |           | December 31, |   | December 31, |           | December 27,
|                                               |                                            | 1999(1)                                                      |                          | 2000(2)     |           | 2001(3)      |   | 2002(4)      |           | 2003(5)     
|                                               |                                            |                                                              |                          |             |           |              |   |              |           |             
|                                               |                                            |                                                             
|                                               |                                            | (In thousands, except share, per share data and stock price)
|Consolidated Statements of Operations
    Data |                                            |                                                              |                          |             |           |              |   |              |           |              |   |        |           |        |   |        |           |        |   |       
|                                               | Net sales                                  |                                                              | $                        | 14,867      |           |              | $ | 33,179       |           |              | $ | 46,851 |           |        | $ | 36,161 |           |        | $ | 39,077 |          
|                                               | Cost of goods sold                         |                                                              |                          | 11,728      |           |              |   | 22,233       |           |              |   | 31,439 |           |        |   | 22,397 |           |        |   | 22,457 |          
|                                               |                                            |                                                              |                          |             |           |              |   |              |           |              |   |        |           |        |   |        |           |        |   |       
|                                               | Gross profit                               |                                                              |                          | 3,139       |           |              |   | 10,946       |           |              |   | 15,412 |           |        |   | 13,764 |           |        |   | 16,620 |          
|                                               | Operating expenses:                        |                                                              |                          |             |           |              |   |              |           |              |   |        |           |        |   |        |           |        |   |        |          
|                                               |                                            | Selling, general and administrative expenses                 |                          |             | 4,646     |              |   |              | 9,705     |              |   |        | 11,917    |        |   |        | 9,661     |        |   |        | 12,696    |       
|                                               |                                            | Other expense, net                                           |                          |             | 311       |              |   |              | 1,016     |              |   |        | 375       |        |   |        | 442       |        |   |        | 1,377     |       
|                                               |                                            |                                                              |                          |             |           |              |   |              |           |              |   |        |           |        |   |        |           |        |   |       
|                                               |                                            |                                                              | Total operating expenses |             |           | 4,957        |   |              |           | 10,721       |   |        |           | 12,292 |   |        |           | 10,103 |   |        |           | 14,073 | 
|                                               |                                            |                                                              |                          |             |           |              |   |              |           |              |   |        |           |        |   |        |           |        |   |       
|                                               | Operating (loss) income                    |                                                              |                          | (1,818      | )         |              |   | 225          |           |              |   | 3,120  |           |        |   | 3,661  |           |        |   | 2,547  |          
|                                               | Interest expense                           |                                                              |                          | 193         |           |              |   | 1,363        |           |              |   | 1,683  |           |        |   | 751    |           |        |   | 620    |          
|                                               |                                            |                                                              |                          |             |           |              |   |              |           |              |   |        |           |        |   |        |           |        |   |       
|                                               | (Loss) earnings before income taxes        |                                                              |                          | (2,011      | )         |              |   | (1,138       | )         |              |   | 1,437  |           |        |   | 2,910  |           |        |   | 1,927  |          
|                                               | Income tax (benefit) expense               |                                                              |                          | (483        | )         |              |   | (456         | )         |              |   | 67     |           |        |   | 1,207  |           |        |   | 986    |          
|                                               |                                            |                                                              |                          |             |           |              |   |              |           |              |   |        |           |        |   |        |           |        |   |       
|                                               | Net (loss) earnings                        |                                                              | $                        | (1,528      | )         |              | $ | (682         | )         |              | $ | 1,370  |           |        | $ | 1,703  |           |        | $ | 941    |          
|                                               |                                            |                                                              |                          |             |           |              |   |              |           |              |   |        |           |        |   |        |           |        |   |       
|                                               | Net (loss) earnings per share(6)           |                                                              |                          |             |           |              |   |              |           |              |   |        |           |        |   |        |           |        |   |        |          
|                                               |                                            | Basic                                                        |                          | $           | (0.49     | )            |   | $            | (0.22     | )            |   | $      | 0.44      |        |   | $      | 0.50      |        |   | $      | 0.24      |       
|                                               |                                            | Diluted                                                      |                          | $           | (0.49     | )            |   | $            | (0.22     | )            |   | $      | 0.41      |        |   | $      | 0.45      |        |   | $      | 0.22      |       
|                                               | Weighted average common shares outstanding |                                                              |                          |             |           |              |   |              |           |              |   |        |           |        |   |        |           |        |   |        |          
|                                               |                                            | Basic                                                        |                          |             | 3,138,172 |              |   |              | 3,141,190 |              |   |        | 3,137,688 |        |   |        | 3,418,468 |        |   |        | 3,963,382 |       
|                                               |                                            | Diluted                                                      |                          |             | 3,138,172 |              |   |              | 3,141,190 |              |   |        | 3,444,042 |        |   |        | 3,781,634 |        |   |        | 4,350,132 |       
|Consolidated Balance Sheet Data                |                                            |                                                              |                          |             |           |              |   |              |           |              |   |        |           |        |   |        |           |        |   |       
|                                               | Cash and cash equivalents                  |                                                              | $                        | 225         |           |              | $ | 1            |           |              | $ | 1,161  |           |        | $ | 1,265  |           |        | $ | 1,058  |          
|                                               |                                            | Working capital                                              |                          |             | 4,414     |              |   |              | (1,607    | )            |   |        | 5,358     |        |   |        | 8,812     |        |   |        | 13,423    |       
|                                               |                                            | Total assets                                                 |                          |             | 10,252    |              |   |              | 38,424    |              |   |        | 27,577    |        |   |        | 18,954    |        |   |        | 36,411    |       
|                                               | Contingent liability                       |                                                              |                          |            |           |              |   |             |           |              |   |       |           |        |   |       |           |        |   | 1,942  |          
|                                               |                                            | Total bank debt                                              |                          |             | 2,849     |              |   |              | 18,926    |              |   |        | 14,829    |        |   |        | 3,000     |        |   |        | 12,082    |       
|                                               |                                            | Total stockholders equity                                   |                          | $           | 6,477     |              |   | $            | 5,898     |              |   | $      | 7,452     |        |   | $      | 10,112    |        |   | $      | 14,987    |       



---



|    |                                                                                                                                                                                                                                                                                                                                                                            
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | We ceased our manufacturing operations completely
    during fiscal 1999 and as part of the restructuring incurred
    severance costs of $311,000. Raw material inventory write-offs
    of $589,000 are also included in costs of goods sold in fiscal
    1999 as part of the restructuring.                                                                            
|   
|(2) | Includes $808,000 of expenses associated with the
    relocation of our headquarters and distribution operation from
    Dolgeville, New York to the newly acquired facilities in Old
    Town, Maine. Costs associated with this relocation included
    severance, moving expenses and closing facilities. In addition,
    we recognized an impairment loss of $208,000.
|   
|(3) | The net amount of $375,000 in Other
    expense, net consists primarily of a $1.2 million
    gain in connection with the divestiture of our slipper business
    and a $1.7 million loss incurred in connection with the
    termination of the Penobscot Shoe Company pension plan and a net
    gain on the sale of property of $142,000.                             

19



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|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(4) | The net amount of $442,000 in Other
    expense, net consists primarily of losses on dispositions
    and write-offs.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   
|(5) | The net amount of $1,377,000 in Other
    expense, net consists primarily of $394,000, or
    $0.06 per diluted share, of non-capitalized acquisition
    expenses, $354,000 in expenses, or $0.05 per diluted share,
    associated with the relocation of our corporate offices from Old
    Town, Maine to Carlsbad, California, litigation costs and
    expenses totaling $733,000 or $0.17 per diluted share
    associated with the dissenting stockholders appraisal
    proceeding resulting from our fiscal 2000 acquisition of
    Penobscot Shoe Company and a $163,000 write-off of a non-trade
    receivable, or $0.02 per diluted share. These amounts were
    offset partially by an excise tax refund totaling $285,000, or
    $0.07 per diluted share, which was not taxable, associated
    with the fiscal 2001 termination of the Penobscot pension plan.
    Interest expense includes $376,000 or $0.05 per
    diluted share, of interest expense related to the settlement of
    the dissenting stockholders appraisal proceeding. On an
    aggregate basis, these amounts reduced our fiscal 2003 per
    diluted share earnings by $0.28.
|   
|(6) | Per share and share data have been adjusted to
    reflect the 2-for-1 stock split effective at the close of
    business on June 12, 2003. Our 401(k) plan holds
    798,847 shares of our common stock, of which
    592,331 shares were not allocated to the accounts of plan
    participants as of December 27, 2003 and were classified as
    treasury shares for financial statement reporting purposes, but
    are outstanding for voting purposes and other legal purposes,
    and are excluded from the weighted average shares outstanding.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      



|        |                                                                                          
|------- | -----------------------------------------------------------------------------------------
|Item 7. | Managements Discussion and Analysis
    of Financial Condition and Results of Operations

The following discussion should be read in
conjunction with the historical consolidated financial
statements and the related notes and the other financial
information included elsewhere in this Annual Report on
Form 10-K. This discussion contains forward-looking
statements that involve risks and uncertainties. Our actual
results could differ materially from those anticipated in these
forward-looking statements as a result of any number of factors,
including those set forth under Risks Related To Our
Business and under other captions contained elsewhere in
this Annual Report on Form 10-K.

Effective January 1, 2003, we changed our
accounting year to a 52/53 week period. Our annual
accounting period ends on the Saturday nearest to
December 31. The change in fiscal year end did not
materially impact our fiscal 2003 results of operations or
year-over-year comparisons.

Overview

We are a mens and womens footwear and
apparel company. We design, develop and market branded dress and
casual footwear and apparel. We sell over 80 different styles of
footwear and over 250 different styles of apparel products.
Through our own sales force and independent contractors we sell
our footwear products primarily to department stores, national
and regional chain stores and independent retailers, and sell
our apparel products primarily to specialty retailers. We also
distribute our products directly to consumers over our Internet
websites, through third-party catalog companies, through our own
direct mail catalogs and through our two retail outlet stores in
Berkeley and Modesto, California. In addition, we offer a
limited number of private label programs to retailers. We
distribute our footwear products from our Old Town, Maine
distribution center and our apparel products from our Modesto,
California distribution center.

By emphasizing traditional style, quality and
fit, we believe we can better maintain a loyal consumer
following that is less susceptible to fluctuations due to
changing fashion trends and consumer preferences. As a result, a
significant number of our product styles carry over from
year-to-year. In addition, our design and product development
teams seek to create and introduce new products and styles that
complement these longstanding core products, are consistent with
our brand images and meet our high quality standards. We believe
our brands have significant potential for growth through
increases in product assortment, brand extensions and expansion
of our retail channels.

20



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##### Table of Contents



In recent years, we have implemented a number of
strategic initiatives that had a positive impact on our revenue
growth, business operations and financial condition. In June
1999, to increase our production flexibility and capacity while
at the same time allowing us to substantially reduce capital
expenditures and avoid the costs of managing a large production
work force, we discontinued our domestic manufacturing
operations and began to outsource all of our footwear products
operations to foreign sources. All of our products are now
produced by foreign manufacturers located in Brazil, China,
South and Central America and Southeast Asia. We purchase our
products with short-term purchase orders denominated in
U.S. dollars.

During the second quarter of fiscal 2003, we
relocated our corporate offices from Old Town, Maine to
Carlsbad, California. We believe this relocation assists us in
attracting and retaining key personnel and provides us with
greater access to our major customers and markets.

Acquisition Program

In fiscal 2000, we embarked on an acquisition
program in order to enhance our growth and increase
profitability by leveraging our corporate infrastructure. In
fiscal 2000, we acquired L.B. Evans Companys mens
slipper business and related brands and Penobscot Shoe Company
including its Trotters brand of traditional womens
footwear. In fiscal 2003 we acquired H.S. Trask & Co.,
a mens footwear company, and Royal Robbins, Inc., an
apparel company.

We intend to continue to pursue acquisitions of
sustainable niche brands in the footwear and apparel industry
that could complement or expand our business, or augment our
market coverage. We seek companies or product lines that have
consistent historical cash flow and brand growth potential and
can be purchased at a reasonable price. We also may acquire
businesses that we feel could provide us with important
relationships or otherwise offer us growth opportunities. We
plan to fund our future acquisitions through bank financing,
seller debt or equity financing and public or private equity
financing. Although we are actively seeking acquisitions, as of
the date of this Annual Report on Form 10-K we have no
agreements with respect to any such acquisitions, and there can
be no assurance that we will be able to identify and acquire
such businesses or obtain necessary financing on favorable terms.

We funded our acquisitions in fiscal 2000
primarily through bank debt, which at December 31, 2000
totaled $18.9 million. In fiscal 2001, we received a
$2.0 million investment in our common stock by our 401(k)
plan, which was funded through a reversion of Penobscots
over-funded pension plan, and a $750,000 investment by our
Chairman and Chief Executive Officer in a convertible
subordinated debenture that he later converted into shares of
our common stock in fiscal 2002. In December 2001, we sold our
mens and womens slipper business, which included the
Daniel Green, L.B. Evans and
Woolrich brands and the related inventory, for a
gain of $1.2 million, so that we could concentrate our
efforts on the Trotters and SoftWalk brands and on future
acquisitions.

During fiscal 2002, we continued our focus on
operating our business profitably and reducing our bank debt. By
December 31, 2002 we reduced our bank debt to
$3.0 million. As a result, we positioned ourselves to
continue with our strategy of building our organization and
portfolio of brands through acquisitions.

In the last two quarters of fiscal 2003, we
acquired H.S. Trask & Co., a mens footwear
company and Royal Robbins, Inc., an apparel company. We
paid a total purchase price of $13.2 million for these two
acquisitions, of which $9.5 million was cash and the
remainder was an issuance of 771,869 shares of our common
stock. We also included potential earnout payments in the Royal
Robbins transaction, subject to certain financial thresholds.
These acquisitions were funded through a combination of bank
financing, and seller equity and debt financing. We accounted
for both of these acquisitions using the purchase method of
accounting and, accordingly, the assets acquired, liabilities
assumed, and results of operations are included in our
consolidated financial statements from the date of the
acquisitions. The excess of the purchase price in these
acquisitions over the fair value of identifiable net assets
acquired represents goodwill and unamortizable intangible assets
that must periodically be tested for impairment. Trademarks and
trade names are deemed to have an indefinite useful life and are
not presently being amortized but we periodically test them for
impairment in accordance with current accounting standards. In
connection with the Royal Robbins acquisition, our bank provided
us with a new $24.8 million secured credit facility, which
we used to refinance

21



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##### Table of Contents



our existing indebtedness and to fund the cash
portion of the purchase price paid for the Royal Robbins and
H.S. Trask acquisitions. (See Liquidity & Capital
Resources.)


Our fiscal 2003 acquisitions added to our
portfolio of brands, diversified our product offerings and
customer base and provided a base for significant additional
revenues in the future. Since making these acquisitions, we have
integrated their operations with our infrastructure and have
rationalized their operations to take advantage of duplicative
overhead and operational inefficiencies.

During fiscal 2003, we also focused on investing
in our infrastructure to support our existing and newly acquired
brands. For example, we hired seasoned personnel in the areas of
product design, merchandizing and brand management.
Additionally, to accommodate our newly acquired brands, in March
2004 we expanded our corporate headquarters by adding
approximately 5,000 additional square feet at annual additional
rent and related costs of $107,000.

Results of Operations

The following table sets forth selected
consolidated operating results for each of the last three fiscal
years, presented as a percentage of net sales.

|                                                           |                              |                   |     |              |   |              |      |     |  |  |      |     | 
|---------------------------------------------------------- | ---------------------------- | ----------------- | --- | ------------ | - | ------------ | ---- | --- |  |  | ---- | --- | 
|                                                           |                              |                  
|                                                           |                              | Fiscal Year Ended
|                                                           |                              |                  
|                                                           |                              | December 31,      |     | December 31, |   | December 27,
|                                                           |                              | 2001              |     | 2002         |   | 2003        
|                                                           |                              |                   |     |              |   |             
|Net sales                                                  |                              |                   | 100 | %            |   |              | 100% |     |  |  | 100% |    
|Costs of goods sold                                        |                              |                   | 67  | %            |   |              | 62%  |     |  |  | 57%  |    
|                                                           | Gross profit                 |                   |     | 33           | % |              |      | 38% |  |  |      | 43% | 
|Selling, general and administrative and other
    expenses |                              |                   | 26  | %            |   |              | 28%  |     |  |  | 36%  |    
|                                                           | Operating income             |                   |     | 7            | % |              |      | 10% |  |  |      | 7%  | 
|Interest expense                                           |                              |                   | 4   | %            |   |              | 2%   |     |  |  | 2%   |    
|                                                           | Earnings before income taxes |                   |     | 3            | % |              |      | 8%  |  |  |      | 5%  | 
|Income tax expense                                         |                              |                   |    |              |   |              | 3%   |     |  |  | 3%   |    
|                                                           | Net earnings                 |                   |     | 3            | % |              |      | 5%  |  |  |      | 2%  | 

Fiscal 2003 Compared to Fiscal 2002

Net Sales.Our net
sales for fiscal 2003 were $39.1 million compared to
$36.2 million for fiscal 2002, representing an 8% increase.
Included in fiscal 2003 net sales are partial year net
sales of $4.7 million from 2003 acquisitions. Excluding
these sales, our fiscal 2003 net sales would have decreased
$1.8 million, or 5%, compared to fiscal 2002. Against the
backdrop of depressed retail and economic conditions this
decrease was primarily associated with decreased sales volume of
our Trotters brand, although partially offset by the
growth in the sales volume of our SoftWalk brand. The drop in
Trotters sales was due to poor retail acceptance of certain
Trotters styles during the Spring and Summer selling
seasons. We subsequently increased our investment in new product
design, which resulted in a product offering that received
increased retailer support for the Trotters brand 2003 Fall and
Winter selling seasons. We expect to continue to increase our
investment in product development in future periods, as
demonstrated by the recently introduced H.S. Trask womens
and Strol product lines. Additionally, the Royal Robbins product
line has historically invested significant resources in new
product development, and we anticipate this will continue in the
future.

Gross Profit.Our
gross profit for fiscal 2003 increased to $16.6 million
compared to $13.8 million for fiscal 2002. Our gross profit
percentage increased to 43% compared to 38% for fiscal 2002. Our
gross profit percentage improvement reflects a reduction in the
costs of our products through better inventory management and
improved sourcing. In addition, this improvement relates to a
change in product mix and a reduction in the volume of closeout
sales and associated mark-downs from the previous fiscal year.

Selling, General and Administrative
Expenses.Our selling, general and
administrative (SG&A) expenses for fiscal 2003
were $12.7 million, or 32% of net sales, compared to
$9.7 million, or 27% of net sales,

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for fiscal 2002. The increase includes $1.6
million in SG&A expenses associated with our brands acquired
in fiscal 2003, $417,000 of additional employee compensation and
benefit costs from additional hires, $516,000 of increased
marketing and advertising expenses, and $531,000 of additional
occupancy costs. These same items contributed to the increase of
SG&A as a percentage of net sales in 2003. We anticipate
that our fiscal 2004 SG&A expenses will increase as a result
of our fiscal 2003 acquisitions and our hiring of additional
staff to further strengthen our corporate infrastructure and
management team.


Other Expense, Net.Our other expenses, net, for fiscal 2003 were approximately
$1.4 million, compared to $442,000 for fiscal 2002. Fiscal
2003 other expenses, net, primarily consisted of $733,000 in
litigation expenses incurred with the dissenting Penobscot
stockholders settlement, $394,000 in non-capitalized acquisition
costs, $354,000 in expenses related to our corporate
headquarters relocation and the write-off of non-trade
receivables totaling $163,000. These expenses were partially
offset by an excise tax refund of $285,000 associated with the
2001 Penobscot pension plan reversion. Other expense, net,
totaled $442,000 for 2002 and consisted primarily of a loss on
the sale of assets and asset impairment charges.

