<PAGE>
 
================================================================================
                       SECURITIES AND EXCHANGE COMMISSION
                              WASHINGTON, DC 20549

                                    FORM 10-K

|X|  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
     ACT OF 1934 FOR THE FISCAL YEAR ENDED January 2, 1999.

                                       OR

|_|  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
     EXCHANGE ACT OF 1934 [NO FEE REQUIRED] FOR THE TRANSITION PERIOD FROM
     _________ TO __________

                         COMMISSION FILE NUMBER 1-13430

                                  CONVERSE INC.
             (Exact name of registrant as specified in its charter)

         DELAWARE                                        43-1419731
(State or other jurisdiction of                   (I.R.S. Employer
incorporation or organization)                    Identification No.)

                                ONE FORDHAM ROAD
                        NORTH READING MASSACHUSETTS 01864
               (Address of principal executive offices) (Zip Code)
       Registrant's telephone number, including area code: (978) 664-1100
          -----------------------------------------------------------  
          Securities registered pursuant to Section 12(b) of the Act:


TITLE OF EACH CLASS                                   NAME OF EACH EXCHANGE
                                                      ON WHICH REGISTERED
Common stock, without par value                       New York Stock Exchange
7% Convertible Subordinated Notes                     New York Stock Exchange
  due 2004

          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 Securities Exchange Act of
1934 during the preceding 12 months (or such shorter period that registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days: YES [X] NO [ ]

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

     As of March 12, 1999, the aggregate market value of the registrant's voting
stock held by non-affiliates of the registrant was approximately $19,415,852,
based on the closing sales price of the registrant's Common Stock as reported on
the New York Stock Exchange as of such date ($3 5/8).

     Indicate with a check mark whether the registrant has filed all documents
and reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a Court. YES [X] NO [ ]

     As of March 12, 1999, 17,345,728 shares of the registrant's Common Stock
were outstanding.

                       DOCUMENTS INCORPORATED BY REFERENCE

     Portions of the Registrant's definitive Proxy Statement to be filed with
the Securities and Exchange Commission on or before April 30, 1999 for the
Annual Meeting of Stockholders to be held on May 12, 1999 are incorporated by
reference into Part III of this Report, as indicated herein.

================================================================================
<PAGE>
 
                                  CONVERSE INC.
                           ANNUAL REPORT ON FORM 10-K
                                TABLE OF CONTENTS

                                                                            Page
                                                                            ----
                                     PART I.

Item 1.  Business........................................................... 1
             Products....................................................... 1
             Marketing and Product Development.............................. 3
             Sales and Distribution......................................... 3
             Licensing Agreements........................................... 4
             Sourcing and Manufacturing..................................... 4
             Research and Development....................................... 5
             Backlog........................................................ 6
             Competition.................................................... 6
             Trademarks and Patents......................................... 6
             Environmental Matters.......................................... 7
             Employees...................................................... 7
             Risk Factors................................................... 7

Item 2.  Properties......................................................... 9
Item 3.  Legal Proceedings.................................................. 9
Item 4.  Submission of Matters to a Vote of Security Holders................ 9

                                    PART II.

Item 5.  Market for Registrant's Common Equity and Related
         Stockholder Matters................................................ 10
Item 6.  Selected Financial Data............................................ 10
Item 7.  Management's Discussion and Analysis of Financial
         Condition and Results of Operations................................ 12
Item 7A. Quantitative and Qualitative Disclosure About Market Risk.......... 23
Item 8.  Financial Statements and Supplemental Data......................... 24
Item 9.  Changes in and Disagreements with Accountants on
         Accounting and Financial Disclosure................................ 24

                                    PART III.
Item 10. Directors and Executive Officers of the Registrant................. 25
Item 11. Executive Compensation............................................. 26
Item 12. Security Ownership of Certain Beneficial Owners and Management..... 26
Item 13. Certain Relationships and Related Transactions..................... 26

                                    PART IV.
Item 14. Exhibits, Financial Statement Schedules, and Reports
         on Form 8-K........................................................ 27

                                   SIGNATURES
         Signatures......................................................... 30
<PAGE>
 
Information contained or incorporated by reference in this Report contains
"forward-looking statements" which can be identified by the use of
forward-looking terminology such as "believes," "expects," "may," "will,"
"should," or "anticipates" or the negative thereof or other variations thereon
or comparable terminology, or by discussions of strategy. See, e.g.,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations." No assurance can be given that the future results covered by the
forward-looking statements will be achieved. The Risk Factors contained in
"Business--Risk Factors" of this Report constitute cautionary statements
identifying important factors with respect to such forward-looking statements,
including certain risks and uncertainties, that could cause actual results to
vary materially from the future results covered in such forward-looking
statements. Other factors could also cause actual results to vary materially
from the future results covered in such forward-looking statements. Converse
Inc. (hereinafter the "Company" or "Converse") undertakes no obligation to
publicly release any revisions to these forward-looking statements to reflect
any future events or occurrences.

                                     PART I
                                     ------

ITEM 1.  BUSINESS.
------------------

     Converse is a leading global designer, manufacturer and marketer of high
quality athletic footwear for men, women and children. The Company is also a
global licensor of sports apparel, accessories and selected footwear. The
Company, founded in 1908, began establishing its authentic footwear heritage
with the introduction of its original canvas Chuck Taylor(R) basketball shoe in
1923. Throughout its 91-year history, Converse has achieved a high level of
brand name recognition due to its reputation for high performance products,
quality, value and style. Through its well-known Converse(R) All Star(R) brand,
the Company has consistently maintained its position as the American performance
brand with authentic sports heritage.

     The Company's footwear consists of five product categories: basketball,
athletic originals, children's, action sports and cross training. The basketball
category is comprised of high performance footwear for athletes and typically
features innovative design constructions and various proprietary performance
technologies. Converse's athletic originals category is centered on the
Converse(R) Chuck Taylor(R) All Star(R) canvas athletic shoe, which management
believes is the world's all time best-selling athletic shoe with over 560
million pairs sold since its introduction. Converse's children's category
consists of colorful and imaginative footwear especially for kids, as well as
children's-sized versions of the Company's performance athletic footwear. The
Company entered the action sports category in 1998, initially focusing on
skateboard athletes and recently expanding to include eco-training, in order to
capitalize on the dramatic growth in the popularity of individualistic sports.
The cross training category consists of high performance athletic shoes used for
sports training and fitness.

     The Company's products are distributed in over 90 countries to
approximately 9,000 customers, which include specialty athletic, sporting goods,
department and shoe stores, as well as to 28 Company-operated retail outlet
stores. In 1998 the Company reported net sales of $308.4 million. However, this
figure understates the total worldwide presence of Converse-branded products
since a large amount is sold through licensees, and Converse recognizes only a
percentage of these licensees' sales which it records as royalty income. Global
wholesale sales of Converse-branded products, which include direct sales by the
Company to retailers, sales by Converse distributors and sales of licensed
products by Converse licensees, were approximately $680 million in 1998, of
which over $469 million, or approximately 69%, were outside of the United
States.

PRODUCTS

     In 1998, the Company concentrated its marketing, product development and
sales efforts on its five core categories: basketball, athletic originals,
children's, action sports and cross training.

                                       1
<PAGE>
 
Basketball

     Converse basketball footwear offerings are high performance products
generally featuring one or more proprietary performance technologies developed
by the Company. For example in spring 1999, the All Star(R) Sky will feature
REACT(R) II technology designed to provide improved cushioning and stability in
addition to an anti-roll lever, a forefoot stability technology designed to
reduce forefoot movements, the All Star(R) Smooth will feature the innovative
"Shoe within a Shoe" concept allowing the athlete to be closer to the ground
increasing foot stability, and the All Star(R) Shakedown will feature
lightweight performance with multi-directional traction and flexibility. The
Company sells its basketball footwear at suggested retail prices ranging from
$45.00 to $95.00 through an extensive network of athletic specialty, department
and sporting goods stores.

Athletic Originals

     Converse's athletic originals footwear line is centered on the Chuck
Taylor(R) All Star(R) canvas athletic shoe. Since its introduction in 1923 as
the world's first basketball shoe, the Company has sold over 560 million pairs,
and management believes it to be the all-time best selling athletic shoe ever.
Converse's athletic originals footwear encompasses classic, time tested athletic
and aftersport shoes. Sold in a wide variety of colors, this line sells at
suggested retail prices ranging from $20.00 to $65.00 in athletic specialty,
sporting goods, department and shoe stores, as well as specialty apparel
retailers.

Children's

     The Company has recently implemented a new strategy in the children's
product category that revolves around offering colorful and imaginative footwear
designed specifically for children, in addition to offering its traditional
children's sized versions of the Company's basketball, athletic originals and
cross training products. Converse has also entered into a long term agreement
with Koosh(R), a leading marketer and innovator of kids toys rooted in sports.
Children's products are sold at suggested retail prices from $18.00 to $40.00
through athletic specialty, children's bootery, sporting goods and department
stores.

Action Sports

     In 1998, Converse made the strategic decision to enter the action sports
category, a rapidly growing product category that focuses on alternative sports
such as skateboarding and eco-training. The Converse ECO system is a line of
outdoor footwear built for athletes who enjoy testing their limits of fear
through extreme sports like climbing, mountain biking, and adventure running.
The Company will sell a full line of both skateboard and eco-training products
in fall 1999. These products are sold through a separate U.S. sales force to
independent skate shops and through more traditional distribution channels
internationally at suggested retail prices from $60.00 to $85.00.

Cross Training

     The Company's cross training category consists of high performance athletic
shoes used for multiple sports activities. The All Star(R) Catalyst, to be
introduced in spring 1999 is extremely lightweight and breathable and is
designed for superior durability in a full range of activities. Converse's cross
training footwear sells at suggested retail prices ranging from $50.00 to $75.00
through an extensive network of athletic specialty, sporting goods, department
and shoe stores.