Interest Expense.Interest expense for fiscal 2003 was
$620,000, including $376,000 related to the Penobscot
litigation, compared to $751,000, including $280,000 associated
with the Penobscot litigation in fiscal 2002. Exclusive of the
interest for the Penobscot litigation, interest expense would
have decreased $227,000 during fiscal 2003 as a result of lower
interest rates and average borrowings on our revolving credit
facility, which was partially offset by new term loans for a
portion of the fiscal year in connection with our 2003
acquisitions.

Income Taxes.Our
income tax expense for fiscal 2003 was $986,000 compared to
$1.2 million for fiscal 2002. Our effective tax rate was
51% for fiscal 2003 and 42% for fiscal 2002. The increase in the
2003 effective tax rate was primarily associated with the
Penobscot litigation settlement, which was substantially
non-deductible for income tax purposes and an excise tax refund,
which was substantially non-taxable for income tax purposes. We
anticipate our effective income tax rate for fiscal 2004 to be
approximately 42% based on our current operations, corporate
structure and asset base. Deferred income taxes reflect the net
tax effects of temporary differences between the carrying
amounts of assets and liabilities, for financial reporting
purposes, and the amounts used for income tax purposes.

Net Earnings.Our
net earnings were $941,000 for fiscal 2003, which was $762,000,
or 45%, lower than our net earnings for fiscal 2002. These
results represented diluted earnings per share of $0.22, which
was $0.23 lower than during fiscal 2002. Poor retail conditions
throughout the majority of 2003 and the items discussed in
Other Expense, Net above negatively affected our
financial performance. In early 2004, we have encountered a
marginal improvement in retailer optimism as indicated by
initial Spring order activity. Although we are cautiously
optimistic of the initial 2004 retail environment and the
related reports of increased consumer spending, there is no
assurance that a positive economic trend has been established or
if established, that it will continue in the future.

Fiscal 2002 Compared to Fiscal 2001

Net Sales.Our net
sales for fiscal 2002 were $36.2 million compared to
$46.9 million for fiscal 2001. Net sales for fiscal 2001
included $12.6 million from the slipper brands we divested
in December 2001. Combined net sales for our two then current
brands, Trotters and SoftWalk, increased 5% or $1.8 million
for fiscal 2002 compared to fiscal 2001, primarily due to
increased volume.

Gross Profit.Our
gross profit for fiscal 2002 decreased to $13.8 million
from $15.4 million for fiscal 2001. The decrease in the
dollar amount of our gross profit was primarily due to our
reduction in net sales following the divestiture of our slipper
brands. Our gross profit percentage increased to 38% for fiscal
2002 compared to 33% for fiscal 2001. The increase in gross
profit margin percentage reflects the fact that the divested
slipper brands carried a lower gross margin than our combined
Trotters and SoftWalk shoe brands.

Selling, General and Administrative Expenses.Our SG&A expenses for fiscal 2002
were $9.7 million, or 27% of net sales compared to
$11.9 million, or 25% of net sales, for fiscal 2001. The
reduction in SG&A

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expenses and the increase in SG&A expenses as
a percentage of net sales during fiscal 2002 was primarily
related to the divestiture of our slipper brands.


Other Expenses, Net.Our other expenses, net, for fiscal 2002 were $442,000, compared
to $375,000 for fiscal 2001. Included in the fiscal 2002 amount
was a loss of $254,000 on the sale of property; impairment
charges of $84,000 on a building held for sale and a write-off
of a $104,000 receivable associated with the sale of our slipper
brands in 2001. Included in the fiscal 2001 amount were costs
associated with the termination of the Penobscot pension plan,
totaling $1.7 million. During the fiscal quarter ended
June 30, 2001, we completed the termination of this pension
plan. Upon termination, the plan had $2.4 million in
surplus, which was less than the carrying value of our prepaid
pension cost asset of $3.7 million. This resulted in a
$1.3 million loss. This loss was increased by an excise tax
totaling $357,000, which resulted in a total loss on this
transaction of $1.7 million. Also included in other
expenses, net for fiscal 2001 is a gain of $1.2 million
associated with the 2001 sale of our slipper brands and a
$142,000 gain on the sale of property.

Interest Expense.Interest expense for fiscal 2002 was $751,000 compared to
$1.7 million for fiscal 2001. This decrease resulted from
lower interest rates and lower average outstanding indebtedness.

Income Taxes.Our
income tax expense for fiscal 2002 was $1.2 million
compared to $67,000 for fiscal 2001. Our effective tax rate was
approximately 42% in fiscal 2002, compared to 5% in fiscal 2001.
Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and
liabilities, for financial reporting purposes, and the amounts
used for income tax purposes. The difference in the effective
tax rates for the two fiscal years resulted from earnings
generated in fiscal 2002 and the reduction of the deferred tax
asset valuation allowance in fiscal 2001 as a result of our
evaluation of the realization of our deferred tax assets.

Net Earnings.Our
net earnings were approximately $1.7 million for fiscal
2002, which was $333,000, or 24%, higher than our net earnings
for fiscal 2001. These results represented $0.45 per
diluted share in fiscal 2002 and $0.41 per diluted share in
fiscal 2001. The increase in net earnings during fiscal 2002 was
primarily associated with our divestiture during late fiscal
2001 of our slipper brands, which historically generated
operating losses, and increased sales and profits during fiscal
2002 of our womens footwear brands.

Seasonal and Quarterly Fluctuations

The following sets forth our net sales and income
(loss) from operations for the quarterly periods indicated (in
thousands).

|                       |  |               |        |                |  |               |       |                |  |   |       |  |  |   |       | 
|---------------------- |  | ------------- | ------ | -------------- |  | ------------- | ----- | -------------- |  | - | ----- |  |  | - | ----- | 
|                       |  |              
|                       |  | 2002         
|                       |  |              
|                       |  | First Quarter |        | Second Quarter |  | Third Quarter |       | Fourth Quarter
|                       |  |               |        |                |  |               |       |               
|Net sales              |  | $             | 10,793 |                |  | $             | 8,446 |                |  | $ | 9,521 |  |  | $ | 7,401 | 
|Income from operations |  | $             | 1,240  |                |  | $             | 675   |                |  | $ | 992   |  |  | $ | 754   | 

|                              |  |               |       |                |  |               |       |                |  |   |        |  |  |   |        | 
|----------------------------- |  | ------------- | ----- | -------------- |  | ------------- | ----- | -------------- |  | - | ------ |  |  | - | ------ | 
|                              |  |              
|                              |  | 2003         
|                              |  |              
|                              |  | First Quarter |       | Second Quarter |  | Third Quarter |       | Fourth Quarter
|                              |  |               |       |                |  |               |       |               
|Net sales                     |  | $             | 9,207 |                |  | $             | 7,552 |                |  | $ | 11,002 |  |  | $ | 11,316 | 
|Income (loss) from operations |  | $             | 691   |                |  | $             | (353  | )              |  | $ | 1,714  |  |  | $ | 495    | 

Our quarterly results of operations have
fluctuated, and we expect will continue to fluctuate in the
future, as a result of seasonal variances. Net sales and income
from operations in our first and third quarters typically are
stronger than in our second and fourth quarters.

Liquidity and Capital Resources

Our primary liquidity requirements include debt
service, capital expenditures, working capital needs and
financing for acquisitions. We have historically met these
liquidity needs with cash flows from operations, borrowings
under our term loans and revolving credit facility, and seller
financing in acquisitions.

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On October 31, 2003, we obtained a new
secured $24.8 million credit facility from Manufacturers
and Traders Trust Company. The proceeds of this credit facility
were used to fund the cash portion of the purchase price due in
the Royal Robbins acquisition and to refinance our then-existing
credit facility, including the debt previously incurred with the
H.S. Trask acquisition, and to pay related fees and expenses.
This credit facility includes three term loans totaling
$6.8 million in principal and a revolving credit facility
with maximum availability running from $15.0 million during
the months of June through the following January to
$18.0 million during the months from February through the
following May. The aggregate amount that we may borrow under the
revolving credit facility at any time is established by a
borrowing base formula, which is determined according to our
inventory and accounts receivable levels, less a
$2.0 million amortized term loan and outstanding letters of
credit. The agreement is secured by substantially all of our
assets.

Amounts borrowed under our revolving credit
facility bear interest at a rate, as selected by us, equal to
LIBOR plus 2.75%, or the prime rate plus .25%, which was 4.0% at
March 5, 2004. The weighted average interest rate on the
balance of our revolver was 3.78% at March 5, 2004. The
term loans bear interest at a rate, as selected by us, equal to
LIBOR plus 3.00%, or the prime rate plus .375%. At March 5,
2004, the weighted average interest rate on the term loans was
3.58%.

Our credit facility contains covenants that
restrict, among other things, our ability to incur additional
indebtedness, pay dividends, create certain liens and make
acquisitions. Our credit facility also contains certain
financial maintenance covenants, which, among other things,
specify capital expenditure limits, a maximum average borrowed
funds to EBITDA ratio and current ratios and minimum cash flow
coverage ratio and net earnings requirements. In the event we
violate any of these covenants, or violate any other provision
of our lending arrangement, our credit agreement provides that
our lender has the right to accelerate repayment of all amounts
outstanding under the agreement and/or to commence foreclosure
proceedings on our assets. We were in compliance with all
covenants at December 27, 2003 and remain so as of the date
of this Annual Report on Form 10-K.

The outstanding balances for the revolving credit
facility and our term loans at March 5, 2004 were
$8.0 million and $6.3 million, respectively. The
available borrowing capacity under the revolving credit
facility, net of outstanding letters of credit of
$2.2 million, was approximately $1.0 million at
March 5, 2004. Future uses of proceeds of the revolving
credit facility are restricted to funding our working capital
requirements and capital expenditures.

The revolving credit facility matures on
May 1, 2006. Our $2.3 million term loan is payable in
three remaining consecutive $750,000 installments due on the
first day of May in each subsequent year. Our $2.7 million
term loan is payable in 18 remaining consecutive quarterly
installments each in the amount of $150,000, payable on
May 1, August 1, November 1 and February 1
of each year. Our $1.5 million term loan is payable in 56
remaining monthly payments of $25,000 due on the first day of
each month.

Cash Flows Provided By
Operations.During fiscal 2003 and
fiscal 2002, we generated $282,000 and $9.9 million,
respectively, in cash flows from operations. The
$9.6 million decline in cash flows provided by operations
resulted from our payment of settlement expenses relating to the
Penobscot dissenting stockholders action and the lack of any
carry-over receivables from our divested slipper business. Net
cash provided by operating activities for fiscal 2002 was due
primarily to the decrease in working capital resulting from the
fiscal 2001 divestiture of our slipper brands, including the
liquidation of approximately $5.0 million in receivables
that we retained when we divested our slipper business. Our
fiscal 2003 acquisitions resulted in increases in our in-stock
inventory position as well as our trade receivables. In
addition, non-capitalized expenses associated with our
acquisition activities contributed to the decline in cash
provided by operations during fiscal 2003.

Working capital at the end of fiscal 2003 was
approximately $13.4 million, compared to approximately
$8.8 million at the end of fiscal 2002. Our working capital
varies from time to time as a result of the seasonal
requirements of our brands, which have historically been
heightened during the first and third quarters, the timing of
factory shipments, the need to increase inventories and support
an in-stock position in anticipation of customers orders,
and the timing of accounts receivable collections. The
improvement in working capital at the end of fiscal 2003
compared to the end of fiscal 2002 is due primarily to the
impact of our fiscal 2003 acquisitions. These acquisitions
caused us to increase our short and long term debt and caused
increases in our

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year-end inventory and accounts receivable
balances. Our current ratio, the relationship of current assets
to current liabilities, decreased to 2.37 at December 27,
2003 from 2.58 at December 31, 2002 due primarily to our
fiscal 2003 acquisitions and the dissenting stockholders
litigation settlement. Accounts receivable days sales increased
from 72 days in 2002 to 76 days in 2003, reflective of
extended payment terms, and slower collection activity partially
offset by higher consumer direct sales, which are predominantly
settled through credit card payments.


Investing
Activities.In fiscal 2003, our cash
used in investing activities totaled $7.8 million compared
to cash provided by investing activities in fiscal 2002 and
fiscal 2001 of $1.3 million and $2.0 million,
respectively. During fiscal 2003 most of our cash used in
investing activities consisted of the purchase price payments we
made for our 2003 acquisitions. Cash provided by investing
activities in fiscal 2002 consisted mostly of the
$1.6 million in note receivable proceeds we received
related to the sale of our slipper brands. Cash provided by
investing activities in fiscal 2001 consisted primarily of the
$1.5 million in proceeds we received related to the sale of
our slipper brands.

For fiscal 2003, our capital expenditures were
$326,000 compared to $309,000 for fiscal 2002. These capital
expenditures consisted mostly of furniture, fixtures and
computer equipment associated with the relocation of the
Companys headquarters from Maine to California. In
addition, we renovated portions of our distribution center in
Maine to decrease the amount of office space and increase our
warehouse storage capacity. We currently have no material
commitments for future capital expenditures. For the current
fiscal year we anticipate capital expenditures of approximately
$560,000, which will consist generally of new computer hardware
and software, a trade show booth and a new roof for our Maine
distribution center. The actual amount of capital expenditures
for fiscal 2004 may differ from this estimate, largely depending
on acquisitions we may complete or unforeseen needs to replace
existing assets.

Financing Activities.For fiscal 2003, our net cash provided
by financing activities was $7.3 million compared to net
cash used of $11.1 million and $2.1 million for fiscal
2002 and fiscal 2001, respectively. The difference resulted
primarily from $4.0 million in additional advances under
our revolving credit facility and $4.5 million in new term
loan proceeds in fiscal 2003, both of which were partially
offset by $927,000 in repayments of notes payable and $201,000
in repurchases of common stock. We incurred the additional
indebtedness generally to fund the Penobscot litigation
settlement and our new acquisitions, including the payment of
the cash portion of the purchase price due and to refinance
working capital indebtedness of the acquired businesses. This
additional indebtedness was provided to us by our bank under our
new $24.8 million credit facility described above. In
comparison, during fiscal 2002 we used cash flow from operations
and note receivable proceeds from the sale of our slipper brands
to pay down $8.2 million on our revolving credit facility
and a net $2.9 million on our term loans. In fiscal 2001 we
used cash flow from operations, proceeds from the sale of our
slipper brands and the net cash surplus contributed to our
401(k) plan following termination of the Penobscot pension
plan to pay down $4.3 million on our revolving credit
facility.

On August 7, 2003, we acquired the H.S.
Trask footwear brand and rights to the Ducks Unlimited footwear
brand through the purchase of all the outstanding shares of H.S.
Trask & Co., a Bozeman, Montana based mens
footwear company, for an aggregate purchase price of
$6.4 million, including $2.9 million in cash, common
stock valued at $3.2 million and $300,000 in acquisition
related expenses. The value of the 699,980 shares of common
shares issued was determined based on the average closing market
price of the Companys common shares over the 3-day period
before the terms of the acquisition were agreed to and
announced. Concurrent with the acquisition, we entered into an
employment agreement which expired on December 31, 2003 and
a consulting agreement with Harrison Trask, founder of H.S.
Trask & Co., through December 31, 2005. The
consulting agreement provides for an annual fee of $90,000, and
we received a non-compete agreement from Mr. Trask, which
expires December 31, 2005.

On October 31, 2003, we acquired the Royal
Robbins apparel brand through the purchase of all the
outstanding shares of Royal Robbins, Inc. a Modesto,
California based apparel company, for an aggregate purchase
price of $6.8 million, including $6.0 million in cash,
71,889 shares of common stock valued at approximately
$500,000 and $300,000 in acquisition related expenses, plus
potential contingent earnout cash payments. The potential
contingent earnout payments equal 25% of the Royal Robbins
product lines gross

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profit over the 12 month periods ending
May 31, 2004 and 2005, respectively, so long as minimum
gross profit thresholds are achieved. The value of the 71,889
common shares issued was determined based on the average market
price of the Companys common shares over the 10-day
trading period ending on the second to last day prior to the
closing date of the acquisition. We expect that the earnout
payment that is due for the 12 months ended May 31,
2004 and payable on or before June 30, 2004 will be
approximately $2.5 million, which we will fund either from
operations or our revolving credit facility. However, in
accordance with SFAS No. 141, Business Combinations,
we recorded a contingent liability in the amount of
$1.9 million as of December 27, 2003. See Note 5
to Consolidated Financial Statements. Payments in excess of this
amount will result in an increase to the purchase price and
goodwill for this acquisition. Concurrent with the acquisition,
we entered into a consulting agreement with Dan Costa, former
chief executive officer and previous controlling stockholder of
Royal Robbins, Inc., through October 31, 2005, which
provides for an annual fee of $150,000, and we received a
non-compete agreement from Mr. Costa, which expires
October 31, 2008.


Our liquidity and capital resources have been
significantly impacted by acquisitions and may be impacted in
the foreseeable future by additional acquisitions. We have
historically financed acquisitions with borrowings, cash flows
from operations, issuances of our stock and in our last
acquisition through deferred contingent earnout payments. In the
future, we may further increase our indebtedness to finance
additional acquisitions. To the extent future acquisitions, if
any, are financed by additional indebtedness, the resulting
increase in debt and interest expense could have a negative
impact on liquidity. In May 2002, our board of directors
authorized us to repurchase shares of our outstanding common
stock in the open market or privately negotiated transactions
from time to time. We repurchased 8,000 and zero shares during
fiscal 2003 and fiscal 2002, respectively, under this program at
a total cost of $27,000. This program has been terminated. Our
board of directors has authorized us to repurchase, and from
time to time we have repurchased, shares in private transactions
from our 401(k) plan upon the election of the plan participant.
During 2003, we repurchased 49,833 shares from the 401(k)
plan at a total cost of $174,000. We place repurchased shares in
treasury and they are subsequently retired.

Our ability to generate sufficient cash to fund
our operations depends generally on the results of our
operations and the availability of financing. Our management
believes that cash flows from operations in conjunction with the
available borrowing capacity under the revolving credit
facility, net of outstanding letters of credit, of approximately
$1.0 million at March 5, 2004, will be sufficient for
the foreseeable future to fund operations, meet debt service
requirements and fund capital expenditures other than future
acquisitions.

Additional financing will have to be obtained for
any future acquisitions that we may make. We expect this
financing to be a combination of seller financing, cash from
operations, borrowings under our financing facilities and/or
issuances of additional equity or debt securities. Seller
financing depends upon the sellers willingness to accept
our shares as part of the consideration for an acquisition and
our willingness to issue our common shares, which will be
impacted by the market value of our common shares. If seller
financing is not available, we may be required to use cash from
operations, borrowings under our financing facilities and/or
issuances of additional equity or debt securities. Using cash
from operations to finance acquisitions would reduce the funds
we have available for other corporate purposes. Additional
borrowings would increase interest expense and may require us to
commit to additional covenants that further limit our financial
and operational flexibility.

Inflation

We believe that the relatively moderate rates of
inflation in recent years have not had a significant impact on
our net sales or profitability.

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Contractual Obligations

The following table summarizes our contractual
obligations at December 27, 2003 and the effects we expect
such obligations to have on liquidity and cash flow in future
periods.

|                              |  |                                       |        |           |  |           |       |           |  |         |       |  |  |   |       |  |  |  |   | 
|----------------------------- |  | ------------------------------------- | ------ | --------- |  | --------- | ----- | --------- |  | ------- | ----- |  |  | - | ----- |  |  |  | - | 
|                              |  |                                      
|                              |  | Payments Due by Period (in thousands)
|                              |  |                                      
|                              |  |                                       |        | Less than |  |           |       | More than
|                              |  | Total                                 |        | 1 Year    |  | 1-3 Years |       | 3-5 Years |  | 5 Years
|                              |  |                                       |        |           |  |           |       |           |  |        
|Long-term debt obligations    |  | $                                     | 12,082 |           |  | $         | 1,661 |           |  | $       | 8,792 |  |  | $ | 1,629 |  |  |  |  | 
|Operating leases              |  |                                       | 1,052  |           |  |           | 484   |           |  |         | 349   |  |  |   | 219   |  |  |  |  | 
|Potential earnout payments(1) |  | $                                     | 5,000  |           |  | $         | 2,500 |           |  | $       | 2,500 |  |  |   |      |  |  |  |  | 



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | In connection with our acquisition of Royal
    Robbins, we agreed to pay as part of the purchase price
    potential earnout cash payments equal to 25% of the gross profit
    of the Royal Robbins product lines for the 12-month periods
    ending May 31, 2004 and 2005, respectively, so long as
    minimum thresholds are achieved by the acquired business during
    these periods. The $5.0 million represents
    managements current estimate of the potential earnout cash
    payments the Company may be required to pay. Actual payments may
    vary from these estimated amounts.