Sports Apparel, Accessories and Selected Footwear Licensing (Royalty Income)

     Converse utilizes licensees who manufacture or purchase and distribute
sports apparel, accessories and selected footwear to provide consumers globally
with Converse-branded products from head-to-toe. Converse has entered into 74
separate licensing agreements permitting the licensees to design and market
selected products under the Converse brand name in specific markets. Japanese
licensees accounted for approximately 43.0% of Converse's total worldwide
royalty 

                                       2
<PAGE>
 
income in 1998. Royalty income in the Pacific Region, including Japan,
contributed 63.7% of total worldwide royalty income. Royalty income generated in
the U.S. represented approximately 15.2% of total worldwide royalty income in
1998. Royalty income for 1996, 1997, and 1998 was $27.6, $22.6, and $20.2
million, respectively.

MARKETING AND PRODUCT DEVELOPMENT

     The Company's marketing strategy is centered on the Converse All Star
brand, which is positioned as the American performance brand with authentic
sports heritage. The Company believes that there are significant opportunities
to build the brand, which commands high consumer awareness generated by reason
of its 91-year history. The Company's consumer research has become an integral
part of its product development, advertising campaigns and in-store point of
purchase materials.

     In 1998, the Company adopted "Stay True" as its new brand positioning
statement and tag line. "Stay True" is intended to convey the concept, through
the products, that athletes should stay true to themselves and be proud of who
they are and where they came from and to communicate a feeling of continuing
respect for people and institutions that enabled the athlete to succeed.

     To complement its marketing strategies, Converse cultivates the endorsement
and promotion of Converse footwear among athletes. The Company's endorsers
include prominent current NBA athletes as well as NBA athletes from an earlier
era, including Julius "Dr. J" Erving and Larry Bird. The Company is also a
leading supplier of athletic shoes to premier NCAA basketball teams, including
the University of Arkansas, Indiana University, the University of Louisville,
the University of New Mexico and the University of South Carolina. Management
believes that there are substantial opportunities to utilize these endorsers to
influence its target customers and further build the Converse All Star brand
through the Company's focused and integrated marketing strategies.

SALES AND DISTRIBUTION

     The Company's products are distributed in over 90 countries to
approximately 9,000 customers, including athletic specialty, sporting goods,
department and shoe stores, as well as to 28 Company-operated retail outlet
stores. Beginning in 1996, the Company has significantly increased its
distribution through specialty athletic retailers that showcase the Company's
and its licensees' coordinated head-to-toe product offerings.

United States Market

     The Company's 34-member U.S. sales force markets Converse footwear through
approximately 3,800 active retail accounts. In 1998, domestic sales represented
54% of total Company net sales. The Company has recently refined its
distribution strategy to increase its focus on key growth accounts such as
specialty athletic retailers. National and large regional accounts are serviced
by 7 account executives who focus on the product and merchandising needs of
these retailers. A majority of the Company's larger domestic customers are
served by an electronic data interface ("EDI") ordering system. In addition, a
quick response system has been implemented with a number of the Company's high
volume accounts. The quick response system provides for rapid replenishment of
retailer stock through an inventory management process that produces constant
"on hand" inventory quantities.

International Market

     The Company currently markets its products in approximately 90 countries
outside of the United States through subsidiaries, branch offices, independent
distributors and licensees. Non-U.S. sales accounted for 46% of total net sales
in 1998.

     Management believes that the Company is well-positioned to take advantage
of international growth opportunities. Although the tradition of the Converse(R)
All Star(R) brand as a high performance brand is not as well known
internationally as in the United States, the Company believes that because of
the global reach of NBA basketball, music, fashion, media and alternative
sports, the styles and trends among the Company's target customer group
internationally 

                                       3
<PAGE>
 
are similar in many ways to those in the United States. Management believes that
the Company has opportunities in Western Europe and the Pacific Rim as well as
in the developing markets of Latin America and Eastern Europe.

     In the key Western European markets of France, Italy, Benelux, United
Kingdom, Germany and Scandinavia, Converse has wholly-owned operating units of
the Company. These Converse operating units are responsible for the marketing
and distribution of Converse-branded footwear, apparel and accessories to
sporting goods, department and specialty stores within these territories. Sales
in Eastern Europe, the Middle East, Africa and Latin America are made through
independent licensees/distributors. The Company has recently executed new
distribution and license agreements for Spain, Portugal and Canada to replace
wholly-owned operating units in these countries.

     Sales of footwear in the Pacific region are also made through independent
licensees/distributors, the largest of which is MoonStar Chemical Corporation,
the Company's exclusive distributor of footwear in Japan since 1980. MoonStar
contributes approximately 19% to the Company's total net sales worldwide. The
Pacific Region also contributes the largest percentage of international
licensing income.

     The Latin American market is supplied by six footwear
  licensees/distributors and five apparel licensees.

LICENSING AGREEMENTS

     Converse utilizes licensees who manufacture or purchase and distribute
sports apparel, accessories and selected footwear to provide customers
head-to-toe Converse-branded products globally. Converse has entered into 74
separate licensing agreements permitting the licensees to design and market
selected products under the Converse brand name in specific markets. Under the
terms of Converse's licensee arrangements, all products designed by licensees,
as well as the related advertising, must be approved in advance by Converse. In
addition, the license agreements give Converse the right to monitor the quality
of the licensed products on an ongoing basis.


     The following table details sales by Converse's licensees and the related
royalty income to Converse:

                                            Fiscal Year Ended
                             ---------------------------------------------------
                             December 28, 1996  January 3, 1998  January 2, 1999
                             -----------------  ---------------  ---------------
                                             (Dollars in thousands)
Total sales by licensees:
    Footwear ..................   $101,117         $141,344         $121,666
    Apparel and accessories ...    307,011          208,866          179,330
                                  --------         --------         --------
Total .........................   $408,128         $350,210         $300,996
                                  ========         ========         ========
Total royalty income:                                            
    Footwear ..................   $  7,944         $ 10,013         $  9,776
    Apparel and accessories ...     19,694           12,556           10,399
                                  --------         --------         --------
Total .........................   $ 27,638         $ 22,569         $ 20,175
                                  ========         ========         ========
                                                              
     Traditionally, royalty income has accounted for a stable source of income.
However, in 1996, royalty income was abnormally high primarily due to a Japanese
apparel licensee's "over distribution" of the brand. Converse subsequently
charged the licensee a penalty of approximately $1.8 million and streamlined the
distribution of the Company's licensed products in order to maintain the high
quality of products bearing Converse trademarks.

SOURCING AND MANUFACTURING

     The majority of the Company's footwear models are sourced from various Far
East manufacturers. However, most of the Company's athletic originals products
are manufactured domestically by Converse.

                                       4
<PAGE>
 
Sourcing

     In 1998, approximately 46% of all Converse footwear was sourced from a
variety of Far East manufacturers on a per order basis. These manufacturers
produce the Company's footwear according to the Company's own design
specifications and quality standards. Sourcing is managed by the Company's
corporate headquarters in the United States. In selecting contractors, Converse
attempts to use manufacturers that specialize in the type of footwear being
produced and to avoid over reliance on any particular supplier by having a
sufficient diversity of manufacturing resources. The Company utilizes one
sourcing agent in Taiwan who assists the Company in selecting and overseeing
third party contractors, ensuring quality, sourcing fabrics and monitoring
quotas and other trade regulations. The Company's production staff and
independent sourcing agent together oversee all aspects of manufacturing and
production. Many of the manufacturers utilized by Converse are also used by the
Company's competitors.

     In 1998, the Company purchased approximately 7.3 million pairs from 11
manufacturers located in China, Taiwan, Macau, Vietnam and the Philippines.
While one manufacturer produced approximately 41% of the Company's products, the
Company believes any manufacturer can be replaced, if necessary, subject to
short-term supply disruptions.

Manufacturing

     Converse is the largest manufacturer of athletic footwear in the United
States, producing approximately 8.4 million pairs domestically in 1998. Converse
owns and operates a manufacturing facility in Lumberton, North Carolina, and
leases manufacturing facilities in Mission, Texas and Reynosa, Mexico. The
Company manufactures a majority of its athletic originals models at its 386,761
square foot Lumberton facility. The Company utilizes its Lumberton factory to
produce components and for the final assembly, its Mission facility for canvas
cutting and limited production, and all stitching and leather cutting is done at
the Reynosa facility to capitalize on lower labor costs.

     The domestic manufacturing of Converse's athletic originals products has
enabled the Company to utilize an EDI/quick response system with some of its
major customers. Management believes that its ability to produce its
best-selling athletic originals models with significantly shorter lead-times
than foreign-sourced products is a competitive advantage.

     The principal materials used in Converse's athletic originals footwear
products are canvas, linen and rubber. The Company purchases its raw materials
from diverse suppliers. While one supplier accounts for approximately 23% of raw
materials purchases, the Company believes that any supplier can be replaced, if
necessary, subject to short-term supply disruptions.

RESEARCH AND DEVELOPMENT

     Converse is a leading innovator of new footwear technologies. The Company
spent $6.5 million, $8.8 million and $7.7 million on research and development in
1996, 1997 and 1998, respectively. Converse's state of the art biomechanics
laboratory, located in a leased facility near the Company's headquarters,
continually conducts research on new performance-enhancing technologies. The
Company's biomechanical engineers are also involved in the design stages of
athletic footwear to help develop new technologies and attributes to improve the
function of shoes for specific sports. The Company maintains a full set of
production equipment at its biomechanics laboratory to develop prototypes, and
to ensure that new products can be manufactured efficiently to Converse's
specifications. In addition, Converse maintains a chemistry laboratory that
develops and tests midsole and outsole compounds, adhesives and fabrics for use
in its products.

     Many of Converse's basketball shoes use the patented REACT(R) shock
absorption technology. REACT gel is a polymer encapsulated in the midsoles of
Converse basketball shoes in the heel and forefoot regions that attenuates shock
as athletes run and jump and force pressure on their feet.

     Converse developed a breakthrough method to encapsulate helium molecules in
a technology that results in an extremely lightweight shoe that delivers
cushioning, stability and comfort. Designed to be among the lightest cushioning

                                       5
<PAGE>
 
technologies available, the helium technology will improve the performance needs
of serious athletes. Converse is the first footwear manufacturer to harness the
lighter-than-air helium molecule by developing a revolutionary polymer that is
impermeable to the helium molecule. The cylindrical metallic gray Helium Capsule
is visible through a clear window on the outsole and midsole of the shoes and is
attached to the heel of the inner bootie. A Converse patent-in-process polymer
known as Nanofilament(TM) allows the Helium Capsule to trap the helium molecules
and prevents them from escaping. The new helium technology makes its initial
appearance in the All Star(R) He:01 model available at Holiday 1999. Converse
plans to introduce a complete line of helium products in 2000 in the product
categories of basketball, training, running and action sports.