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements other
than operating leases. See Contractual Obligations
above. We do not believe that these operating leases are
material to our current or future financial condition, results
of operations, liquidity, capital resources or capital
expenditures.

Related Party Transactions

In connection with bank financing, the Company
has in the past required the guaranties of Riedman Corporation.
In consideration therefor, the Board of Directors
(Mr. Riedman abstaining) granted Riedman Corporation three
options to purchase the Companys common stock. The first
was granted on July 17, 1997 to purchase 50,000 shares
at an exercise price of $2.38 per share, the market price.
The second and third were for 100,000 shares each. The
second was granted on September 1, 1999 and has an exercise
price of $2.38 per share, $1.00 per share more than
the market price on that date. The third was granted on
January 19, 2001 and has an exercise price of
$1.88 per share, the market price on that date. Each option
is for 10 years.

In order to assist the Company with its working
capital requirements, Mr. Riedman loaned the Company
$750,000 on April 11, 2001. The note evidencing the
indebtedness was due in one year and was convertible into
407,608 shares of common stock at $1.84, the market price
of the stock on that date. (Mr. Riedman exercised his
conversion right.) At the same time, Mr. Riedman was
granted an option to purchase 50,000 shares for
10 years at $1.84 per share. The Companys
continuing cash requirements necessitated an increase in the
Companys bank line and on June 1, 2001
Mr. Riedman guaranteed a portion thereof for which he was
granted an option to purchase 100,000 shares for
10 years at $1.75 per share, the market price of the
stock on that date.

Critical Accounting Policies

Managements discussion and analysis of our
financial condition and results of operations is based upon our
consolidated financial statements, which have been prepared in
accordance with the rules and regulations of the Securities and
Exchange Commission. The preparation of these financial
statements requires management to make estimates and judgments
that affect the reported amounts of assets, liabilities,
revenues and expenses, and related disclosure of contingent
assets and liabilities. We evaluate these estimates, including
those related to bad debts, inventories, intangible assets,
income taxes, and contingencies and litigation, on an ongoing
basis. We base these estimates on historical experiences and on
various other assumptions that we believe are reasonable under
the circumstances. These assumptions form our basis for making
judgments

28



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##### Table of Contents



about the carrying values of assets and
liabilities that are not readily apparent from other sources.
Actual results may differ from these estimates under different
assumptions or conditions.


We believe the following critical accounting
policies and the related estimates and assumptions discussed
below are among those most important to an understanding of our
consolidated financial statements.

Accounts receivable.We maintain allowances for doubtful accounts, discounts and
claims resulting from the inability of customers to make
required payments, and any claims customers may have for
merchandise. We initially record a provision for doubtful
accounts based on historical experience of write-offs and then
adjust this provision at the end of each reporting period based
on a detailed assessment of our accounts receivable and
allowance for doubtful accounts. In estimating the provision for
doubtful accounts, our management considers the age of the
accounts receivable, our historical write-offs, the
credit-worthiness of the customer, the economic conditions of
the customers industry, and general economic conditions,
among other factors. Should any of these factors change, the
estimates made by management will also change, which could
impact the level of our future provision for doubtful accounts.
Specifically, if the financial condition of our clients were to
deteriorate, affecting their ability to make payments,
additional provisions for doubtful accounts may be required. At
December 27, 2003, our gross trade accounts receivable
balance was $9.1 million and our allowance for doubtful
accounts was $1.0 million.

Inventory.We write
down inventory for estimated obsolescence or unmarketable
inventory in an amount equal to the differences between the cost
of the inventory and the estimated market value based upon
assumptions about future demand and market conditions. If actual
market conditions are less favorable than those projected by
management, additional inventory write-downs may be required. At
December 27, 2003, inventories were $13.6 million and
our inventory obsolescence reserve was $878,000. Our use of
different estimates and assumptions could produce different
financial results. For example, if we had assumed a 10.0%
reduction in our estimated selling prices, our inventory
obsolescence reserve at December 27, 2003 would have
increased by $110,000 to $988,000.

Business
Combinations.Acquisitions require
significant estimates and judgments related to the fair value of
assets acquired and liabilities assumed to which the transaction
costs are allocated under the purchase method of accounting.
Certain liabilities are subjective in nature. We reflect such
liabilities based upon the most recent information available.
The ultimate settlement of such liabilities may be for amounts
that are different from the amounts initially recorded. A
significant amount of judgment also is involved in determining
the fair value of assets acquired. Different assumptions could
yield materially different results.

Goodwill and Intangible
Assets.Certain of our identifiable
intangible assets, including non-compete agreements and customer
lists, are being amortized on the straight-line method over
their estimated useful lives, which range from 2 to
13 years. Additionally, we have recorded goodwill and
trademarks and trade names, all of which have indefinite useful
lives and are therefore not amortized. All of our intangible
assets and goodwill are reviewed for impairment whenever events
or changes in circumstances indicate that the carrying amount of
an asset may not be recoverable, and goodwill and intangible
assets with indefinite lives are reviewed for impairment at
least annually. Among other considerations, we consider the
following factors:



| |   |                                                                                                                              
| | - | -----------------------------------------------------------------------------------------------------------------------------
| |  | the assets ability to continue to generate
    income from operations and positive cash flow in future periods;             
|
| |  | our future plans regarding utilization of the
    assets;                                                                    
|
| |  | changes in legal ownership of rights to the
    assets; and                                                                  
|
| |  | changes in consumer demand or acceptance of the
    related brand names, products or features associated with the
    assets.

If we consider the assets to be impaired, we
recognize an impairment loss equal to the amount by which the
carrying value of the assets exceeds the estimated fair value of
the assets. In addition, as it relates to long-lived assets, we
base the useful lives and related amortization or depreciation
expenses on the estimate of the period that the assets will
generate sales or otherwise be used by us. At December 27,
2003, we had goodwill

29



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##### Table of Contents



and other intangible assets of
$10.8 million. The Company determined that there was no
impairment of goodwill to be recorded during the years ended
December 27, 2003 or December 31, 2002.


Recent Accounting Pronouncements

In June 2001, the Financial Accounting Standards
Board, or FASB, issued SFAS No. 143, Accounting for
Asset Retirement Obligations. SFAS No. 143
requires us to record the fair value of an asset retirement
obligation as a liability in the period in which it incurs a
legal obligation associated with the retirement of tangible
long-lived assets that result from the acquisition,
construction, development, and/or normal use of the assets. We
also record a corresponding asset that is depreciated over the
life of the asset. Subsequent to the initial measurement of the
asset retirement obligation, the obligation will be adjusted at
the end of each period to reflect the passage of time and
changes in the estimated future cash flows underlying the
obligation. We adopted SFAS No. 143 on January 1,
2003. The adoption of SFAS No. 143 did not have a
material effect on our consolidated financial position or
results from operations.

Effective January 1, 2002, we adopted
SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets, which addresses financial
accounting and reporting for the impairment or disposal of
long-lived assets. While SFAS No. 144 supersedes
SFAS No. 121, Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of, it retains many of the fundamental provisions of that
statement. The adoption of this standard did not have a material
impact on our consolidated financial position or results from
operations.

In April 2002, the FASB issued
SFAS No. 145, Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13,
and Technical Corrections. SFAS No. 145 amends
existing guidance on reporting gains and losses on the
extinguishment of debt to prohibit the classification of the
gain or loss as extraordinary, as the use of such
extinguishments have become part of the risk management strategy
of many companies. SFAS No. 145 also amends
SFAS No. 13 to require sale-leaseback accounting for
certain lease modifications that have economic effects similar
to sale-leaseback transactions. The provisions of the Statement
related to the rescission of Statement No. 4 is applied in
fiscal years beginning after May 15, 2002. We adopted
SFAS No. 145 on January 1, 2003. The adoption of
SFAS No. 145 did not have a material effect on our
consolidated financial position or results from operations.

In June 2002, the FASB issued
SFAS No. 146, Accounting for Costs Associated with
Exit or Disposal Activities. SFAS No. 146
addresses financial accounting and reporting for costs
associated with exit or disposal activities and nullifies
Emerging Issues Task Force Issue 94-3, Liability Recognition
for Certain Employee Termination Benefits and Other Costs to
Exit an Activity. The provisions of this Statement are
effective for exit or disposal activities that are initiated
after December 31, 2002, with early application encouraged.
The adoption of SFAS No. 146 did not have a material
effect on our consolidated financial position or results from
operations.

In November 2002, the FASB issued Interpretation
No. 45, Guarantors Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees
of Indebtedness to Others, an interpretation of FASB Statements
No. 5, 57, and 107 and a rescission of FASB Interpretation
No. 34. This Interpretation elaborates on the
disclosures to be made by a guarantor in its interim and annual
financial statements about its obligations under guarantees
issued. The Interpretation also clarifies that a guarantor is
required to recognize, at inception of a guarantee, a liability
for the fair value of the obligation undertaken. The initial
recognition and measurement provisions of the Interpretation are
applicable to guarantees issued or modified after
December 31, 2002 and are not expected to have a material
effect on our consolidated financial position or results from
operations. The disclosure requirements are effective for
financial statements of interim and annual periods ending after
December 31, 2002 and are included in the notes to our
consolidated financial statements.

In December 2002, the FASB issued
SFAS No. 148, Accounting for Stock-Based
Compensation  Transition and Disclosure, an amendment
of FASB Statement No. 123. This Statement amends FASB
Statement No. 123, Accounting for Stock-Based
Compensation, to provide alternative methods of transition
for a voluntary change to the fair value method of accounting
for stock-based employee compensation. In

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addition, this Statement amends the disclosure
requirements of Statement No. 123 to require prominent
disclosures in both annual and interim financial statements.
Certain of the disclosure modifications are required for fiscal
years ending after December 15, 2002 and are included in
the notes to our consolidated financial statements.


In January 2003, the FASB issued Interpretation
No. 46, Consolidation of Variable Interest Entities,
an interpretation of ARB No. 51, which was revised December
2003. This Interpretation addresses the consolidation by
business enterprises of variable interest entities as defined in
the Interpretation. The Interpretation generally applies
immediately to variable interests in variable interest entities
created after January 31, 2003 and to variable interests in
variable interest entities obtained after March 15, 2004.
The application of this Interpretation did not have a material
effect on our consolidated financial statements.

In May 2003, FASB issued SFAS No. 149,
Amendment of Statement No. 133 on Derivative Instruments
and Hedging Activities. The statement is effective for
contracts entered into or modified after June 30, 2003 and
for hedging relationships designated after June 30, 2003.
This statement amends and clarifies financial accounting and
reporting for derivative instruments, including certain
derivative instruments embedded in other contracts and for
hedging activities. This statement amends Statement No. 133
for decisions made as part of the Derivatives Implementation
Group process that effectively required amendments to Statement
No. 133, in connection with other Board projects dealing
with financial instruments and in connection with implementation
issues raised in relation to the application of the definition
of a derivative. The Company does not believe that the adoption
of this Statement will have a significant impact on the
Companys consolidated financial statements.

In May 2003, the FASB issued
SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and
Equity. The statement is effective for financial instruments
entered into or modified after May 31, 2003, and otherwise
is effective at the beginning of the first interim period
beginning after June 15, 2003. This statement establishes
standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities
and equity. It requires that an issuer classify a financial
instrument that is within its scope as a liability. Many of
those instruments were previously classified as equity. The
Company does not believe that the adoption of this Statement
will have a significant impact on the Companys
consolidated financial statements.



|         |                                                              
|-------- | -------------------------------------------------------------
|Item 7A. | Quantitative and Qualitative Disclosure
    About Market Risk

We are exposed to interest rate changes primarily
as a result of our line of credit and long-term debt, which we
use to maintain liquidity and to fund capital expenditures and
expansion. Our market risk exposure with respect to this debt is
to changes in the prime rate in the U.S. and changes
in LIBOR. Our revolving line of credit and our term loans
provide for interest on outstanding borrowings at rates tied to
the prime rate or, at our election, tied to LIBOR. At
December 27, 2003, we had $12.1 million in outstanding
borrowings under our credit facility. A 1.0% increase in
interest rates on our current borrowings would have had a
$121,000 impact on income (loss) before income taxes. We do not
enter into derivative or interest rate transactions for
speculative purposes.

In the normal course of business and consistent
with established policies and procedures we use the necessary
financial instruments to manage the fluctuations in interest
rates. The Company does not have any foreign currency risk.

31



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##### Table of Contents





|        |                                               
|------- | ----------------------------------------------
|Item 8. | Financial Statements and Supplemental
    Data

Summarized Quarterly Data
(Unaudited)

|                                     |         |                                       |       |      |  |     |       |       |   |       |        |      |  |   |        |      |  |   |        |      | 
|------------------------------------ | ------- | ------------------------------------- | ----- | ---- |  | --- | ----- | ----- | - | ----- | ------ | ---- |  | - | ------ | ---- |  | - | ------ | ---- | 
|                                     |         |                                      
|                                     |         | Fiscal Year 2003 Quarters            
|                                     |         |                                      
|                                     |         | 1st                                   |       | 2nd  |  | 3rd |       | 4th   |   | Total
|                                     |         |                                       |       |      |  |     |       |       |   |      
|                                     |         |                                      
|                                     |         | (In thousands, except per share data)
|Net sales                            |         | $                                     | 9,207 |      |  | $   | 7,552 |       |   | $     | 11,002 |      |  | $ | 11,316 |      |  | $ | 39,077 |     
|Gross Profit                         |         | $                                     | 4,020 |      |  | $   | 3,187 |       |   | $     | 4,539  |      |  | $ | 4,874  |      |  | $ | 16,620 |     
|Net income (loss)                    |         | $                                     | 375   |      |  | $   | (688  | )     |   | $     | 1,146  |      |  | $ | 108    |      |  | $ | 941    |     
|Earnings (loss) per Common Share:(1) |         |                                       |       |      |  |     |       |       |   |       |        |      |  |   |        |      |  |   |        |     
|                                     | Basic   |                                       | $     | 0.10 |  |     | $     | (0.19 | ) |       | $      | 0.28 |  |   | $      | 0.02 |  |   | $      | 0.24 | 
|                                     | Diluted |                                       | $     | 0.10 |  |     | $     | (0.19 | ) |       | $      | 0.26 |  |   | $      | 0.02 |  |   | $      | 0.22 | 

|                              |         |                                       |        |      |  |     |       |      |  |       |       |      |  |   |       |      |  |   |        |      | 
|----------------------------- | ------- | ------------------------------------- | ------ | ---- |  | --- | ----- | ---- |  | ----- | ----- | ---- |  | - | ----- | ---- |  | - | ------ | ---- | 
|                              |         |                                      
|                              |         | Fiscal Year 2002 Quarters            
|                              |         |                                      
|                              |         | 1st                                   |        | 2nd  |  | 3rd |       | 4th  |  | Total
|                              |         |                                       |        |      |  |     |       |      |  |      
|                              |         |                                      
|                              |         | (In thousands, except per share data)
|Net sales                     |         | $                                     | 10,793 |      |  | $   | 8,446 |      |  | $     | 9,521 |      |  | $ | 7,401 |      |  | $ | 36,161 |     
|Gross Profit                  |         | $                                     | 3,832  |      |  | $   | 3,083 |      |  | $     | 3,818 |      |  | $ | 3,031 |      |  | $ | 13,764 |     
|Net income                    |         | $                                     | 605    |      |  | $   | 343   |      |  | $     | 551   |      |  | $ | 204   |      |  | $ | 1,703  |     
|Earnings per Common Share:(1) |         |                                       |        |      |  |     |       |      |  |       |       |      |  |   |       |      |  |   |        |     
|                              | Basic   |                                       | $      | 0.20 |  |     | $     | 0.10 |  |       | $     | 0.16 |  |   | $     | 0.06 |  |   | $      | 0.50 | 
|                              | Diluted |                                       | $      | 0.17 |  |     | $     | 0.09 |  |       | $     | 0.14 |  |   | $     | 0.06 |  |   | $      | 0.45 | 



---



|    |                                                                                                                                                                                                      
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Earnings per share are computed individually for
    each of the quarters presented; therefore, the sum of the
    quarterly earnings per share may not necessarily equal the total
    for the year.

Management of Phoenix Footwear Group, Inc.
is responsible for the information and representations contained
in this report. The financial statements have been prepared in
conformity with the generally accepted accounting principles we
considered appropriate in the circumstances and include some
amounts based on our best estimates and judgments. Other
financial information in this report is consistent with these
financial statements.

Our accounting systems include controls designed
to reasonably assure that assets are safeguarded from
unauthorized use or disposition and which provide for the
preparation of financial statements in conformity with generally
accepted accounting principles. These systems are supplemented
by the selection and training of qualified accounting personnel
and an organizational structure providing for appropriate
segregation of duties.

The Audit Committee is responsible for
recommending to the Board of Directors the appointment of the
independent accountants and reviews with the independent
accountants and management the scope of the annual examination,
the effectiveness of the accounting control system and other
matters relating to the financial affairs of Phoenix Footwear as
they deem appropriate. The independent accountants have access
to the Audit Committee, with and without presence of management,
to discuss any appropriate matters.



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

There has been no change of accountants nor any
disagreements with accountants on any matter of accounting
principles or practices of financial statement disclosure
required to be reported under this Item.



|         |                        
|-------- | -----------------------
|Item 9A. | Controls and Procedures

An evaluation was performed under the supervision
of the Companys management, including the Chief Executive
Officer (CEO) and Chief Financial Officer (CFO), of the
effectiveness of the design and operation of the Companys
disclosure controls and procedures (as defined in Securities
Exchange Act of 1934 (the

32



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##### Table of Contents



Exchange Act) Rules 13a-15(e)
and 15-d-15(e)) as of the end of the period covered by this
report. Based on that evaluation, the Companys management,
including the CEO and CFO, concluded that the Companys
disclosure controls and procedures were effective to provide
reasonable assurance that information we are required to
disclose in reports that we file or submit under the Exchange
Act is recorded, processed, summarized and reported within the
time periods specified in SEC rules and forms.


Notwithstanding the foregoing, there can be no
assurance that the Companys disclosure controls and
procedures will detect or uncover all failures of persons within
the Company and its consolidated subsidiaries to disclose
material information otherwise required to be set forth in the
Companys periodic reports. There are inherent limitations
to the effectiveness of any system of disclosure controls and
procedures, including the possibility of human error and the
circumvention or overriding of the controls and procedures.
Accordingly, even effective disclosure controls and procedures
can only provide reasonable, not absolute, assurance of
achieving their control objectives.

There has been no change in the Companys
internal controls over financial reporting that occurred during
the last fiscal quarter that has materially affected, or is
reasonably likely to materially affect, the Companys
internal controls over financial reporting.