BACKLOG

     At the end of 1998, the Company's global backlog was $89.8 million,
compared to $129.5 million at the end of 1997. The amount of backlog at a
particular time is affected by a number of factors, including the scheduling of
the introduction of new products and the timing of the manufacturing and
shipping of the Company's products. Also, the Company has recently converted two
of its wholly-owned operating units to new licensee agreements which had the
impact of reducing the Company's global backlog and will lower future net sales
offset by increased royalty income. Accordingly, a comparison of backlog as of
two different dates is not necessarily meaningful.

COMPETITION

     The athletic footwear market is highly competitive. Industry participants
compete with respect to fashion, price, quality, performance and durability.
During the second half of 1997, there was an overall weakening of the athletic
footwear and apparel market which resulted in an oversupply of inventory in the
marketplace. This weakness and oversupply of inventory continued through 1998.
The athletic footwear industry in the United States can be broken down into
several groups. Nike Inc. ("Nike"), with 1998 estimated U.S. footwear revenues
exceeding $3 billion, controls over 40% of the U.S. athletic footwear market.
Reebok International, Inc. ("Reebok") and adidas-Solomon AG ("adidas"), each
with 1998 estimated U.S. footwear revenues of approximately $1 billion, each
control over 10% of the U.S. athletic footwear market. Each of these companies
has full lines of product offerings, competes with Converse in the Far East for
manufacturing sources, distributes to more than 10,000 outlets worldwide and
spends substantially more on advertising and promotion than Converse. New
Balance Athletic Shoe, Inc., Stride Rite Corporation and Fila USA, Inc. each
have 1998 U.S. branded athletic footwear revenues of between $200 million and
$350 million. All of these companies also compete with Converse for access to
foreign manufacturing facilities. In addition to these competitors, there are
companies with U.S. revenues of under $200 million, including K-Swiss, Vans,
Airwalk, ASICS Tiger, Etonic and Saucony among others. Some of these companies
emphasize footwear in categories such as running, tennis or team sports that are
not currently being produced by the Company. Worldwide footwear industry data is
unavailable, but the largest companies worldwide are believed to be Nike, Reebok
and adidas.

TRADEMARKS AND PATENTS

     Converse utilizes trademarks on virtually all of its footwear, licensed
apparel and accessories. Converse's main trademarks are "Converse(R) All
Star(R)", "Chuck Taylor(R)" and "REACT(R)" name and design and the "Converse All
Star Chuck Taylor Patch" and "All Star and Design" logos. In addition to those
main trademarks, from time to time Converse registers and/or uses other special
trademarks for special product lines, or products or features. Converse believes
that these trademarks are important in identifying products with the Converse
brand image, and the trademarks are often incorporated prominently in product
designs.

     The Company believes the Converse brand to be among its most important and
valuable assets for its marketing and generally seeks protection for its
trademarks in most countries where significant existing or potential markets for
its products exist. Converse takes vigorous action to defend its trademarks in
any jurisdiction where infringement is threatened or has occurred or where
others have tried to register them. It is impossible to estimate the amount of
counterfeiting involving Converse products or the effect such counterfeiting may
have on Converse's revenue and brand image.

                                       6
<PAGE>
 
     The Company maintains and preserves its trademarks and the related
registrations and aggressively protects such rights by taking appropriate legal
action against infringement, counterfeiting and misuse when warranted. The
Company is not aware of any material claim of infringement or other challenges
to the Company's right to use any of its trademarks, tradenames, or patents.

     The Company has a variety of patents, including a number of U.S. and
foreign patents and patent applications on its Helium and REACT(R) technologies.

ENVIRONMENTAL MATTERS

     The Company's operations are subject to federal, state and local laws,
regulations and ordinances relating to the operation and removal of underground
storage tanks and the storage, handling, generation, treatment, emission,
release, discharge and disposal of certain materials, substances and wastes. The
nature of the Company's operations expose it to the risk of claims with respect
to environmental matters and there can be no assurance that material costs or
liabilities will not be incurred in connection with such claims.

     Based on the Company's experience to date, the Company believes that its
future cost of compliance with environmental laws, regulations and ordinances,
or exposure to liability for environmental claims, will not have a material
adverse effect on the Company's business, operations or financial position.
However, future events such as changes in existing laws and regulations, or
unknown contamination of sites owned or operated by the Company (including
contamination caused by prior owners and operators of such sites) may give rise
to additional compliance costs which could have a material adverse effect on the
Company's financial condition.

EMPLOYEES

     As of January 2, 1999, Converse employed 2,658 individuals, of which 1,844
were in manufacturing, and 814 were in sales, administration, development and
distribution. Management believes its relationship with its employees to be
good. Converse has not experienced any material work stoppages or strikes in
recent years. The Reynosa, Mexico manufacturing workforce, representing
approximately 28% of Converse's work force, is represented by a union.

RISK FACTORS

     Investors should carefully consider the following factors, together with
other information contained and incorporated by reference in this Report, in
evaluating an investment in the Company.

Recent Operating Results; Industry Conditions

     We suffered significant net losses in 1996, 1997 and 1998. We also had an
accumulated stockholders' deficit of $69.3 million at January 2, 1999. Since
1997, there has been a significant slowdown in the branded athletic footwear
industry, led by the diminishing importance of basketball shoes worn casually
all over the world. The slowdown has been magnified by the economic problems
being experienced in the Southeast Asia and Latin America regions. Our sales
decline in 1998 is indicative of the continued industry-wide softening of demand
for athletic footwear that has negatively impacted the Company. This weakening
demand has led to an excessive amount of retail inventory levels of athletic
footwear. We can provide no assurance that we can attain profitability or that
we can maintain any profitability that we might achieve.

Competition; Changes in Consumer Preferences

     The branded athletic footwear industry is highly competitive. Our success
depends on our ability to anticipate and respond to changing merchandise trends
and consumer preferences and demands in a timely manner. If we fail to
anticipate and respond to changing trends and consumer preferences and demands,
consumer acceptance of our brand name and product line could be materially
adversely affected.

                                       7
<PAGE>
 
Foreign Production

     We utilize independent producers located in the Far East, particularly
China, Taiwan, Macau, Vietnam and the Philippines, to manufacture approximately
46% of our footwear. We also operate a facility in Mexico for the stitching of
canvas uppers for certain athletic originals category footwear. Our operations
are subject to the customary risks of doing business abroad, including
fluctuations in the value of currencies, import and export duties and trade
barriers (including quotas), restrictions on the transfer of funds, work
stoppages and, in certain parts of the world, political instability.

Economic Conditions and Seasonality

     Converse and the footwear industry are dependent on the economic
environment and levels of consumer spending which affect not only the ultimate
consumer, but also retailers, Converse's primary direct customers. Downward
trends in the economy or events that adversely affect the economy in general,
may adversely affect our results. Sales of Converse's footwear products are
somewhat seasonal in nature with the strongest sales generally occurring in the
first and third quarters. Any prolonged economic downturn or changes in consumer
spending patterns could have a material adverse effect on us.

International Sales and Currency Exchange

     International sales represent a significant portion of our net sales.
International sales are made through Company-owned subsidiaries denominated in
local currencies and through independent distributors denominated in U.S.
dollars. Our future operating results will depend, in part, on the Company's
ability to maintain or replace independent distributor relationships in key
markets as existing agreements expire. Additionally, changes in demand resulting
from fluctuations in currency exchange rates may affect our international sales.
All distributor sales are denominated in U.S. dollars and an increase in the
value of the U.S. dollar relative to foreign currencies could make Converse
products less competitive in those markets. During 1998, we used foreign
currency options to protect the Company from the effect of changes in foreign
exchange rates on our statement of operations with respect to our European
subsidiaries. International sales and operations may also be subject to risks
such as the imposition of governmental controls, export license requirements,
political instability, trade restrictions, changes in tariffs and difficulties
in staffing and managing international operations and managing accounts
receivable. In addition, the laws of certain countries do not protect Converse's
products and intellectual property rights to the same extent as the laws of the
United States. Any of these factors could have a material adverse effect on us.

Risks Associated with the Year 2000

     The Year 2000 issue is the result of computer programs being written using
two digits rather than four to define the applicable year. In other words,
date-sensitive software may recognize a date using "00" as the year 1900 rather
than the year 2000. This could result in systems failures or miscalculations
causing disruptions of operations, including, among others, a temporary
inability to process transactions, send invoices or engage in similar normal
business activities.

     While we are in the process of conducting an evaluation of the Year 2000
issue on our business, we do not believe that we have a material exposure to the
Year 2000 issue with respect to our own information systems. We are also
conducting an analysis to determine the extent to which our major suppliers and
customers' systems (insofar as they relate to Converse business) are not Year
2000 compliant or otherwise at risk with respect to the Year 2000 issue. We are
currently unable to predict the extent to which the Year 2000 issue will affect
our suppliers and customers, or the extent to which we would be vulnerable to
our suppliers and customers' failure to remediate any Year 2000 issue on a
timely basis. The failure of a major supplier or customer to convert its systems
on a timely basis or a conversion that is incompatible with our systems could
have a material adverse effect on us.

Controlling Stockholders

     Apollo Investment Fund, L.P. ("Apollo") and its affiliate Lion Advisors,
L.P., on behalf of an investment account 

                                       8
<PAGE>
 
under management ("Lion"; Apollo and Lion together being referred to herein as
the "Apollo Stockholders"), together beneficially owned approximately 65% of the
outstanding Common Stock at January 2, 1999. By reason of their ownership of
shares of Common Stock, the Apollo Stockholders have the power effectively to
control or influence control of Converse, including in elections of the Board of
Directors and other matters submitted to a vote of our stockholders, including
extraordinary corporate transactions such as mergers. The Apollo Stockholders
may exercise such control from time to time. A majority of the Board of
Directors consists of individuals associated with affiliates of Apollo and Lion.