PART III



|         |                                                       
|-------- | ------------------------------------------------------
|Item 10. | Directors and Executive Officers of the
    Registrant

The information required by Item 10 is
included under Election of Directors and
Executive Officers of the Company, in the definitive
Proxy Statement for our 2004 Annual Meeting of Stockholders to
be filed with the Commission within 120 days after the end
of fiscal 2003, pursuant to Regulation 14A and is
incorporated herein by reference.



|         |                       
|-------- | ----------------------
|Item 11. | Executive Compensation

The information required by Item 402 of
Regulation S-K regarding executive compensation is included
under Election of Directors and Executive
Officers of the Company, and Performance Graph
in the definitive Proxy Statement for our 2004 Annual Meeting of
Stockholders to be filed with the Commission within
120 days after the end of fiscal 2003, pursuant to
Regulation 14A and is incorporated herein by reference.



|         |                                                                   
|-------- | ------------------------------------------------------------------
|Item 12. | Security Ownership of Certain Beneficial
    Owners and Management

The information required by Items 201(d) and
403 of Regulation S-K regarding equity compensation and
security ownership, respectively, is included under Equity
Compensation Plan Information and Security Ownership
of Certain Beneficial Owners and Management, respectively,
in the definitive Proxy Statement for our 2004 Annual Meeting of
Stockholders and is incorporated herein by reference.



|         |                                                   
|-------- | --------------------------------------------------
|Item 13. | Certain Relationships and Related
    Transactions

The information required by Item 404 of
Regulation S-K regarding certain relationships and related
transactions is included under Certain Relationships and
Transactions in the definitive Proxy Statement for our
2004 Annual Meeting of Stockholders to be filed with the
Commission within 120 days after the end of fiscal 2003,
pursuant to Regulation 14A and is incorporated herein by
reference.



|         |                                           
|-------- | ------------------------------------------
|Item 14. | Principal Accounting Fees and
    Services

The information required under Item 14 is
included under Financial Matters with Deloitte &
Touche LLP in the definitive Proxy Statement for our 2004
Annual Meeting of Stockholders to be filed with the Commission
within 120 days after the end of fiscal 2003, pursuant to
Regulation 14A and is incorporated herein by reference.

33



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PART IV




|         |                                                                     
|-------- | --------------------------------------------------------------------
|Item 15. | Exhibits, Financial Statements Schedule,
    and Reports on Form 8-K

(a) Exhibits  Financial
Statements; Financial Statements Schedules and Exhibits



| |                          
| | -------------------------
| | (1) Financial Statements:



| |                                                       
| | ------------------------------------------------------
| | 1. Independent Auditors Report                       
| | 2. Consolidated Balance Sheets                        
| | 3. Consolidated Statements of Operations              
| | 4. Consolidated Statements of
    Stockholders Equity
| | 5. Consolidated Statements of Cash Flows              



| |                                                 
| | ------------------------------------------------
| | (2) Financial Statement Schedules(See (c) below)
|
| | (3) Exhibits:                                   

| |    |    |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | -- | -- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 2  | .1 |  | Agreement and Plan of Merger dated as of
    June 16, 2003, by and among Phoenix Footwear Group, Inc.,
    H.S. Trask & Co., PFG Acquisition, Inc. and Nancy
    Delekta as stockholder representative (incorporated by reference
    to the Quarterly Report on Form 10-Q filed August 12, 2003
    by Phoenix Footwear Group, Inc. (SEC File
    No. 001-31309)) (Exhibits and schedules have been omitted
    pursuant to Item 601(b)(2) of Regulation S-K, but a
    copy will be furnished supplementally to the Securities and
    Exchange Commission upon request)                                                                                               
| | 2  | .2 |  | Letter Amendment to Agreement and Plan of Merger
    dated August 6, 2003, by and among Phoenix Footwear
    Group, Inc., H.S. Trask & Co., and PFG
    Acquisition, Inc., and Nancy Delekta as stockholder
    representative (incorporated by reference to the Quarterly
    Report on Form 10-Q filed August 12, 2003 by Phoenix
    Footwear Group, Inc. (SEC File No. 001-31309))                                                                                                                                                                                                                                                                                   
| | 2  | .3 |  | Stock Purchase Agreement By and Among Dan J. and
    Denise L. Costa, as trustees of the Dan J. and
    Denise L. Costa 1997 Family Trust and Douglas Vient as
    trustee of the Kelsie L. Costa Trust and the Daniel S.
    Costa Trust, Royal Robbins, Inc., and Phoenix Footwear Group,
    Inc., dated October 2, 2003 (incorporated by reference to
    Exhibit 2.1 to the Current Report Form 8-K dated
    November 5, 2003 (SEC File No. 001-31309)) (Exhibits
    and schedules have been omitted pursuant to Item 601(b)(2)
    of Regulation S-K, but a copy will be furnished
    supplementally to the Securities and Exchange Commission upon
    request)
| | 3  | .1 |  | Certificate of Incorporation. (incorporated
    herein by reference to Appendix B of the definitive Proxy
    Statement on Schedule 14A dated March 29, 2002 (SEC
    File No. 000-00774)).                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | 3  | .2 |  | By-Laws. (incorporated herein by reference to
    Appendix C of the definitive Proxy Statement on
    Schedule 14A dated March 29, 2002 (SEC File
    No. 000-00774)).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| | 3  | .3 |  | Certificate of Amendment to Certificate of
    Incorporation. (incorporated herein by reference to
    Exhibit A of the Definitive Proxy Statement on Schedule 14A
    dated April 14, 2003 (SEC File No. 001-31309)).                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| | 10 | .1 |  | Stock Purchase Agreement between Phoenix Footwear
    Group, Inc. (f/k/a Daniel Green Company) and Riedman Corporation
    dated June 26, 1996 (incorporated by reference to
    Exhibit 2 of Form 8-K dated July 10, 1996 (SEC
    File No. 000-00774)).                                                                                                                                                                                                                                                                                                                                                                                                                
| | 10 | .2 |  | Stock Purchase Option between Phoenix Footwear
    Group, Inc. (f/k/a Daniel Green Company) and Riedman Corporation
    dated July 29, 1997 (incorporated by reference to
    Exhibit 99.1 of Form SC 13D/A dated
    August 11, 1997 (SEC File No. 005-36674)).                                                                                                                                                                                                                                                                                                                                                                                                         
| | 10 | .3 |  | Stock Purchase Option between Phoenix Footwear
    Group, Inc. (f/k/a Daniel Green Company) and Riedman Corporation
    dated September 1, 1999                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | 10 | .4 |  | Agreement by and between Phoenix Footwear Group,
    Inc. and Wilhelm Pfander dated December 18, 2000                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | 10 | .5 |  | Stock Purchase Option between Phoenix Footwear
    Group, Inc. (f/k/a Daniel Green Company) and Riedman Corporation
    dated January 19, 2001 (incorporated by reference to
    Exhibit 99.1 of Form SC 13D/A dated
    February 28, 2001 (SEC File No. 005-36674)).                                                                                                                                                                                                                                                                                                                                                                                                    

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| |    |     |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| | -- | --- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 10 | .6  |  | Stock Purchase Option between Phoenix Footwear
    Group, Inc. (f/k/a Daniel Green Company) and Riedman Corporation
    dated April 11, 2001.                                                                                                                                                                                                                                                                                                                                                                                                         
| | 10 | .7  |  | Stock Purchase Option between Phoenix Footwear
    Group, Inc. (f/k/a Daniel Green Company) and James R.
    Riedman dated June 1, 2001 (incorporated by reference to
    Exhibit 10 of Form 8-K dated June 26, 2001 (SEC
    File No. 000-00774)).                                                                                                                                                                                                                                                                                                   
| | 10 | .8  |  | Employment Agreement by and between Phoenix
    Footwear Group, Inc. and Greg A. Tunney dated
    September 1, 2001.                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | 10 | .9  |  | Amendment No. 1 to the Employment Agreement
    by and between Phoenix Footwear Group, Inc. and Greg A.
    Tunney dated September 1, 2001                                                                                                                                                                                                                                                                                                                                                                                                            
| | 10 | .10 |  | Non-Competition and Non-Disclosure Agreement
    between Harrison S. Trask and H.S. Trask &
    Co., dated August 6, 2003 (incorporated by reference to
    Exhibit 10.5 to the Quarterly Report on Form 10-Q
    dated August 12, 2003 (SEC File No. 001-31309))                                                                                                                                                                                                                                                                                     
| | 10 | .11 |  | Employment and Consulting Agreement between
    Harrison S. Trask and H.S. Trask & Co., dated
    August 6, 2003 (incorporated by reference to
    Exhibit 10.4 to the Quarterly Report on Form 10-Q
    dated August 12, 2003 (SEC File No. 001-31309))                                                                                                                                                                                                                                                                                              
| | 10 | .12 |  | Assignment for Patent Application (All Rights) by
    and between Wilhelm F. Pfander and Phoenix Footwear
    Group, Inc. dated August 27, 2003                                                                                                                                                                                                                                                                                                                                                                                                       
| | 10 | .13 |  | Second Amended and Restated Revolving Credit and
    Term Loan Agreement By and Between Phoenix Footwear Group,
    Inc. and Manufacturers and Traders Trust Company, dated
    October 30, 2003 (incorporated by reference to
    Exhibit 10.4 to the Quarterly Report on Form 10-Q
    dated November 12, 2003 (SEC File No. 001-31309))
    (Exhibits and schedules have been omitted pursuant to
    Item 601(b)(2) of Regulation S-K, but a copy will be
    furnished supplementally to the Securities and Exchange
    Commission upon request)
| | 10 | .14 |  | Noncompetition and Confidentiality Agreement
    between Phoenix Footwear Group, Inc., Royal Robbins, Inc. and
    Dan J. Costa entered into as of October 31, 2003
    (incorporated by reference to Exhibit 10.3 to the Quarterly
    Report on Form 10-Q dated November 12, 2003 (SEC File
    No. 001-31309))                                                                                                                                                                                                                                     
| | 10 | .15 |  | Consulting Agreement dated October 31, 2003
    between Royal Robbins, Inc. and Dan J. Costa (incorporated
    by reference to Exhibit 10.2 to the Quarterly Report on
    Form 10-Q dated November 13, 2003 (SEC file
    No. 001-31309))                                                                                                                                                                                                                                                                                                            
| | 10 | .16 |  | Employment Agreement by and between Phoenix
    Footwear Group, Inc. and Francisco Morales dated
    October 31, 2003                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | 10 | .17 |  | Employment Agreement by and between Phoenix
    Footwear Group, Inc. and James R. Riedman dated
    January 1, 2004                                                                                                                                                                                                                                                                                                                                                                                                                                   
| | 14 |     |  | Code of Ethics                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | 21 | .1  |  | Subsidiaries of Registrant. Penobscot Shoe
    Company, Royal Robbins, Inc. and H.S. Trask &
    Co., Inc.                                                                                                                                                                                                                                                                                                                                                                                                                                            
| | 23 | .1  |  | Consent of Deloitte & Touche LLP                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | 24 | .   |  | Power of Attorney.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | 31 | .1  |  | Certification of James R. Riedman pursuant to
    Rule 13a-14(a) and 15d-14(a), as adopted pursuant to
    Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                                                             
| | 31 | .2  |  | Certification of Kenneth Wolf pursuant to
    Rule 13a-14(a) and 15d-14(a), as adopted pursuant to
    Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                                                                 
| | 32 | .1  |  | Certification pursuant to 18 U.S.C.
    Section 1350, as adopted pursuant to Section 906 of
    the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                                                                                       

(b) Reports on Form 8-K



| |                                                                                                                                                                                                                                                                         
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 1) On November 5, 2003, the Company
    filed a report on Form 8-K announcing that on
    October 31, 2003 the Company acquired all of the
    outstanding capital stock of Royal Robbins, Inc., a
    privately held California-based casual and outdoor apparel brand.
|
| | 2) On October 24, 2003, the Company
    filed a report on Form 8-K announcing the signing of a
    definitive stock purchase agreement to acquire all of the
    outstanding capital stock of Royal Robbins, Inc.                                                       

35



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##### Table of Contents





| |                                                                                                                                                                                                                                                         
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 3) On October 22, 2003, the Company
    filed a report on Form 8-K announcing the Companys
    results of operations for the three and nine month periods ended
    September 27, 2003.                                                                
|
| | 4) On March 26, 2004, the Company filed
    a report on Form 8-K/A amending and restating the report
    filed on February 13, 2004, furnishing the Companys
    results of operations for the three month period and year ended
    December 27, 2003.

(c) Financial Statement Schedulesfor
the years ended December 27, 2003, December 31, 2002
and 2001 are as follows:



| |                                                                                                                                                                                                                                                       
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 1) Consolidated Valuation and Qualifying
    Accounts (Schedule II)                                                                                                                                                                                   
|
| | 2) Other Financial Statement Schedules not
    included in this Annual Report on Form 10-K have been
    omitted because they are not applicable or because the required
    information is included in the financial statements or notes
    thereto.

36



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##### Table of Contents








SCHEDULE II     CONSOLIDATED
VALUATION AND QUALIFYING ACCOUNTS


For The Years Ended December 27, 2003,
December 31, 2002 and 2001


|                                     |  |                |        |             |  |               |        |   |  |   |      |  
|------------------------------------ |  | -------------- | ------ | ----------- |  | ------------- | ------ | - |  | - | ---- | -
|                                     |  |                |        |             |  | Valuation    
|                                     |  | Allowance for  |        | Reserve for |  | Allowance for
|                                     |  | Doubtful       |        | Obsolete    |  | Deferred Tax 
|Period                               |  | Accounts       |        | Inventory   |  | Assets       
|                                     |  |                |        |             |  |              
|                                     |  |               
|                                     |  | (In thousands)
|Balance, December 31, 2000           |  | $              | 2,249  |             |  | $             | 1,862  |   |  | $ | 707  |  
|Provision                            |  |                | 2,677  |             |  |               | 1,705  |   |  |   |     |  
|Write-off, disposal, costs and other |  |                | (3,458 | )           |  |               | (2,826 | ) |  |   | (647 | )
|                                     |  |                |        |             |  |               |        |   |  |   |      |  
|Balance, December 31, 2001           |  | $              | 1,468  |             |  | $             | 741    |   |  | $ | 60   |  
|Provision                            |  |                | 1,327  |             |  |               | 1,814  |   |  |   |     |  
|Write-off, disposal, costs and other |  |                | (2,316 | )           |  |               | (2,071 | ) |  |   | (60  | )
|                                     |  |                |        |             |  |               |        |   |  |   |      |  
|Balance, December 31, 2002           |  | $              | 479    |             |  | $             | 484    |   |  |   |     |  
|                                     |  |                |        |             |  |               |        |   |  |   |      |  
|Provision                            |  |                | 738    |             |  |               | 883    |   |  |   |     |  
|Write-off, disposal, costs and other |  |                | (191   | )           |  |               | (489   | ) |  |   |     |  
|                                     |  |                |        |             |  |               |        |   |  |   |      |  
|Balance, December 27, 2003           |  | $              | 1,026  |             |  | $             | 878    |   |  |   |     |  
|                                     |  |                |        |             |  |               |        |   |  |   |      |  

37



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SIGNATURES

Pursuant to the requirements of Section 13
or 15(d) of the Securities and Exchange Act of 1934, the
registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.



| |                             
| | ----------------------------
| | PHOENIX FOOTWEAR GROUP, INC.



| |     |                     
| | --- | --------------------
| | By: | /s/ JAMES R. RIEDMAN

| |                    
| | -------------------
| |                    
| | James R. Riedman,  
| | Chairman and C.E.O.



| |     |                 
| | --- | ----------------
| | By: | /s/ KENNETH WOLF

| |                        
| | -----------------------
| |                        
| | Kenneth Wolf,          
| | Chief Financial Officer

Date: March 26, 2004

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.

|                                      |  |                                    |  |                |  | 
|------------------------------------- |  | ---------------------------------- |  | -------------- |  | 
|                                      |  |                                    |  |               
|Signature                             |  | Title                              |  | Date          
|                                      |  |                                    |  |               
|                                     
|/s/ JAMES R. RIEDMANJames R. Riedman  |  | Chairman and C.E.O.                |  | March 26, 2004
|                                     
|/s/ KENNETH WOLFKenneth Wolf          |  | Chief Financial Officer            |  | March 26, 2004
|                                     
|/s/ EDWARD BLOOMBERG*Edward Bloomberg |  | Director                           |  | March 26, 2004
|                                     
|/s/ STEVEN DEPERRIOR*Steven DePerrior |  | Director                           |  | March 26, 2004
|                                     
|/s/ GREGORY HARDEN*Gregory Harden     |  | Director                           |  | March 26, 2004
|                                     
|/s/ WILHELM PFANDER*Wilhelm Pfander   |  | Director and Senior VP of Sourcing |  | March 26, 2004
|                                     
|/s/ JOHN KRATZER*John Kratzer         |  | Director                           |  | March 26, 2004
|                                     
|/s/ GARY PFLUGFELDER*Gary Pflugfelder |  | Director                           |  | March 26, 2004
|                                     
|/s/ GREG A. TUNNEY*Greg A. Tunney     |  | Director and President and C.O.O.  |  | March 26, 2004



|  |                                                                                    
|- | -----------------------------------------------------------------------------------
|* | Signed by James R. Riedman pursuant to Power of
    Attorney in Item 15(a)24 above.

38



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PHOENIX FOOTWEAR GROUP, INC.

Consolidated Financial Statements as of
December 27, 2003 and December 31, 2002, and

for Each of the Three Years in the Period
Ended December 27, 2003 and


Independent Auditors Report


39



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INDEPENDENT AUDITORS REPORT


To the Board of Directors and Stockholders of
Phoenix Footwear Group, Inc.

Carlsbad, California.


We have audited the accompanying consolidated
balance sheets of Phoenix Footwear Group, Inc. and
subsidiary as of December 27, 2003 and December 31,
2002, and the related consolidated statements of operations,
stockholders equity, and cash flows for each of the three
years in the period ended December 27, 2003. Our audits
also included the financial statement schedule listed in the
Index at Item 15. These financial statements and financial
statement schedule are the responsibility of the Companys
management. Our responsibility is to express an opinion on the
financial statements and financial statement schedule based on
our audits.

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

In our opinion, such consolidated financial
statements present fairly, in all material respects, the
financial position of Phoenix Footwear Group, Inc. and
subsidiary as of December 27, 2003 and December 31,
2002, and the results of their operations and their cash flows
for each of the three years in the period ended
December 27, 2003, in conformity with accounting principles
generally accepted in the United States of America. Also, in our
opinion, such financial statement schedule, when considered in
relation to the basic consolidated financial statements taken as
a whole, presents fairly in all material respects the
information set forth therein.

As discussed in Note 1 to the consolidated
financial statements, in 2002 the Company changed its method of
accounting for goodwill to conform with Statement of Financial
Accounting Standards No. 142, Goodwill and Other
Intangible Assets.

DELOITTE & TOUCHE LLP

San Diego, CA

February 6, 2004


40



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##### Table of Contents



PHOENIX FOOTWEAR GROUP, INC.