Shares Eligible for Future Sale

     The Apollo Stockholders have the right to cause Converse to register the
shares of Common Stock that they own pursuant to a registration rights
agreement. Investors who bought the Company's Senior Secured Notes in 1998 hold
warrants to purchase 360,000 shares of the Company's Common Stock. Future sales
of such shares, or the availability of such shares for future sale, could
adversely affect the market prices for the Common Stock.

Anti-Takeover Provisions

     Our Restated Certificate of Incorporation (i) provides that our Board of
Directors may issue preferred stock without stockholder approval, (ii) prohibits
stockholder action by written consent and (iii) requires 75% ("supermajority")
stockholder vote to alter, amend, repeal or adopt certain provisions of the
Restated Certificate of Incorporation. In addition, our Restated Certificate of
Incorporation limits the ability of any person who is the beneficial owner of
more than 10% of our outstanding voting stock to effect certain transactions
involving Converse unless a majority of the Disinterested Directors (as defined
in the Restated Certificate of Incorporation of the Company) approves them.
These provisions could make it more difficult for a third-party to acquire us.

ITEM 2.  PROPERTIES.

     Converse owns or leases the following principal plants, offices and
warehouses:

                                                  Floor Space
Location               Type of Facility          (Square Feet)   Owned/Leased
--------               ----------------          -------------   ------------

North Reading, MA....  Headquarters                   106,800        Owned
Wilmington, MA.......  Research and 
                         Development Facility          23,192       Leased
Lumberton, NC........  Plant                          386,761        Owned
Charlotte, NC........  Distribution Center            431,665       Leased
Reynosa, Mexico......  Plant                          100,948       Leased
Mission, TX..........  Plant                           55,552       Leased

     In addition to the above properties, the Company leases space for 27 retail
stores in the U.S. and 1 retail store in the United Kingdom. The Company also
leases several sales and customer service offices and distribution centers
throughout the world. The Wilmington, Massachusetts lease expires in 2003, the
Charlotte, North Carolina lease expires in 2001, the Reynosa, Mexico lease
expires in 2008 and the Mission, Texas facility lease expires in 2003. For
further information regarding the Lumberton, Mission and Reynosa facilities see
"Business--Sourcing and Manufacturing".

ITEM 3.  LEGAL PROCEEDINGS.

     Converse is or may become a defendant in a number of pending or threatened
legal proceedings in the ordinary course of its business. Converse believes the
ultimate outcome of any such proceedings will not have a material adverse effect
on its financial position or results of operations.

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

     Not applicable.

                                       9
<PAGE>
 
                                     PART II


ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

     The Company's common stock ("Common Stock") is traded on the New York Stock
Exchange ("NYSE") under the symbol "CVE." The following table sets forth the
range of high and low closing sales prices for the Common Stock as reported by
the NYSE for the periods indicated:

                                            High                   Low
                                            ----                   ---
1996
First Quarter.......................        7 1/8                 4 1/8  
Second Quarter......................        5 1/2                 3 7/8  
Third Quarter.......................        6 7/8                 4 1/8  
Fourth Quarter......................       15 3/4                 6     

1997
----
First Quarter.......................       27 3/8                14 1/4  
Second Quarter......................       22                    13 1/4  
Third Quarter.......................       22 1/8                10 5/16 
Fourth Quarter......................       10 1/4                 5 5/8  

1998
----
First Quarter.......................        8 1/4                 5 13/16 
Second Quarter......................        6 9/16                4 1/16 
Third Quarter.......................        5 3/16                2 9/16 
Fourth Quarter......................        3 1/4                 1 15/16

     As of March 12, 1999 there were 17,345,728 shares of Common Stock issued
and outstanding, which shares were held by approximately 2,200 holders of record
of the Company's Common Stock.

     The Company has not paid any dividends on its Common Stock during the
periods indicated and does not anticipate paying any dividends on its Common
Stock in the foreseeable future. Any future payment of dividends will depend
upon the financial condition, capital requirements, earnings and loan covenant
restrictions of Converse, as well as upon other factors that the Board of
Directors may deem relevant.

                                       10
<PAGE>
 
ITEM 6.  SELECTED FINANCIAL DATA

     The following selected consolidated financial data of Converse should be
read in conjunction with Converse's historical consolidated financial statements
and the notes thereto contained herein. The following selected historical
consolidated financial data has been derived from the historical consolidated
financial statements of Converse. Prior to the Distribution (as defined on page
12) effected on November 17, 1994, Converse was a wholly-owned subsidiary of
Furniture Brands International, Inc. ("Furniture Brands"). The historical
consolidated financial statements of Converse for 1994 may not reflect the
results of operations or financial position that would have been obtained had
Converse been a separate, independent company during that period.