CONSOLIDATED BALANCE SHEETS


DECEMBER 27, 2003 AND DECEMBER 31,
2002


|                                           |                                                                                                                                           |                            |            |            |            |   |            |            |            | 
|------------------------------------------ | ----------------------------------------------------------------------------------------------------------------------------------------- | -------------------------- | ---------- | ---------- | ---------- | - | ---------- | ---------- | ---------- | 
|                                           |                                                                                                                                           | 2003                       |            | 2002      
|                                           |                                                                                                                                           |                            |            |           
|CURRENT ASSETS:                            |                                                                                                                                           |                            |            |            |            |   |            |           
|                                           | Cash                                                                                                                                      |                            | $          | 1,058,000  |            |   | $          | 1,265,000  |           
|                                           | Accounts receivable (less allowances of
    $1,026,000 in 2003 and $479,000 in 2002)                                                      |                            |            | 8,083,000  |            |   |            | 5,679,000  |           
|                                           | Inventories  net                                                                                                                         |                            |            | 12,717,000 |            |   |            | 6,662,000  |           
|                                           | Other receivable                                                                                                                          |                            |            | 530,000    |            |   |            | 316,000    |           
|                                           | Other current assets                                                                                                                      |                            |            | 803,000    |            |   |            | 185,000    |           
|                                           | Deferred income tax asset                                                                                                                 |                            |            |           |            |   |            | 297,000    |           
|                                           |                                                                                                                                           |                            |            |            |            |   |            |           
|                                           |                                                                                                                                           | Total current assets       |            |            | 23,191,000 |   |            |            | 14,404,000 | 
|PLANT AND EQUIPMENT  Net                  |                                                                                                                                           |                            | 1,623,000  |            |            |   | 1,499,000  |           
|OTHER ASSETS:                              |                                                                                                                                           |                            |            |            |            |   |            |           
|                                           | Other assets  net                                                                                                                        |                            |            | 115,000    |            |   |            | 158,000    |           
|                                           | Goodwill                                                                                                                                  |                            |            | 5,178,000  |            |   |            | 1,645,000  |           
|                                           | Unamortizable intangibles                                                                                                                 |                            |            | 3,820,000  |            |   |            |           |           
|                                           | Intangible assets, net                                                                                                                    |                            |            | 1,766,000  |            |   |            |           |           
|                                           | Other receivable                                                                                                                          |                            |            | 718,000    |            |   |            | 1,248,000  |           
|                                           |                                                                                                                                           |                            |            |            |            |   |            |           
|                                           |                                                                                                                                           | Total other assets         |            |            | 11,597,000 |   |            |            | 3,051,000  | 
|                                           |                                                                                                                                           |                            |            |            |            |   |            |           
|TOTAL ASSETS                               |                                                                                                                                           | $                          | 36,411,000 |            |            | $ | 18,954,000 |           
|                                           |                                                                                                                                           |                            |            |            |            |   |            |           
|                                          
|LIABILITIES AND STOCKHOLDERS
    EQUITY  
|CURRENT LIABILITIES:                       |                                                                                                                                           |                            |            |            |            |   |            |           
|                                           | Accounts payable                                                                                                                          |                            | $          | 4,782,000  |            |   | $          | 1,872,000  |           
|                                           | Accrued expenses                                                                                                                          |                            |            | 1,077,000  |            |   |            | 1,164,000  |           
|                                           | Contingent liability                                                                                                                      |                            |            | 1,942,000  |            |   |            |           |           
|                                           | Notes payable  current                                                                                                                   |                            |            | 1,661,000  |            |   |            | 750,000    |           
|                                           | Liability to former stockholders                                                                                                          |                            |            |           |            |   |            | 1,806,000  |           
|                                           | Deferred income tax                                                                                                                       |                            |            | 195,000    |            |   |            |           |           
|                                           | Income taxes payable                                                                                                                      |                            |            | 111,000    |            |   |            |           |           
|                                           |                                                                                                                                           |                            |            |            |            |   |            |           
|                                           |                                                                                                                                           | Total current liabilities  |            |            | 9,768,000  |   |            |            | 5,592,000  | 
|OTHER LIABILITIES:                         |                                                                                                                                           |                            |            |            |            |   |            |           
|                                           | Notes payable  noncurrent                                                                                                                |                            |            | 4,941,000  |            |   |            | 2,250,000  |           
|                                           | Notes payable  line of credit                                                                                                            |                            |            | 5,480,000  |            |   |            |           |           
|                                           | Deferred income tax liability                                                                                                             |                            |            | 1,235,000  |            |   |            | 1,000,000  |           
|                                           |                                                                                                                                           |                            |            |            |            |   |            |           
|                                           |                                                                                                                                           | Total other liabilities    |            |            | 11,656,000 |   |            |            | 3,250,000  | 
|                                           |                                                                                                                                           |                            |            |            |            |   |            |           
|                                           |                                                                                                                                           | Total liabilities          |            |            | 21,424,000 |   |            |            | 8,842,000  | 
|Commitments and contingencies
    (Note 3) |                                                                                                                                           |                            |            |            |            |   |            |           
|STOCKHOLDERS EQUITY:                      |                                                                                                                                           |                            |            |            |            |   |            |           
|                                           | Common stock, $.01 par value 
    50,000,000 shares authorized; 5,061,000 and
    4,588,000 shares issued in 2003 and 2002, respectively |                            |            | 51,000     |            |   |            | 46,000     |           
|                                           | Additional paid-in-capital                                                                                                                |                            |            | 11,190,000 |            |   |            | 8,081,000  |           
|                                           | Retained earnings                                                                                                                         |                            |            | 5,320,000  |            |   |            | 4,379,000  |           
|                                           |                                                                                                                                           |                            |            |            |            |   |            |           
|                                           |                                                                                                                                           |                            | 16,561,000 |            |            |   | 12,506,000 |           
|                                           | Less: Treasury stock at cost, 603,000 and
    998,000 shares in 2003 and 2002, respectively                                               |                            |            | (1,574,000 | )          |   |            | (2,394,000 | )         
|                                           |                                                                                                                                           |                            |            |            |            |   |            |           
|                                           |                                                                                                                                           | Total stockholders equity |            |            | 14,987,000 |   |            |            | 10,112,000 | 
|                                           |                                                                                                                                           |                            |            |            |            |   |            |           
|TOTAL LIABILITIES AND STOCKHOLDERS EQUITY |                                                                                                                                           | $                          | 36,411,000 |            |            | $ | 18,954,000 |           
|                                           |                                                                                                                                           |                            |            |            |            |   |            |           

See notes to consolidated financial statements.

41



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PHOENIX FOOTWEAR GROUP, INC.






CONSOLIDATED STATEMENTS OF
OPERATIONS


YEARS ENDED DECEMBER 27, 2003 AND
DECEMBER 31, 2002 AND 2001


|                             |                                              |                          |            |            |            |      |            |           |            |   |            |            |            | 
|---------------------------- | -------------------------------------------- | ------------------------ | ---------- | ---------- | ---------- | ---- | ---------- | --------- | ---------- | - | ---------- | ---------- | ---------- | 
|                             |                                              | 2003                     |            | 2002       |            | 2001
|                             |                                              |                          |            |            |            |     
|NET SALES                    |                                              | $                        | 39,077,000 |            |            | $    | 36,161,000 |           |            | $ | 46,851,000 |           
|COST OF GOODS SOLD           |                                              |                          | 22,457,000 |            |            |      | 22,397,000 |           |            |   | 31,439,000 |           
|                             |                                              |                          |            |            |            |      |            |           |            |   |            |           
|GROSS PROFIT                 |                                              |                          | 16,620,000 |            |            |      | 13,764,000 |           |            |   | 15,412,000 |           
|                             |                                              |                          |            |            |            |      |            |           |            |   |            |           
|OPERATING EXPENSES:          |                                              |                          |            |            |            |      |            |           |            |   |            |           
|                             | Selling, general and administrative expenses |                          |            | 12,696,000 |            |      |            | 9,661,000 |            |   |            | 11,917,000 |           
|                             | Other expense  net                          |                          |            | 1,377,000  |            |      |            | 442,000   |            |   |            | 375,000    |           
|                             |                                              |                          |            |            |            |      |            |           |            |   |            |           
|                             |                                              | Total operating expenses |            |            | 14,073,000 |      |            |           | 10,103,000 |   |            |            | 12,292,000 | 
|                             |                                              |                          |            |            |            |      |            |           |            |   |            |           
|OPERATING INCOME             |                                              |                          | 2,547,000  |            |            |      | 3,661,000  |           |            |   | 3,120,000  |           
|INTEREST EXPENSE             |                                              |                          | 620,000    |            |            |      | 751,000    |           |            |   | 1,683,000  |           
|                             |                                              |                          |            |            |            |      |            |           |            |   |            |           
|EARNINGS BEFORE INCOME TAXES |                                              |                          | 1,927,000  |            |            |      | 2,910,000  |           |            |   | 1,437,000  |           
|INCOME TAX EXPENSE           |                                              |                          | 986,000    |            |            |      | 1,207,000  |           |            |   | 67,000     |           
|                             |                                              |                          |            |            |            |      |            |           |            |   |            |           
|NET EARNINGS                 |                                              | $                        | 941,000    |            |            | $    | 1,703,000  |           |            | $ | 1,370,000  |           
|                             |                                              |                          |            |            |            |      |            |           |            |   |            |           
|NET EARNINGS PER SHARE:      |                                              |                          |            |            |            |      |            |           |            |   |            |           
|                             | Basic                                        |                          | $          | 0.24       |            |      | $          | 0.50      |            |   | $          | 0.44       |           
|                             |                                              |                          |            |            |            |      |            |           |            |   |            |           
|                             | Diluted                                      |                          | $          | 0.22       |            |      | $          | 0.45      |            |   | $          | 0.41       |           
|                             |                                              |                          |            |            |            |      |            |           |            |   |            |           

See notes to consolidated financial statements.

42



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PHOENIX FOOTWEAR GROUP, INC.






CONSOLIDATED STATEMENTS OF STOCKHOLDERS
EQUITY


YEARS ENDED DECEMBER 27, 2003 AND
DECEMBER 31, 2002 AND 2001


|                            |                                                                                    |              |           |            |   |          |           |                |   |        |            |           |   |       |           |           |  |  |            |          |   |   |            |            |   |   |            |            |  
|--------------------------- | ---------------------------------------------------------------------------------- | ------------ | --------- | ---------- | - | -------- | --------- | -------------- | - | ------ | ---------- | --------- | - | ----- | --------- | --------- |  |  | ---------- | -------- | - | - | ---------- | ---------- | - | - | ---------- | ---------- | -
|                            |                                                                                    |              |           |            |   |          |           |                |   |       
|                            |                                                                                    | Common Stock |           | Additional |   |          |           | Treasury Stock |   |       
|                            |                                                                                    |              |           | Paid-In    |   | Retained |           |                |   |       
|                            |                                                                                    | Shares       |           | Amount     |   | Capital  |           | Earnings       |   | Shares |            | Amount    |   | Total
|                            |                                                                                    |              |           |            |   |          |           |                |   |        |            |           |   |      
|BALANCE  January 1, 2001   |                                                                                    |              | 3,398,000 |            |   | $        | 4,246,000 |                |   | $      | 816,000    |           |   | $     | 1,306,000 |           |  |  | (242,000   | )        |   | $ | (470,000   | )          |   | $ | 5,898,000  |           
|                            | Issuance of common stock                                                           |              |           | 782,000    |   |          |           | 978,000        |   |        |            | 1,037,000 |   |       |           |           |  |  |            |          |   |   |            |            |   |   |            | 2,015,000  |  
|                            | Unallocated shares held in the Company sponsored
    defined contribution plan     |              |           |            |   |          |           |                |   |        |            |           |   |       |           |           |  |  |            | (782,000 | ) |   |            | (2,015,000 | ) |   |            | (2,015,000 | )
|                            | Purchases of treasury stock                                                        |              |           |            |   |          |           |                |   |        |            |           |   |       |           |           |  |  |            | (24,000  | ) |   |            | (52,000    | ) |   |            | (52,000    | )
|                            | Issuance of common stock options in consideration
    for debt and debt guarantees |              |           |            |   |          |           |                |   |        |            | 236,000   |   |       |           |           |  |  |            |          |   |   |            |            |   |   |            | 236,000    |  
|                            | Net earnings  2001                                                                |              |           |            |   |          |           |                |   |        |            |           |   |       |           | 1,370,000 |  |  |            |          |   |   |            |            |   |   |            | 1,370,000  |  
|                            |                                                                                    |              |           |            |   |          |           |                |   |        |            |           |   |       |           |           |  |  |            |          |   |   |            |            |   |   |            |           
|BALANCE  December 31, 2001 |                                                                                    |              | 4,180,000 |            |   |          | 5,224,000 |                |   |        | 2,089,000  |           |   |       | 2,676,000 |           |  |  | (1,048,000 | )        |   |   | (2,537,000 | )          |   |   | 7,452,000  |           
|                            | Issuance of common stock                                                           |              |           | 408,000    |   |          |           | 511,000        |   |        |            | 244,000   |   |       |           |           |  |  |            |          |   |   |            |            |   |   |            | 755,000    |  
|                            | Purchases of treasury stock                                                        |              |           |            |   |          |           |                |   |        |            |           |   |       |           |           |  |  |            | (20,000  | ) |   |            | (35,000    | ) |   |            | (35,000    | )
|                            | Allocation of shares in Company sponsored defined
    contribution plan            |              |           |            |   |          |           |                |   |        |            | 59,000    |   |       |           |           |  |  |            | 70,000   |   |   |            | 178,000    |   |   |            | 237,000    |  
|                            | Effect of change in par value                                                      |              |           |            |   |          |           | (5,689,000     | ) |        |            | 5,689,000 |   |       |           |           |  |  |            |          |   |   |            |            |   |   |            |            |  
|                            | Net earnings  2002                                                                |              |           |            |   |          |           |                |   |        |            |           |   |       |           | 1,703,000 |  |  |            |          |   |   |            |            |   |   |            | 1,703,000  |  
|                            |                                                                                    |              |           |            |   |          |           |                |   |        |            |           |   |       |           |           |  |  |            |          |   |   |            |            |   |   |            |           
|BALANCE  December 31, 2002 |                                                                                    |              | 4,588,000 |            |   |          | 46,000    |                |   |        | 8,081,000  |           |   |       | 4,379,000 |           |  |  | (998,000   | )        |   |   | (2,394,000 | )          |   |   | 10,112,000 |           
|                            | Issuance of common stock                                                           |              |           | 35,000     |   |          |           |                |   |        |            | 34,000    |   |       |           |           |  |  |            |          |   |   |            |            |   |   |            | 34,000     |  
|                            | Purchases of treasury stock                                                        |              |           |            |   |          |           |                |   |        |            |           |   |       |           |           |  |  |            | (58,000  | ) |   |            | (201,000   | ) |   |            | (201,000   | )
|                            | Allocation of shares in Company sponsored defined
    contribution plan            |              |           |            |   |          |           |                |   |        |            | 97,000    |   |       |           |           |  |  |            | 119,000  |   |   |            | 305,000    |   |   |            | 402,000    |  
|                            | Retirement of treasury stock                                                       |              |           | (334,000   | ) |          |           | (3,000         | ) |        |            | (713,000  | ) |       |           |           |  |  |            | 334,000  |   |   |            | 716,000    |   |   |            |            |  
|                            | Issuance of common stock in connection with
    acquisitions                       |              |           | 772,000    |   |          |           | 8,000          |   |        |            | 3,691,000 |   |       |           |           |  |  |            |          |   |   |            |            |   |   |            | 3,699,000  |  
|                            | Net earnings  2003                                                                |              |           |            |   |          |           |                |   |        |            |           |   |       |           | 941,000   |  |  |            |          |   |   |            |            |   |   |            | 941,000    |  
|                            |                                                                                    |              |           |            |   |          |           |                |   |        |            |           |   |       |           |           |  |  |            |          |   |   |            |            |   |   |            |           
|BALANCE  December 27, 2003 |                                                                                    |              | 5,061,000 |            |   | $        | 51,000    |                |   | $      | 11,190,000 |           |   | $     | 5,320,000 |           |  |  | (603,000   | )        |   | $ | (1,574,000 | )          |   | $ | 14,987,000 |           
|                            |                                                                                    |              |           |            |   |          |           |                |   |        |            |           |   |       |           |           |  |  |            |          |   |   |            |            |   |   |            |           

See notes to consolidated financial statements.

43



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##### Table of Contents



PHOENIX FOOTWEAR GROUP, INC.






CONSOLIDATED STATEMENTS OF CASH
FLOWS


YEARS ENDED DECEMBER 27, 2003 AND
DECEMBER 31, 2002 AND 2001


|                                      |                                                                                         |                                                                        |                         |                                                      |                                                      |      |            |            |         |   |             |            |            |   |            |           | 
|------------------------------------- | --------------------------------------------------------------------------------------- | ---------------------------------------------------------------------- | ----------------------- | ---------------------------------------------------- | ---------------------------------------------------- | ---- | ---------- | ---------- | ------- | - | ----------- | ---------- | ---------- | - | ---------- | --------- | 
|                                      |                                                                                         | 2003                                                                   |                         | 2002                                                 |                                                      | 2001
|                                      |                                                                                         |                                                                        |                         |                                                      |                                                      |     
|CASH FLOWS FROM OPERATING ACTIVITIES: |                                                                                         |                                                                        |                         |                                                      |                                                      |      |            |            |         |   |             |           
|                                      | Net earnings                                                                            |                                                                        | $                       | 941,000                                              |                                                      |      | $          | 1,703,000  |         |   | $           | 1,370,000  |           
|                                      | Adjustments to reconcile net earnings to net cash
    provided by operating activities: |                                                                        |                         |                                                      |                                                      |      |            |            |         |   |             |            |           
|                                      |                                                                                         | Depreciation and amortization                                          |                         |                                                      | 317,000                                              |      |            |            | 266,000 |   |             |            | 710,000    |  
|                                      |                                                                                         | Provision for losses on accounts receivable                            |                         |                                                      | 252,000                                              |      |            |            | 142,000 |   |             |            | 517,000    |  
|                                      |                                                                                         | Write-off of non-trade receivable                                      |                         |                                                      | 163,000                                              |      |            |            |        |   |             |            |           |  
|                                      |                                                                                         | Allocation of shares in defined contribution plan                      |                         |                                                      | 402,000                                              |      |            |            | 237,000 |   |             |            |           |  
|                                      |                                                                                         | Loss on impairment of assets                                           |                         |                                                      |                                                     |      |            |            | 338,000 |   |             |            |           |  
|                                      |                                                                                         | Loss on pension plan termination, net of excise
    tax                |                         |                                                      |                                                     |      |            |            |        |   |             |            | 1,357,000  |  
|                                      |                                                                                         | Noncash debt issuance expense                                          |                         |                                                      |                                                     |      |            |            |        |   |             |            | 49,000     |  
|                                      |                                                                                         | Loss (Gain) on sale of property and equipment                          |                         |                                                      | 8,000                                                |      |            |            |        |   |             |            | (142,000   | )
|                                      |                                                                                         | Gain on sale of slipper brands                                         |                         |                                                      |                                                     |      |            |            |        |   |             |            | (1,196,000 | )
|                                      |                                                                                         | Changes in assets and liabilities (net of effect
    of acquisitions): |                         |                                                      |                                                      |      |            |            |         |   |             |            |            |  
|                                      |                                                                                         |                                                                        | (Increase) decrease in: |                                                      |                                                      |      |            |            |         |   |             |            |            |   |           
|                                      |                                                                                         |                                                                        |                         | Accounts receivable                                  |                                                      |      | 1,288,000  |            |         |   | 2,376,000   |            |            |   | 5,887,000  |          
|                                      |                                                                                         |                                                                        |                         | Inventories                                          |                                                      |      | (2,272,000 | )          |         |   | 3,791,000   |            |            |   | 1,026,000  |          
|                                      |                                                                                         |                                                                        |                         | Other receivable                                     |                                                      |      | 300,000    |            |         |   | 129,000     |            |            |   |           |          
|                                      |                                                                                         |                                                                        |                         | Other current assets                                 |                                                      |      | (1,204,000 | )          |         |   | 19,000      |            |            |   | (10,000    | )        
|                                      |                                                                                         |                                                                        |                         | Other noncurrent assets                              |                                                      |      | 48,000     |            |         |   |            |            |            |   | 9,000      |          
|                                      |                                                                                         |                                                                        |                         | Deferred income tax asset/liability                  |                                                      |      | 727,000    |            |         |   | 699,000     |            |            |   | 46,000     |          
|                                      |                                                                                         |                                                                        |                         | Prepaid pension                                      |                                                      |      |           |            |         |   |            |            |            |   | (124,000   | )        
|                                      |                                                                                         |                                                                        | Increase (decrease) in: |                                                      |                                                      |      |            |            |         |   |             |            |            |   |           
|                                      |                                                                                         |                                                                        |                         | Accounts payable                                     |                                                      |      | 2,435,000  |            |         |   | 286,000     |            |            |   | (7,572,000 | )        
|                                      |                                                                                         |                                                                        |                         | Accrued expenses                                     |                                                      |      | (1,428,000 | )          |         |   | (99,000     | )          |            |   | 210,000    |          
|                                      |                                                                                         |                                                                        |                         | Liability to former stockholders                     |                                                      |      | (1,806,000 | )          |         |   |            |            |            |   |           |          
|                                      |                                                                                         |                                                                        |                         | Income taxes payable                                 |                                                      |      | 111,000    |            |         |   |            |            |            |   | (883,000   | )        
|                                      |                                                                                         |                                                                        |                         |                                                      |                                                      |      |            |            |         |   |             |           
|                                      |                                                                                         |                                                                        |                         |                                                      | Net cash provided by operating activities            |      |            | 282,000    |         |   |             | 9,887,000  |            |   |            | 1,254,000 | 
|                                      |                                                                                         |                                                                        |                         |                                                      |                                                      |      |            |            |         |   |             |           
|CASH FLOWS FROM INVESTING ACTIVITIES: |                                                                                         |                                                                        |                         |                                                      |                                                      |      |            |            |         |   |             |           
|                                      | Purchases of equipment                                                                  |                                                                        |                         | (326,000                                             | )                                                    |      |            | (309,000   | )       |   |             | (18,000    | )         
|                                      | Proceeds from disposal of property and equipment                                        |                                                                        |                         | 457,000                                              |                                                      |      |            | 76,000     |         |   |             | 212,000    |           
|                                      | Proceeds from other receivable                                                          |                                                                        |                         |                                                     |                                                      |      |            | 1,578,000  |         |   |             |           |           
|                                      | Proceeds from pension plan termination, net                                             |                                                                        |                         |                                                     |                                                      |      |            |           |         |   |             | 362,000    |           
|                                      | Proceeds from sale of slipper brands                                                    |                                                                        |                         |                                                     |                                                      |      |            |           |         |   |             | 1,485,000  |           
|                                      | Acquisitions, net of cash acquired                                                      |                                                                        |                         | (7,925,000                                           | )                                                    |      |            |           |         |   |             |           |           
|                                      |                                                                                         |                                                                        |                         |                                                      |                                                      |      |            |            |         |   |             |           
|                                      |                                                                                         |                                                                        |                         |                                                      | Net cash provided (used) by investing
    activities |      |            | (7,794,000 | )       |   |             | 1,345,000  |            |   |            | 2,041,000 | 
|                                      |                                                                                         |                                                                        |                         |                                                      |                                                      |      |            |            |         |   |             |           
|CASH FLOWS FROM FINANCING ACTIVITIES: |                                                                                         |                                                                        |                         |                                                      |                                                      |      |            |            |         |   |             |           
|                                      | Net (payments) borrowings on note
    payable  line of credit                          |                                                                        |                         | 3,979,000                                            |                                                      |      |            | (8,200,000 | )       |   |             | (4,300,000 | )         
|                                      | Proceeds from notes payable                                                             |                                                                        |                         | 4,500,000                                            |                                                      |      |            | 2,728,000  |         |   |             | 3,850,000  |           
|                                      | Repayments of notes payable                                                             |                                                                        |                         | (927,000                                             | )                                                    |      |            | (5,607,000 | )       |   |             | (3,648,000 | )         
|                                      | Issuance of common stock                                                                |                                                                        |                         | 34,000                                               |                                                      |      |            | 5,000      |         |   |             | 2,015,000  |           
|                                      | Purchases of treasury stock                                                             |                                                                        |                         | (201,000                                             | )                                                    |      |            | (35,000    | )       |   |             | (52,000    | )         
|                                      | Debt issuance and other costs                                                           |                                                                        |                         | (80,000                                              | )                                                    |      |            | (19,000    | )       |   |             |           |           
|                                      |                                                                                         |                                                                        |                         |                                                      |                                                      |      |            |            |         |   |             |           
|                                      |                                                                                         |                                                                        |                         | Net cash provided (used) by financing
    activities |                                                      |      | 7,305,000  |            |         |   | (11,128,000 | )          |            |   | (2,135,000 | )        
|                                      |                                                                                         |                                                                        |                         |                                                      |                                                      |      |            |            |         |   |             |           
|NET INCREASE (DECREASE) IN CASH       |                                                                                         |                                                                        | (207,000                | )                                                    |                                                      |      | 104,000    |            |         |   | 1,160,000   |           
|CASH  Beginning of year              |                                                                                         |                                                                        | 1,265,000               |                                                      |                                                      |      | 1,161,000  |            |         |   | 1,000       |           
|                                      |                                                                                         |                                                                        |                         |                                                      |                                                      |      |            |            |         |   |             |           
|CASH  End of year                    |                                                                                         | $                                                                      | 1,058,000               |                                                      |                                                      | $    | 1,265,000  |            |         | $ | 1,161,000   |           
|                                      |                                                                                         |                                                                        |                         |                                                      |                                                      |      |            |            |         |   |             |           

(Continued)

See notes to consolidated financial statements.

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##### Table of Contents



PHOENIX FOOTWEAR GROUP, INC.


CONSOLIDATED STATEMENTS OF CASH FLOWS 
(Continued)

YEARS ENDED DECEMBER 27, 2003 AND
DECEMBER 31, 2002 AND 2001


|                                                                           |                                                                                                                                                                                                                          |      |   |         |  |      |   |         |  |  |   |           | 
|-------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | ---- | - | ------- |  | ---- | - | ------- |  |  | - | --------- | 
|                                                                           |                                                                                                                                                                                                                          | 2003 |   | 2002    |  | 2001
|                                                                           |                                                                                                                                                                                                                          |      |   |         |  |     
|SUPPLEMENTAL CASH FLOW INFORMATION                                        |                                                                                                                                                                                                                          |      |   |         |  |      |   |         |  |  |   |          
|                                                                           | Cash paid during the year for:                                                                                                                                                                                           |      |   |         |  |      |   |         |  |  |   |           | 
|                                                                           | Interest                                                                                                                                                                                                                 |      | $ | 862,000 |  |      | $ | 540,000 |  |  | $ | 1,605,000 | 
|                                                                           |                                                                                                                                                                                                                          |      |   |         |  |      |   |         |  |  |   |          
|                                                                           | Income taxes                                                                                                                                                                                                             |      | $ | 565,000 |  |      | $ | 567,000 |  |  | $ | 901,000   | 
|                                                                           |                                                                                                                                                                                                                          |      |   |         |  |      |   |         |  |  |   |          
|SUPPLEMENTAL DISCLOSURE OF NONCASH OPERATING AND
    FINANCING ACTIVITIES: |                                                                                                                                                                                                                          |      |   |         |  |      |   |         |  |  |   |          
|                                                                           | During 2002, a $750,000 note payable was
    converted into 204,000 shares of common stock.                                                                                                                              |      |   |         |  |      |   |         |  |  |   |           | 
|                                                                           | During 2001, the Company sold slipper brand net
    assets for receivables of $3,271,000. In addition, the Company
    issued common stock options valued at $236,000 in consideration
    for debt and debt guarantees. |      |   |         |  |      |   |         |  |  |   |           | 

(Concluded)

See notes to consolidated financial statements.

45



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##### Table of Contents



PHOENIX FOOTWEAR GROUP, INC.






NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS


YEARS ENDED DECEMBER 27, 2003 AND
DECEMBER 31, 2002 AND 2001




|   |                                                                           
|-- | --------------------------------------------------------------------------
|1. | DESCRIPTION OF BUSINESS AND SUMMARY OF
    SIGNIFICANT ACCOUNTING POLICIES

DESCRIPTION OF BUSINESS  Phoenix
Footwear Group, Inc. (the Company) is engaged
primarily in the import and sale of mens and womens
leisure footwear and apparel. Sales are made principally to
retailers in the United States. During 2002 the Company changed
its name from Daniel Green Company to Phoenix Footwear
Group, Inc.

The Company acquired H.S. Trask & Co.
(Trask) on August 7, 2003 through the purchase
of all the outstanding shares of Trask, a Bozeman, Montana based
footwear company, for an aggregate purchase price of
$6.4 million, including $2.9 million in cash,
699,980 shares of common stock valued at $3.2 million
and $300,000 in acquisition related expenses. Trask is a
provider of mens dress and casual footwear. On
October 31, 2003 the Company acquired Royal
Robbins, Inc. (Robbins) through the purchase of
all the outstanding shares of Robbins, a Modesto, California
based apparel company, for an aggregate purchase price of
$6.8 million, including $6.0 million in cash,
71,889 shares of common stock valued at $500,000 and
$300,000 in acquisition related expenses, plus potential
contingent earnout cash payments. The potential contingent
earnout payments equal 25% of the Royal Robbins product
lines gross profit over the 12 month periods ended
May 31, 2004 and 2005, respectively, so long as minimum
gross profit thresholds are achieved. Robbins is engaged in the
import and sale of casual and outdoor apparel. The results of
Trasks and Robbins operations have been included in
the consolidated financial statements since the date of their
respective acquisitions (see Note 5).

On December 28, 2001, the Company sold its
Daniel Green and L.B. Evans slipper brands to an unrelated third
party for approximately $4.8 million. The recorded value of
the net assets sold was approximately $3.6 million which
included inventory, related other assets and a related
liability. The sale price includes guaranteed, minimum royalty
payments at a present value at the date of sale of approximately
$1.7 million. At December 27, 2003, the balance due to
the Company for the minimum royalty totaled approximately
$1.2 million of which $530,000 is classified as a current
other receivable in the accompanying 2003 consolidated balance
sheet. The remaining balance of $718,000, which is to be
received over the next two fiscal years, is included as a
noncurrent other receivable in the accompanying 2003
consolidated balance sheet. The Company also recorded a note
receivable at the date of sale for approximately
$1.6 million which was paid in 2002. This transaction
resulted in a gain of approximately $1.2 million which is
included within the account classification entitled other
expense, net in the accompanying 2001 consolidated statement of
operations (see Note 10).

On March 30, 2000, the Company purchased all
of the outstanding shares of Penobscot Shoe Company
(Penobscot) from Riedman Corporation, a related
party, for approximately $18.2 million including direct
costs of the acquisition. Penobscot was also engaged in the
import and sale of footwear. The acquisition of Penobscot has
been accounted for under the purchase method of accounting and
accordingly, the operating results of Penobscot have been
included in the Companys consolidated financial statements
since the date of acquisition. The allocation of the purchase
price to the fair market value of assets and liabilities
acquired was finalized in 2001 and totaled approximately
$20.4 million and $4.0 million respectively. The
excess of the aggregate purchase price over the estimated fair
market value of the net assets acquired (goodwill)
was approximately $1.9 million.

STOCK SPLIT  On May 22, 2003, the
Board of Directors authorized a two-for-one stock split which
became effective on June 12, 2003. All references in these
consolidated financial statements and notes related to numbers
of shares and per share amounts have been restated to reflect
the effect of the stock split.

46



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##### Table of Contents



PHOENIX FOOTWEAR GROUP, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

PRINCIPLES OF CONSOLIDATION  The
consolidated financial statements consist of Phoenix Footwear
Group, Inc. and its wholly-owned subsidiaries, Penobscot
Shoe Company, H.S. Trask & Co. and Royal
Robbins, Inc. Intercompany accounts and transactions have
been eliminated in consolidation.

ACCOUNTING PERIOD  Effective
January 1, 2003, the Company changed its year-end to a
fiscal year that is the 52- or 53-week period ending the
Saturday nearest to December 31st.

ESTIMATES  The preparation of
financial statements in conformity with accounting principles
generally accepted in the United States of America requires
management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from
those estimates.

INVENTORIES, net  Inventories are
stated at the lower of cost or market net of reserve for
obsolescence. Cost is determined on a first-in, first-out basis.
Inventories consist of finished goods. The reserve for obsolete
inventory was $878,000 and $484,000 as of December 27, 2003
and December 31, 2002, respectively.

PLANT AND EQUIPMENT, net  Plant and
equipment is stated at cost, less accumulated depreciation.
Expenditures for maintenance and repairs are charged to earnings
as incurred. Replacements of significant items and major
renewals and betterments are capitalized. Depreciation is
computed using estimated useful lives under the straight-line
method as follows:

|                        |  |  |           | 
|----------------------- |  |  | --------- | 
|Buildings               |  |  | 20  years | 
|Machinery and equipment |  |  | 10  years | 
|Computers               |  |  | 4 years   | 
|Vehicles                |  |  | 4 years   | 
|Furniture and fixtures  |  |  | 8 years   | 

OTHER ASSETS  Other assets consist
primarily of deferred financing costs as of December 27,
2003 and December 31, 2002 which are being amortized over
the term of the related debt instruments. Accumulated
amortization as of December 27, 2003 and December 31,
2002 totaled $528,000 and $442,000, respectively.

GOODWILL  Effective January 1,
2002, the Company changed its method of accounting for goodwill
to conform with Statement of Financial Accounting Standards
(SFAS) No. 142, Goodwill and Other Intangible
Assets.SFAS No. 142 discontinues the practice of
amortizing goodwill and initiates an annual review for
impairment. Impairment would be examined more frequently if
certain indicators are encountered. The Company determined that
there was no impairment of goodwill to be recorded during the
years ended December 27, 2003 or December 31, 2002.

47



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PHOENIX FOOTWEAR GROUP, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Actual results of operations for each of the
three years in the period ended December 27, 2003 and
as-adjusted results of operations for 2002 and 2001 had the
nonamortization provisions of SFAS No. 142 been
applied in those periods are as follows:

|                            |                       |      |   |         |  |      |   |           |  |  |   |           | 
|--------------------------- | --------------------- | ---- | - | ------- |  | ---- | - | --------- |  |  | - | --------- | 
|                            |                       | 2003 |   | 2002    |  | 2001
|                            |                       |      |   |         |  |     
|Net earnings:               |                       |      |   |         |  |      |   |           |  |  |   |          
|                            | As reported           |      | $ | 941,000 |  |      | $ | 1,703,000 |  |  | $ | 1,370,000 | 
|                            | Goodwill amortization |      |   |        |  |      |   |          |  |  |   | 204,000   | 
|                            |                       |      |   |         |  |      |   |           |  |  |   |          
|                            | As-adjusted           |      | $ | 941,000 |  |      | $ | 1,703,000 |  |  | $ | 1,574,000 | 
|                            |                       |      |   |         |  |      |   |           |  |  |   |          
|Basic earnings per share:   |                       |      |   |         |  |      |   |           |  |  |   |          
|                            | As reported           |      | $ | 0.24    |  |      | $ | 0.50      |  |  | $ | 0.44      | 
|                            | As-adjusted           |      | $ | 0.24    |  |      | $ | 0.50      |  |  | $ | 0.50      | 
|Diluted earnings per share: |                       |      |   |         |  |      |   |           |  |  |   |          
|                            | As reported           |      | $ | 0.22    |  |      | $ | 0.45      |  |  | $ | 0.41      | 
|                            | As-adjusted           |      | $ | 0.22    |  |      | $ | 0.45      |  |  | $ | 0.48      | 

ASSET IMPAIRMENTS  Effective
January 1, 2002, the Company adopted the provisions of
SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets, which replaces
SFAS No. 121 and the accounting and reporting
provisions of APB Opinion No. 30. The Company periodically
reviews the carrying value of its long-lived assets for
impairment whenever events or changes in circumstances indicate
that the carrying value of assets may not be recoverable.
Identification of any impairment would include a comparison of
estimated future operating cash flows anticipated to be
generated during the remaining life of the assets with their net
carrying value. An impairment loss would be recognized as the
amount by which the carrying value of the assets exceeds their
fair value. The Company recorded an impairment loss of $84,000
during 2002 related to a property held for sale. This item are
included within the account classification entitled other
expense, net in the accompanying 2002 consolidated statement of
operations (see Note 10).

REVENUE RECOGNITION  Revenues are
recognized when products are shipped as all risk of loss
transfers to the Companys customer upon shipment.
Provisions for discounts, returns and other adjustments are
provided for in the same period the related sales are recorded.

SHIPPING AND HANDLING FEES AND COSTS 
Amounts billed to customers related to shipping and handling are
included in net sales. Related costs incurred are included in
cost of goods sold.

RESEARCH AND DEVELOPMENT COSTS 
Expenditures relating to the development of new products and
processes, including significant improvements and refinements to
existing products, are expensed as incurred. The amounts charged
to expense were $556,000 in 2003, $315,000 in 2002 and $229,000
in 2001 and are included in selling, general and administrative.

INCOME TAXES  Income taxes are
provided on the earnings in the consolidated financial
statements. Deferred income taxes are provided to reflect the
impact of temporary differences between the amounts
of assets and liabilities for financial reporting purposes and
such amounts as measured by tax laws and regulations. Tax
credits are recognized as a reduction to income taxes in the
year the credits are earned.

PER SHARE DATA  In addition to shares
outstanding held by the public, the Companys defined
contribution 401(k) savings plan held approximately
603,000 shares as of December 27, 2003, which were
issued during 2001 in connection with the termination of the
Companys defined benefit pension plan. These shares, while
eligible to vote, are classified as treasury stock and therefore
are not outstanding for purpose of determining per share
earnings until the time that such shares are allocated to
employee accounts. This

48



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##### Table of Contents



PHOENIX FOOTWEAR GROUP, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

allocation is occurring over a seven year period
which commenced in 2002 (See Note 4). Basic net earnings
per share is computed by dividing net earnings by the weighted
average number of common shares outstanding for the period.
Diluted net earnings per share is calculated by dividing net
earnings and the effect of assumed conversions by the weighted
average number of common and, when applicable, potential common
shares outstanding during the period. A reconciliation of the
numerators and denominators of basic and diluted earnings per
share is presented below.

|                                |                                                                     |      |      |           |  |      |      |           |  |   |      |           | 
|------------------------------- | ------------------------------------------------------------------- | ---- | ---- | --------- |  | ---- | ---- | --------- |  | - | ---- | --------- | 
|                                |                                                                     | 2003 |      | 2002      |  | 2001
|                                |                                                                     |      |      |           |  |     
|Basic net earnings per share:   |                                                                     |      |      |           |  |      |      |           |  |   |      |          
|                                | Net earnings                                                        |      | $    | 941,000   |  |      | $    | 1,703,000 |  |   | $    | 1,370,000 | 
|                                | Weighted average common shares outstanding                          |      |      | 3,963,000 |  |      |      | 3,418,000 |  |   |      | 3,138,000 | 
|Basic net earnings per share    |                                                                     | $    | 0.24 |           |  | $    | 0.50 |           |  | $ | 0.44 |          
|                                |                                                                     |      |      |           |  |      |      |           |  |   |      |          
|Diluted net earnings per share: |                                                                     |      |      |           |  |      |      |           |  |   |      |          
|                                | Net earnings                                                        |      | $    | 941,000   |  |      | $    | 1,703,000 |  |   | $    | 1,370,000 | 
|                                | Interest on convertible debt                                        |      |      |          |  |      |      | 17,000    |  |   |      | 59,000    | 
|                                |                                                                     |      |      |           |  |      |      |           |  |   |      |          
|                                | Net earnings and effect of assumed conversions                      |      | $    | 941,000   |  |      | $    | 1,720,000 |  |   | $    | 1,429,000 | 
|                                |                                                                     |      |      |           |  |      |      |           |  |   |      |          
|                                | Weighted average common shares outstanding                          |      |      | 3,963,000 |  |      |      | 3,418,000 |  |   |      | 3,138,000 | 
|                                | Effect of stock options outstanding                                 |      |      | 387,000   |  |      |      | 262,000   |  |   |      | 2,000     | 
|                                | Effect of convertible debt                                          |      |      |          |  |      |      | 102,000   |  |   |      | 304,000   | 
|                                |                                                                     |      |      |           |  |      |      |           |  |   |      |          
|                                | Weighted average common and potential
    common shares outstanding |      |      | 4,350,000 |  |      |      | 3,782,000 |  |   |      | 3,444,000 | 
|                                |                                                                     |      |      |           |  |      |      |           |  |   |      |          
|Diluted net earnings per share  |                                                                     | $    | 0.22 |           |  | $    | 0.45 |           |  | $ | 0.41 |          
|                                |                                                                     |      |      |           |  |      |      |           |  |   |      |          

Options to purchase shares of common stock which
totaled 200,000, 177,500, and 146,240 in 2003, 2002 and 2001,
respectively, were not included in the computation of diluted
earnings (loss) per share as the effect would be anti-dilutive.

CONCENTRATION OF CREDIT RISK 
Financial instruments that potentially subject the Company to
credit risks consist primarily of accounts receivable and other
receivables. Companies in the retail industry comprise a
significant portion of the accounts receivable balance;
collateral is not required. The Company monitors its exposure
for credit losses on all receivables and maintains allowances
for anticipated losses. Two of our largest customers in the
aggregate constituted 20% and 21% of trade accounts receivable
outstanding at December 27, 2003 and December 31,
2002, respectively. Our inability to collect on our trade
accounts receivable from any of our major customers could
adversely affect our business or financial condition.

FAIR VALUE OF FINANCIAL INSTRUMENTS 
The fair value of financial instruments is determined by
reference to various market data and other valuation techniques,
as appropriate. Unless otherwise disclosed, the fair value of
short-term instruments approximates their recorded values due to
the short-term nature of the instruments. The fair value of
long-term debt instruments approximates their recorded values
primarily due to interest rates approximating current rates
available for similar instruments.

STOCK-BASED COMPENSATION  In December
2002, the Financial Accounting Standards Board issued
SFAS No. 148, Accounting for Stock-Based
Compensation  Transition and Disclosure, which
amends SFAS No. 123, Accounting for Stock-Based
Compensation, to provide alternative methods of transition
for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. In addition,
this Statement amends the disclosure requirements of SFAS
No. 123 to require prominent disclosures in both annual and
interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method
used on reported results. As permitted in

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##### Table of Contents



PHOENIX FOOTWEAR GROUP, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

those standards, the Company has elected to
continue to follow recognition provisions of Accounting
Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees, and related interpretations in
accounting for employee stock-based compensation. No employee
stock-based compensation expense was recorded for the years
ended December 27, 2003 and December 31, 2002, and
2001.

Pro forma information regarding the
Companys net earnings and related per share amounts as
required by SFAS No. 123 and SFAS No. 148
are as follows:

|                                |             |      |   |         |  |      |   |           |  |  |   |           | 
|------------------------------- | ----------- | ---- | - | ------- |  | ---- | - | --------- |  |  | - | --------- | 
|                                |             | 2003 |   | 2002    |  | 2001
|                                |             |      |   |         |  |     
|Net earnings:                   |             |      |   |         |  |      |   |           |  |  |   |          
|                                | As reported |      | $ | 941,000 |  |      | $ | 1,703,000 |  |  | $ | 1,370,000 | 
|                                | Pro forma   |      | $ | 518,000 |  |      | $ | 1,463,000 |  |  | $ | 1,339,000 | 
|Basic net earnings per share:   |             |      |   |         |  |      |   |           |  |  |   |          
|                                | As reported |      | $ | 0.24    |  |      | $ | 0.50      |  |  | $ | 0.44      | 
|                                | Pro forma   |      | $ | 0.13    |  |      | $ | 0.43      |  |  | $ | 0.43      | 
|Diluted net earnings per share: |             |      |   |         |  |      |   |           |  |  |   |          
|                                | As reported |      | $ | 0.22    |  |      | $ | 0.45      |  |  | $ | 0.41      | 
|                                | Pro forma   |      | $ | 0.12    |  |      | $ | 0.39      |  |  | $ | 0.41      | 

SEGMENTS  The Company operates in one
financial reporting segment, footwear and apparel. In addition,
the Companys internal reporting does not make it
practicable to provide information on net sales earned from
different styles of footwear and apparel or from different
geographic locations. Long-lived assets are entirely located in
the United States. Sales to one customer in 2003 totaled
approximately $4.3 million or 11% of the Companys net
sales in 2003. Sales to one customer in 2002 totaled
approximately $4.3 million or 12% of the Companys net
sales in 2002. Sales to one customer in 2001 totaled
approximately $5.2 million or 11% of the Companys net
sales in 2001. Ten major customers represented approximately 39%
and 34% of net sales in 2003 and 2002, respectively; most of
these same customers represented 38% of net sales in 2001. Due
to the uncertain nature of the retail industry, the loss of any
one or more of these customers could have a material adverse
effect on the Companys business.

RECLASSIFICATIONS  Certain
reclassifications have been made to the 2002 and 2001 financial
statements to conform to the classifications used in 2003.



|   |                         
|-- | ------------------------
|2. | PLANT AND EQUIPMENT, net

Plant and Equipment as of December 27 and
December 31, respectively, consisted of the following:

|                                   |  |      |           |      |  |   |           | 
|---------------------------------- |  | ---- | --------- | ---- |  | - | --------- | 
|                                   |  | 2003 |           | 2002
|                                   |  |      |           |     
|Land and buildings                 |  | $    | 688,000   |      |  | $ | 1,215,000 | 
|Machinery, furniture and equipment |  |      | 560,000   |      |  |   | 313,000   | 
|Leasehold improvements             |  |      | 211,000   |      |  |   |          | 
|Computers                          |  |      | 1,034,000 |      |  |   | 703,000   | 
|Vehicles                           |  |      | 76,000    |      |  |   | 47,000    | 
|                                   |  |      |           |      |  |   |           | 
|                                   |  |      | 2,569,000 |      |  |   | 2,278,000 | 
|Less accumulated depreciation      |  |      | 946,000   |      |  |   | 779,000   | 
|                                   |  |      |           |      |  |   |           | 
|Plant and equipment  net          |  | $    | 1,623,000 |      |  | $ | 1,499,000 | 
|                                   |  |      |           |      |  |   |           | 

Depreciation expense for the years ended
December 27, 2003, December 31, 2002 and 2001 totaled
$259,000, $153,000 and $246,000, respectively.

50



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##### Table of Contents



PHOENIX FOOTWEAR GROUP, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|   |                              
|-- | -----------------------------
|3. | COMMITMENTS AND CONTINGENCIES

The Company leases office facilities under
operating lease agreements which expire through December 2006:



| |                                                                          
| | -------------------------------------------------------------------------
| | Future minimum commitments under the lease
    agreements are as follows:

|                      |      |   |           |         | 
|--------------------- | ---- | - | --------- | ------- | 
|Year ending December: |      |   |           |        
|                      | 2004 |   | $         | 484,000 | 
|                      | 2005 |   |           | 349,000 | 
|                      | 2006 |   |           | 219,000 | 
|                      |      |   |           |        
|                      |      | $ | 1,052,000 |        
|                      |      |   |           |        

Total rent expense for the year ended
December 27, 2003 was $231,000 and was zero for the years
ended December 31, 2002 and 2001.



|   |              
|-- | -------------
|4. | BENEFIT PLANS

DEFINED BENEFIT
PENSION PLAN

During 2001, the Company completed the
termination of the Penobscot defined benefit pension plan. On
the date of termination, the surplus from the plan totaling
$2.4 million was less than the carrying value of the
prepaid pension cost asset of $3.7 million, resulting in a
loss of $1.4 million. The loss was increased by an excise
tax totaling $357,000, which resulted in a total loss on this
transaction totaling $1.7 million. This amount is included
within the account classification entitled other expense, net in
the 2001 consolidated statement of operations (see Note 10).

The Plan covered substantially all employees and
it was the Companys policy to fund retirement costs as
accrued. The net pension income for 2001 included the following
components:

|                             |  |      |          |  
|---------------------------- |  | ---- | -------- | -
|                             |  | 2001
|                             |  |     
|Interest cost                |  | $    | (106,000 | )
|Actual return on plan assets |  |      | 237,000  |  
|Amortization of loss         |  |      | (7,000   | )
|                             |  |      |          |  
|Net pension income           |  | $    | 124,000  |  
|                             |  |      |          |  

DEFINED
CONTRIBUTION PLAN

The Company has a defined contribution 401(k)
savings plan (the Plan) covering substantially all
employees of the Company. Following the termination of the
defined benefit pension plan, the net cash surplus of
$2.0 million was contributed to the Plan. Subsequently, the
Plan acquired 782,000 shares of the Companys common
stock at a price per share of $2.58, which was based on an
independent appraisal. The unallocated shares in the Plan have
been classified as treasury stock in stockholders equity.
Compensation expense is recognized as the shares are allocated
to the participants which is expected to occur over a seven-year
period which began in 2002. The amount allocated to participants
during the years ended December 27, 2003 and
December 31, 2002 was $402,000 (119,000 shares) and
$237,000 (70,000 shares), respectively. In addition, the
Companys matching contribution to the Plan totaled
$24,000, $59,000, and $27,000 in 2003, 2002 and 2001,
respectively. The Company terminated the matching contribution
during 2003.

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##### Table of Contents



PHOENIX FOOTWEAR GROUP, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|   |             
|-- | ------------
|5. | ACQUISITIONS

On August 7, 2003, we acquired the H.S.
Trask footwear brand and rights to the Ducks Unlimited footwear
brand through the purchase of all the outstanding shares of H.S.
Trask & Co., a Bozeman, Montana based mens
footwear company, for an aggregate purchase price of
$6.4 million, including $2.9 million in cash,
699,980 shares of common stock valued at $3.2 million
and $300,000 in acquisition related expenses. The value of the
699,980 shares of common shares issued was determined based
on the average closing market price of the Companys common
shares over the 3-day period before the terms of the acquisition
were agreed to and announced. The results of Trasks
operations have been included in the consolidated financial
statements since that date. Trask is a provider of mens
dress and casual footwear and the acquisition allows the Company
to compete in the mens casual footwear market.

The following table summarizes the preliminary
allocation of the purchase price based on the estimated fair
values of the assets acquired and liabilities assumed at
August 7, 2003, the date of acquisition. The preliminary
purchase price allocation is subject to refinement based upon
managements final conclusions.

|                                           |  |   |            |  
|------------------------------------------ |  | - | ---------- | -
|Current assets                             |  | $ | 4,320,000  |  
|Property, plant and equipment              |  |   | 15,000     |  
|Intangible assets, subject to amortization |  |   | 794,000    |  
|Goodwill and unamortizable intangibles     |  |   | 3,804,000  |  
|                                           |  |   |            |  
|Total assets acquired                      |  |   | 8,933,000  |  
|Current liabilities                        |  |   | (2,522,000 | )
|                                           |  |   |            |  
|Net assets acquired                        |  | $ | 6,411,000  |  
|                                           |  |   |            |  

Of the $4.6 million of acquired goodwill and
intangible assets, $1.2 million was preliminarily allocated
to registered trademarks and tradenames that are not subject to
amortization. Intangible assets totaling $794,000 which are
subject to amortization have a weighted-average useful life of
approximately 9 years. The intangible assets subject to
amortization include wholesale customer list of $700,000 (ten
year weighted-average useful life), retail customer list of
$46,000 (five year weighted-average useful life), non-compete
agreement of $23,000 (two year weighted-average useful life) and
website of $25,000 (five year weighted-average useful life).

On October 31, 2003, we acquired the Royal
Robbins apparel brand through the purchase of all the
outstanding shares of Royal Robbins, Inc. a Modesto,
California based apparel company, for an aggregate purchase
price of $6.8 million, including $6.0 million in cash,
71,889 shares of common stock valued at $500,000 and
$300,000 in acquisition related expenses, plus potential
contingent earnout cash payments. The potential contingent
earnout payments equal 25% of the Royal Robbins product
lines gross profit over the 12 month periods ended
May 31, 2004 and 2005, respectively, so long as minimum
gross profit thresholds are achieved. The value of the 71,889
common shares issued was determined based on the average market
price of the Companys common shares over the 10-day
trading period ending on the second to last day prior to the
closing date of the acquisition. Robbins is engaged in the
import and sale of casual and outdoor apparel.

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PHOENIX FOOTWEAR GROUP, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The following table summarizes the preliminary
allocation of the purchase price based on the estimated fair
values of the assets acquired and liabilities assumed at
October 31, 2003, the date of acquisition. The preliminary
purchase price allocation is subject to refinement based upon
managements final conclusions.

|                                           |  |   |            |  
|------------------------------------------ |  | - | ---------- | -
|Current assets                             |  | $ | 4,449,000  |  
|Property, plant and equipment              |  |   | 513,000    |  
|Other assets                               |  |   | 6,000      |  
|Intangible assets, subject to amortization |  |   | 1,031,000  |  
|Goodwill and unamortizable intangibles     |  |   | 3,548,000  |  
|                                           |  |   |            |  
|Total assets acquired                      |  |   | 9,547,000  |  
|Current liabilities                        |  |   | (825,000   | )
|Contingent liability                       |  |   | (1,942,000 | )
|                                           |  |   |            |  
|Net assets acquired                        |  | $ | 6,780,000  |  
|                                           |  |   |            |  

Of the $4.6 million of acquired goodwill and
intangible assets, $2.6 million was preliminarily allocated
to registered trademarks and tradenames that are not subject to
amortization. Intangible assets totaling $1.0 million which
are subject to amortization have a weighted-average useful life
of approximately 11 years. The intangible assets subject to
amortization include wholesale customer list of $766,000
(thirteen year weighted-average useful life), non-compete
agreement of $250,000 (five year weighted-average useful life)
and website of $15,000 (five year weighted-average useful life).
SFAS No. 141, Business Combinations,requires
the Company to record $1.9 million of contingent liability
which reflects the potential payments the Company may be
required to make in connection with the earnout. Amounts greater
or less than the contingent liability recorded will result in an
adjustment to goodwill.

The following table summarizes supplemental
statement of income information on an unaudited pro forma basis
as if the acquisitions of Trask and Robbins had occurred on
January 1, 2001.

|                                       |  |      |            |      |  |      |            |  |  |   |            | 
|-------------------------------------- |  | ---- | ---------- | ---- |  | ---- | ---------- |  |  | - | ---------- | 
|                                       |  | 2003 |            | 2002 |  | 2001
|                                       |  |      |            |      |  |     
|Pro forma net sales                    |  | $    | 58,808,000 |      |  | $    | 61,390,000 |  |  | $ | 73,618,000 | 
|                                       |  |      |            |      |  |      |            |  |  |   |            | 
|Pro forma net income                   |  | $    | 1,468,000  |      |  | $    | 1,018,000  |  |  | $ | 780,000    | 
|                                       |  |      |            |      |  |      |            |  |  |   |            | 
|Basic Pro forma net income per share   |  | $    | 0.33       |      |  | $    | 0.24       |  |  | $ | 0.20       | 
|                                       |  |      |            |      |  |      |            |  |  |   |            | 
|Diluted Pro forma net income per share |  | $    | 0.30       |      |  | $    | 0.22       |  |  | $ | 0.19       | 
|                                       |  |      |            |      |  |      |            |  |  |   |            | 



|   |     
|-- | ----
|6. | DEBT

LONG TERM DEBT  LESS CURRENT
INSTALLMENTS  The Company has a loan agreement which
consists of a revolving line of credit (revolver)
and a term loan facility in the amount of $6.8 million.
Under the terms of the agreement, the borrowing base for the
revolver is based on certain balances of accounts receivable and
inventory, as defined in the agreement. The maximum credit
amount under the revolver is $15.0 million during the
months of June through the following January and
$18.0 million during the months from February through the
following May, reduced by a $2.0 million amortized term
loan and outstanding letters of credit. The revolver expires on
May 1, 2006 and has an interest rate of LIBOR plus
275 basis points (LIBOR with a 90 day maturity was
1.17% on December 27, 2003) or the prime rate plus .25%
(prime was 4.0% at December 27, 2003). Effective
June 30, 2004, the interest rate ranges from LIBOR plus 175
to 300 basis points depending on the level of the
Companys debt to earnings ratio. The revolver is secured
by accounts receivable, inventory and equipment. The term loans,
which are subject to similar interest rate changes as the
revolver, are payable through 2008 and are also secured by
accounts receivable, inventory

53



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PHOENIX FOOTWEAR GROUP, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

and equipment. The balance owed under the
Companys revolving line of credit as of December 27,
2003 and December 31, 2002 totaled $5.5 million and
$-0-, respectively.

The Company had a note payable to a major
stockholder which was converted at the stockholders option
into 407,608 shares of the Companys common stock in
2002.

Long-term debt as of December 27, 2003 and
December 31, 2002 consisted of the following:

|                                                                                                                                                                     |  |      |            |      |  |   |           | 
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | ---------- | ---- |  | - | --------- | 
|                                                                                                                                                                     |  | 2003 |            | 2002
|                                                                                                                                                                     |  |      |            |     
|Revolving line of credit to bank; secured by
    accounts receivable, inventory and equipment; interest due
    monthly at LIBOR plus 275 basis points               |  | $    | 5,000,000  |      |  | $ |          | 
|Revolving line of credit to bank; secured by
    accounts receivable, inventory and equipment; interest due
    monthly at Prime plus .25%                           |  |      | 480,000    |      |  |   |          | 
|Term loan payable to bank in annual installments
    of $750,000 through 2006, interest due monthly at LIBOR plus
    300 basis points                               |  |      | 2,250,000  |      |  |   | 3,000,000 | 
|Term loan payable to bank in quarterly
    installments of $150,000 through 2008, interest due monthly at
    LIBOR plus 300 basis points                            |  |      | 2,850,000  |      |  |   |          | 
|Term loan payable to bank in monthly installments
    of $25,000 through 2008, interest due monthly at LIBOR plus
    300 basis points                               |  |      | 1,475,000  |      |  |   |          | 
|Note payable to financial institution;
    collateralized by vehicle; interest at 0%; principal payable
    $493 monthly; remaining principal balance due July 2007  |  |      | 21,000     |      |  |   |          | 
|Note payable to financial institution;
    collateralized by vehicle; interest at 4.9%; principal payable
    $574 monthly; remaining principal balance due May 2004 |  |      | 3,000      |      |  |   |          | 
|Note payable to financial institution;
    collateralized by vehicle; interest at 6.9%; principal payable
    $551 monthly; remaining principal balance due May 2004 |  |      | 3,000      |      |  |   |          | 
|                                                                                                                                                                     |  |      |            |      |  |   |           | 
|                                                                                                                                                                     |  |      | 12,082,000 |      |  |   | 3,000,000 | 
|Less: current portion                                                                                                                                                |  |      | 1,661,000  |      |  |   | 750,000   | 
|                                                                                                                                                                     |  |      |            |      |  |   |           | 
|Noncurrent portion                                                                                                                                                   |  | $    | 10,421,000 |      |  | $ | 2,250,000 | 
|                                                                                                                                                                     |  |      |            |      |  |   |           | 

The aggregate principal payments of notes payable
are as follows:

|     |       |   |           |            | 
|---- | ----- | - | --------- | ---------- | 
|2004 |       | $ | 1,661,000 |           
|2005 |       |   | 1,656,000 |           
|2006 |       |   | 7,136,000 |           
|2007 |       |   | 903,000   |           
|2008 |       |   | 726,000   |           
|     |       |   |           |           
|     | Total |   | $         | 12,082,000 | 
|     |       |   |           |           

The line of credit and the note payable to bank
contain certain financial covenants relative to average borrowed
funds to earnings ratio, net income, current ratio, and cash
flow coverage. In addition, the payment or declaration of
dividends and distributions is prohibited unless a written
consent from the lender is received.

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##### Table of Contents



PHOENIX FOOTWEAR GROUP, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|   |             
|-- | ------------
|7. | INCOME TAXES

Income tax expense consists of:

|          |         |       |         |         |         |      |         |         |           |  |        |        |        | 
|--------- | ------- | ----- | ------- | ------- | ------- | ---- | ------- | ------- | --------- |  | ------ | ------ | ------ | 
|          |         | 2003  |         | 2002    |         | 2001
|          |         |       |         |         |         |     
|Current:  |         |       |         |         |         |      |         |         |           |  |        |       
|          | Federal |       | $       | 477,000 |         |      | $       | 440,000 |           |  | $      | 8,000  |       
|          | State   |       |         | 172,000 |         |      |         | 68,000  |           |  |        | 13,000 |       
|          |         |       |         |         |         |      |         |         |           |  |        |       
|          |         |       | 649,000 |         |         |      | 508,000 |         |           |  | 21,000 |       
|          |         |       |         |         |         |      |         |         |           |  |        |       
|Deferred: |         |       |         |         |         |      |         |         |           |  |        |       
|          | Federal |       |         | 185,000 |         |      |         | 609,000 |           |  |        | 40,000 |       
|          | State   |       |         | 152,000 |         |      |         | 90,000  |           |  |        | 6,000  |       
|          |         |       |         |         |         |      |         |         |           |  |        |       
|          |         |       | 337,000 |         |         |      | 699,000 |         |           |  | 46,000 |       
|          |         |       |         |         |         |      |         |         |           |  |        |       
|          |         | Total |         | $       | 986,000 |      |         | $       | 1,207,000 |  |        | $      | 67,000 | 
|          |         |       |         |         |         |      |         |         |           |  |        |       

The difference between tax computed at the
statutory federal income tax rate and the Companys
reported tax expense is as follows:

|                                                       |  |      |         |      |  |      |           |   |  |   |          |  
|------------------------------------------------------ |  | ---- | ------- | ---- |  | ---- | --------- | - |  | - | -------- | -
|                                                       |  | 2003 |         | 2002 |  | 2001
|                                                       |  |      |         |      |  |     
|Expense at statutory rate                              |  | $    | 655,000 |      |  | $    | 990,000   |   |  | $ | 489,000  |  
|State and other taxes  net of federal
    tax benefit |  |      | 137,000 |      |  |      | 104,000   |   |  |   | 12,000   |  
|Items not deductible                                   |  |      | 151,000 |      |  |      | 66,000    |   |  |   | 198,000  |  
|Change in tax rate                                     |  |      | 24,000  |      |  |      |          |   |  |   |         |  
|Change in valuation allowance                          |  |      |        |      |  |      | (60,000   | ) |  |   | (647,000 | )
|Other                                                  |  |      | 19,000  |      |  |      | 107,000   |   |  |   | 15,000   |  
|                                                       |  |      |         |      |  |      |           |   |  |   |          |  
|Income tax expense                                     |  | $    | 986,000 |      |  | $    | 1,207,000 |   |  | $ | 67,000   |  
|                                                       |  |      |         |      |  |      |           |   |  |   |          |  

As of December 27, 2003, the Company has
approximately $233,000 of federal net operating loss
carryforwards which begin to expire in 2023. The Company has
approximately $766,000 of net operating loss carryforwards
available for New York State tax purposes, which begin to
expire in 2018. The deferred tax assets are reviewed
periodically for recoverability and valuation allowances are
provided, as necessary.

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##### Table of Contents



PHOENIX FOOTWEAR GROUP, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Components of the Companys deferred income
tax asset (liability) as of December 27, 2003 and
December 31, 2002 are as follows:

|                                 |  |         |          |            |  |   |            |  
|-------------------------------- |  | ------- | -------- | ---------- |  | - | ---------- | -
|                                 |  |        
|                                 |  | 2003   
|                                 |  |        
|                                 |  | Current |          | Noncurrent
|                                 |  |         |          |           
|ASSETS                          
|Non-deductible bad debt reserves |  | $       | 438,000  |            |  | $ |           |  
|Inventory                        |  |         |         |            |  |   | 63,000     |  
|Other accruals                   |  |         | 206,000  |            |  |   | 167,000    |  
|Net operating loss carryforwards |  |         |         |            |  |   | 82,000     |  
|                                
|LIABILITIES                     
|Installment sale gain            |  |         | (171,000 | )          |  |   | (287,000   | )
|Pension                          |  |         | (668,000 | )          |  |   |           |  
|Depreciation                     |  |         |         |            |  |   | (515,000   | )
|Purchased intangibles            |  |         |         |            |  |   | (745,000   | )
|                                 |  |         |          |            |  |   |            |  
|Deferred income tax liability    |  | $       | (195,000 | )          |  | $ | (1,235,000 | )
|                                 |  |         |          |            |  |   |            |  

|                                      |  |         |         |            |  |   |            |  
|------------------------------------- |  | ------- | ------- | ---------- |  | - | ---------- | -
|                                      |  |        
|                                      |  | 2002   
|                                      |  |        
|                                      |  | Current |         | Noncurrent
|                                      |  |         |         |           
|ASSETS                               
|Non-deductible bad debt reserves      |  | $       | 206,000 |            |  | $ |           |  
|Inventory                             |  |         | 91,000  |            |  |   |            |  
|Other accruals                        |  |         |        |            |  |   | 109,000    |  
|Net operating loss carryforwards      |  |         |        |            |  |   | 4,000      |  
|Compensation                          |  |         |        |            |  |   | 52,000     |  
|AMT credit carryforward               |  |         |        |            |  |   | 49,000     |  
|Charitable contribution               |  |         |        |            |  |   | 110,000    |  
|                                     
|LIABILITIES                          
|Installment sale gain                 |  |         |        |            |  |   | (689,000   | )
|Pension                               |  |         |        |            |  |   | (204,000   | )
|Depreciation                          |  |         |        |            |  |   | (431,000   | )
|                                      |  |         |        |            |  |   |            |  
|                                      |  |         |         |            |  |   |            |  
|Deferred income tax asset (liability) |  | $       | 297,000 |            |  | $ | (1,000,000 | )
|                                      |  |         |         |            |  |   |            |  



|   |                                 
|-- | --------------------------------
|8. | LIABILITY TO FORMER STOCKHOLDERS

The accompanying consolidated balance sheet as of
December 31, 2002 includes an obligation of approximately
$1.8 million and accrued interest of $280,000 to dissenting
stockholders of Penobscot Shoe Company. This liability arose
prior to the acquisition of Penobscot and was assumed by the
Company. On May 30, 2003 the Company received from the
Superior Court in Penobscot County, Maine its decision which
stated dissenting Penobscot stockholders are entitled to $7.94
common share, which represents $2.06 more per share than the
amount the Company paid at the time of the acquisition.
Additionally, the ruling granted interest to the dissenting
stockholders bringing the total judgment to $3.1 million.
As a result, during fiscal 2003 the Company recorded in Other
expense, net $733,000 of litigation related legal and settlement
expenses

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##### Table of Contents



PHOENIX FOOTWEAR GROUP, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

and $376,000 of interest expense. The Company
used $500,000 in cash and increased its notes
payable  line of credit in the amount of
$2.6 million to pay the settlement.



|   |                     
|-- | --------------------
|9. | STOCKHOLDERS EQUITY

On May 22, 2003, the Board of Directors
authorized a two-for-one stock split which became effective on
June 12, 2003. All references in these consolidated
financial statements and notes related to numbers of shares and
per share amounts have been restated to reflect the effect of
the stock split.

During 2002, the Company approved a change in the
par value of common stock from $1.25 to $.01. As a result, the
common stock dollar amount decreased $5.7 million with a
corresponding increase to additional paid-in capital of
$5.7 million.

The Company has two plans, the 2001 Long-Term
Incentive Plan and the 1995 Stock Incentive Plan. No shares are
available for grant under the 1995 Stock Incentive Plan at
December 27, 2003. Under the 2001 Plan, awards in the form
of stock options, stock appreciation rights or stock awards may
be granted to employees and directors of the Company and persons
who provide consulting or other services to the Company deemed
by the Board of Directors to be of substantial value to the
Company. Options may also be granted as part of an employment
offer. The Company has reserved 1,000,000 shares of its
common stock for issuance under the Plan. In addition to the
options outstanding under the Plan, the Company has granted
options to two separate major stockholders in consideration for
debt or debt guarantees. Options outstanding and exercisable
under these arrangements totaled 398,000 as of December 27,
2003 and 400,000 as of December 31, 2002 and 2001. The Plan
is administered by the compensation committee of the Board of
Directors.

The stock option activity for the years ended
December 27, 2003 and December 31, 2002 and 2001 is as
follows:

|                                       |  |      |           |          |  |      |      |          |  |      |         |          |  |   |      |  |  |  |         |   |  |   |      | 
|-------------------------------------- |  | ---- | --------- | -------- |  | ---- | ---- | -------- |  | ---- | ------- | -------- |  | - | ---- |  |  |  | ------- | - |  | - | ---- | 
|                                       |  |      |           | Weighted |  |      |      | Weighted |  |      |         | Weighted
|                                       |  |      |           | Average  |  |      |      | Average  |  |      |         | Average 
|                                       |  |      |           | Exercise |  |      |      | Exercise |  |      |         | Exercise
|                                       |  | 2003 |           | Price    |  | 2002 |      | Price    |  | 2001 |         | Price   
|                                       |  |      |           |          |  |      |      |          |  |      |         |         
|Options outstanding, beginning of year |  |      | 756,000   |          |  | $    | 2.46 |          |  |      | 578,000 |          |  | $ | 1.97 |  |  |  | 282,000 |   |  | $ | 2.10 | 
|Options granted                        |  |      | 332,000   |          |  | $    | 4.97 |          |  |      | 180,000 |          |  | $ | 4.15 |  |  |  | 314,000 |   |  | $ | 1.85 | 
|Options exercised                      |  |      | (33,000   | )        |  | $    | 1.77 |          |  |      | (2,000  | )        |  | $ | 3.63 |  |  |  |        |   |  |   |     | 
|Options cancelled                      |  |      | (9,000    | )        |  | $    | 2.57 |          |  |      |        |          |  |   |     |  |  |  | (18,000 | ) |  | $ | 1.78 | 
|                                       |  |      |           |          |  |      |      |          |  |      |         |          |  |   |      |  |  |  |         |   |  |   |      | 
|Options outstanding  end of year      |  |      | 1,046,000 |          |  | $    | 3.28 |          |  |      | 756,000 |          |  | $ | 2.46 |  |  |  | 578,000 |   |  | $ | 1.97 | 
|                                       |  |      |           |          |  |      |      |          |  |      |         |          |  |   |      |  |  |  |         |   |  |   |      | 
|Options exercisable  end of year      |  |      | 722,000   |          |  | $    | 2.50 |          |  |      | 702,000 |          |  | $ | 2.59 |  |  |  | 490,000 |   |  | $ | 2.01 | 
|                                       |  |      |           |          |  |      |      |          |  |      |         |          |  |   |      |  |  |  |         |   |  |   |      | 

The outstanding options as of December 27,
2003 have an exercise price ranging from $1.73-$7.05 per
share and expire at various dates through November 2013.

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##### Table of Contents



PHOENIX FOOTWEAR GROUP, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The following table summarizes information about
stock options outstanding and exercisable at December 27,
2003.

|                        |  |                     |           |                     |  |                |            |                   |  |                |      |  |  |  |         |  |  |   |      | 
|----------------------- |  | ------------------- | --------- | ------------------- |  | -------------- | ---------- | ----------------- |  | -------------- | ---- |  |  |  | ------- |  |  | - | ---- | 
|                        |  |                     |           |                    
|                        |  | Options Outstanding |           | Options Exercisable
|                        |  |                     |           |                    
|                        |  |                     |           | Weighted            |  |                |            |                  
|                        |  | Number              |           | Average             |  | Weighted       |            | Number            |  | Weighted      
|                        |  | Outstanding         |           | Remaining           |  | Average        |            | Exercisable at    |  | Average       
|Range of Exercise Price |  | December 31, 2003   |           | Contractual Life    |  | Exercise Price |            | December 31, 2003 |  | Exercise Price
|                        |  |                     |           |                     |  |                |            |                   |  |               
|$1.73 to $1.84          |  |                     | 296,000   |                     |  |                | 7.36 years |                   |  | $              | 1.77 |  |  |  | 296,000 |  |  | $ | 1.77 | 
|$2.03 to $3.65          |  |                     | 500,000   |                     |  |                | 7.88 years |                   |  | $              | 2.86 |  |  |  | 368,000 |  |  | $ | 2.68 | 
|$4.45 to $5.80          |  |                     | 165,000   |                     |  |                | 8.93 years |                   |  | $              | 5.38 |  |  |  | 58,000  |  |  | $ | 5.13 | 
|$6.77 to $7.05          |  |                     | 85,000    |                     |  |                | 9.88 years |                   |  | $              | 6.99 |  |  |  |        |  |  |   |     | 
|                        |  |                     |           |                     |  |                |            |                   |  |                |      |  |  |  |         |  |  |   |      | 
|                        |  |                     | 1,046,000 |                     |  |                | 8.19 years |                   |  | $              | 3.28 |  |  |  | 722,000 |  |  | $ | 2.50 | 
|                        |  |                     |           |                     |  |                |            |                   |  |                |      |  |  |  |         |  |  |   |      | 

All stock options are granted with an exercise
price equal to the fair market value of the Companys
common stock at the grant date. The weighted average fair value
of the stock options granted was $3.02, $2.69, and $1.08 for
fiscal 2003, 2002, and 2001, respectively. The fair value of
each stock option grant 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 2003: risk-free
interest rate of 3.92%; expected dividend yield of 0%; expected
life of 9.4 years; and expected volatility of 44%. In 2002,
the assumptions were: risk-free interest rate of 4.46%; expected
dividend yield of 0%; expected life of 8.9 years; and
expected volatility of 38%. In 2001, the assumptions were:
risk-free interest rate of 4.96%; expected dividend yield of 0%;
expected life of 8.4 years; and expected volatility of 25%.
Stock options generally expire ten years from the date of grant
with one-third becoming exercisable on each anniversary of the
grant date.



|    |                   
|--- | ------------------
|10. | OTHER EXPENSE, NET

Other expense, net consists primarily of the
following for the year ended December 27, 2003:
non-capitalized acquisition costs of $394,000 associated with
the discontinued Antigua Enterprises acquisition effort and
successful H.S. Trask & Co. and Royal
Robbins, Inc. acquisitions; relocation costs of $354,000
associated with the relocation of the Companys corporate
headquarters from Old Town, Maine to Carlsbad, California;
litigation costs and expenses totaling $733,000 associated with
the dissenting Penobscot stockholders settlement, the write-off
of non-trade receivables totaling $163,000, and asset disposal
charges and other expenses totaling $18,000. These amounts were
partially offset by an excise tax refund of $285,000 associated
with the 2001 Penobscot pension plan reversion.

Other expense, net consists primarily of the
following for the year ended December 31, 2002: loss of
$254,000 on the sale of property; impairment of $84,000 on a
building held for sale in Maine and a write-off of $104,000 of a
receivable associated with the sale of the Companys
slipper brands in 2001.

Other expense, net consists primarily of the
following for the year ended December 31, 2001: the gain of
$1.2 million as a result of the sale of the Companys
slipper brands as described in Note 1; the loss of
$1.7 million as a result of the termination of the
Penobscot defined benefit pension plan as described in
Note 4 and; a net gain on the sale of property of $142,000.



|    |                                 
|--- | --------------------------------
|11. | RECENT ACCOUNTING PRONOUNCEMENTS

In June 2001, the Financial Accounting Standards
Board, or FASB, issued SFAS No. 143, Accounting for
Asset Retirement Obligations. SFAS No. 143
requires us to record the fair value of an asset retirement
obligation as a liability in the period in which it incurs a
legal obligation associated with the retirement of tangible
long-lived assets that result from the acquisition,
construction, development, and/or normal use of the assets. We
also record a corresponding asset that is depreciated over the
life of the asset. Subsequent to the

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##### Table of Contents



PHOENIX FOOTWEAR GROUP, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

initial measurement of the asset retirement
obligation, the obligation will be adjusted at the end of each
period to reflect the passage of time and changes in the
estimated future cash flows underlying the obligation. We
adopted SFAS No. 143 on January 1, 2003. The
adoption of SFAS No. 143 did not have a material
effect on our consolidated financial position or results from
operations.

Effective January 1, 2002, we adopted
SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets, which addresses financial
accounting and reporting for the impairment or disposal of
long-lived assets. While SFAS No. 144 supersedes
SFAS No. 121, Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of, it retains many of the fundamental provisions of that
statement. The adoption of this standard did not have a material
impact on our consolidated financial position or results from
operations.

In April 2002, the FASB issued
SFAS No. 145, Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13,
and Technical Corrections. SFAS No. 145 amends
existing guidance on reporting gains and losses on the
extinguishment of debt to prohibit the classification of the
gain or loss as extraordinary, as the use of such
extinguishments have become part of the risk management strategy
of many companies. SFAS No. 145 also amends
SFAS No. 13 to require sale-leaseback accounting for
certain lease modifications that have economic effects similar
to sale-leaseback transactions. The provisions of the Statement
related to the rescission of Statement No. 4 is applied in
fiscal years beginning after May 15, 2002. We adopted
SFAS No. 145 on January 1, 2003. The adoption of
SFAS No. 145 did not have a material effect on our
consolidated financial position or results from operations.

In June 2002, the FASB issued
SFAS No. 146, Accounting for Costs Associated with
Exit or Disposal Activities. SFAS No. 146
addresses financial accounting and reporting for costs
associated with exit or disposal activities and nullifies
Emerging Issues Task Force Issue 94-3, Liability Recognition
for Certain Employee Termination Benefits and Other Costs to
Exit an Activity. The provisions of this Statement are
effective for exit or disposal activities that are initiated
after December 31, 2002, with early application encouraged.
The adoption of SFAS No. 146 did not have a material
effect on our consolidated financial position or results from
operations.

In November 2002, the FASB issued Interpretation
No. 45, Guarantors Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees
of Indebtedness to Others, an interpretation of FASB Statements
No. 5, 57, and 107 and a rescission of FASB Interpretation
No. 34. This Interpretation elaborates on the
disclosures to be made by a guarantor in its interim and annual
financial statements about its obligations under guarantees
issued. The Interpretation also clarifies that a guarantor is
required to recognize, at inception of a guarantee, a liability
for the fair value of the obligation undertaken. The initial
recognition and measurement provisions of the Interpretation are
applicable to guarantees issued or modified after
December 31, 2002 and are not expected to have a material
effect on our consolidated financial position or results from
operations. The disclosure requirements are effective for
financial statements of interim and annual periods ending after
December 31, 2002 and did not have a material effect on our
consolidated financial statements.

In December 2002, the FASB issued
SFAS No. 148, Accounting for Stock-Based
Compensation  Transition and Disclosure, an amendment
of FASB Statement No. 123. This Statement amends FASB
Statement No. 123, Accounting for Stock-Based
Compensation, to provide alternative methods of transition
for a voluntary change to the fair value method of accounting
for stock-based employee compensation. In addition, this
Statement amends the disclosure requirements of Statement
No. 123 to require prominent disclosures in both annual and
interim financial statements. Certain of the disclosure
modifications are required for fiscal years ending after
December 15, 2002 and are included in the notes to our
consolidated financial statements.

59



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##### Table of Contents



PHOENIX FOOTWEAR GROUP, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

In January 2003, the FASB issued Interpretation
No. 46, Consolidation of Variable Interest Entities,
an interpretation of ARB No. 51, which was revised December
2003. This Interpretation addresses the consolidation by
business enterprises of variable interest entities as defined in
the Interpretation. The Interpretation generally applies
immediately to variable interests in variable interest entities
created after January 31, 2003 and to variable interests in
variable interest entities obtained after March 15, 2004.
The application of this Interpretation is not expected to have a
material effect on our consolidated financial statements.

In May 2003, the FASB issued
SFAS No. 149, Amendment of Statement No. 133
on Derivative Instruments and Hedging Activities. The
statement is effective for contracts entered into or modified
after June 30, 2003 and for hedging relationships
designated after June 30, 2003. This statement amends and
clarifies financial accounting and reporting for derivative
instruments, including certain derivative instruments embedded
in other contracts and for hedging activities. This statement
amends Statement No. 133 for decisions made as part of the
Derivatives Implementation Group process that effectively
required amendments to Statement No. 133, in connection
with other Board projects dealing with financial instruments and
in connection with implementation issues raised in relation to
the application of the definition of a derivative. The adoption
of this Statement did not have a material impact on the
Companys consolidated financial position or results of
operations.

In May 2003, the FASB issued
SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and
Equity. The statement is effective for financial instruments
entered into or modified after May 31, 2003, and otherwise
is effective at the beginning of the first interim period
beginning after June 15, 2003. This statement establishes
standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities
and equity. It requires that an issuer classify a financial
instrument that is within its scope as a liability. Many of
those instruments were previously classified as equity. The
adoption of this Statement did not have a material impact on the
Companys consolidated financial position or results of
operations.

******

60