<TABLE>
<CAPTION>
                                                                                 Fiscal Year Ended
                                                  --------------------------------------------------------------------------------

                                                  Dec. 31, 1994   Dec. 30, 1995    Dec. 28, 1996     Jan. 3, 1998     Jan. 2, 1999
                                                  -------------   -------------    -------------     ------------     ------------
                                                                  (Dollars in thousands, except per share amounts)
<S>                                                  <C>             <C>              <C>             <C>               <C>
Statement of Operations Data:
Net sales ......................................     $ 437,307       $ 407,483        $ 349,335        $ 450,199        $ 308,353
Cost of sales ..................................       286,555         293,948          263,098          329,258          237,671
                                                     ---------       ---------        ---------        ---------        ---------
Gross profit ...................................       150,752         113,535           86,237          120,941           70,682
 
Selling, general and administrative                                                                                 
  expenses .....................................       128,876         146,332          114,888          127,261           92,683
Royalty income .................................        14,212          17,257           27,638           22,569           20,175
Restructuring expense (credit) .................            --          14,182           (1,177)           1,537               -- 
                                                     ---------       ---------        ---------        ---------        ---------
Earnings (loss) from operations ................        36,088         (29,722)             164           14,712           (1,826)
Loss (credit) on investment in                                                                                      
  unconsolidated subsidiary ....................            --          52,160           (1,362)         (12,537)              -- 
Interest expense, net ..........................         7,423          14,043           17,776           15,374           17,525
Other expense, net .............................           504           3,966            6,319            3,026              596
                                                     ---------       ---------        ---------        ---------        ---------
Earnings (loss) from continuing operations                                                                          
  before income taxes ..........................        28,161         (99,891)         (22,569)           8,849          (19,947)
Income tax expense (benefit) ...................        10,565         (28,144)          (4,134)          13,154            3,572
                                                     ---------       ---------        ---------        ---------        ---------
Earnings (loss) from continuing operations .....        17,596         (71,747)         (18,435)          (4,305)         (23,519)
Extraordinary (gain) loss, net of tax                                                                               
expense (benefit) of $(576) and $437, 
respectively ...................................            --              --               --              744             (704)
                                                     ---------       ---------        ---------        ---------        ---------
Net earnings (loss) ............................     $  17,596       $ (71,747)       $ (18,435)       $  (5,049)       $ (22,815)
                                                     =========       =========        =========        =========        =========

Net basic and diluted earnings (loss) per share:                                                                    
  Continuing operations ........................     $    1.05       $   (4.30)       $   (1.10)       $   (0.25)       $   (1.36)
  Extraordinary gain (loss) ....................            --              --               --            (0.04)            0.04
                                                     ---------       ---------        ---------        ---------        ---------
  Net earnings (loss) ..........................     $    1.05       $   (4.30)       $   (1.10)       $   (0.29)       $   (1.32)
                                                     =========       =========        =========        =========        =========

Balance Sheet Data (at period end):                                                                                 
  Working capital ..............................     $ 131,122       $  89,680        $ (32,648)       $  20,260        $   7,058
  Total assets .................................       223,726         224,507          222,603          234,694          195,006
  Long-term debt, less current maturities ......        77,087         112,824            9,644           80,000          101,799
  Total stockholders' equity (deficiency) ......        44,987         (22,685)         (38,868)         (47,982)         (69,310)
</TABLE>

                                       11
<PAGE>
 
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.

     The following discussion is based upon and should be read in conjunction
with the consolidated financial statements and the notes thereto of the Company
included elsewhere herein.

General

     Converse was founded in 1908, and operated as an independent family-owned
company until 1971, when it was acquired by Eltra Corporation, a diversified
holding company. In 1983, Converse became a publicly-traded company through an
initial public offering. In 1986, Furniture Brands, then named INTERCO
INCORPORATED, acquired Converse. On November 17, 1994, Furniture Brands
distributed to its stockholders all of the outstanding Common Stock of Converse
(the "Distribution"), and Converse became an independent publicly-traded
company.

     Converse is a leading global designer, manufacturer and marketer of high
quality athletic footwear for men, women and children. The Company is also a
global licensor of sports apparel, accessories and selected footwear. The
Company's products are distributed in over 90 countries to approximately 9,000
customers, which include athletic specialty, sporting goods, department and shoe
stores, as well as to 28 Company-operated retail outlet stores. The primary
costs and expenses of the Company result from the following: athletic products
sourced from various Far East manufacturers, employee salaries and fringe
benefits, advertising and promotion expenses and the purchase of raw materials
used in the Company's manufacturing process.

     The Company's Fiscal 1998 (as defined below) financial results have been
affected by several significant factors including: (i) continued weakness in the
athletic footwear and apparel market which led to a 31.5% decline in sales
revenue; (ii) the strength of the U.S. dollar in the European and Asian markets
resulting in weaker sales, gross profit and licensing income; and (iii) the
Company's aggressive efforts to reduce operating expenses and improve the
inventory position to address the effects of the industry downturn.

Results of Operations

     The Company's fiscal year end is the Saturday closest to December 31 in
each year. The results of operations will periodically include a 53-week fiscal
year. For purposes of the Company's financial statements, Fiscal 1998 refers to
the 52-week period ended January 2, 1999 ("Fiscal 1998"), Fiscal 1997 refers to
the 53-week period ended January 3, 1998 ("Fiscal 1997"), and Fiscal 1996 refers
to the 52-week period ended December 28, 1996 ("Fiscal 1996").

                                       12
<PAGE>
 
Comparison of Fiscal 1998 and Fiscal 1997

     The following table sets forth certain items related to operations and such
items as a percentage of net sales for Fiscal 1998 and Fiscal 1997:

<TABLE> 
<CAPTION>
                                                                                        Fiscal Year Ended
                                                                 --------------------------------------------------------------
                                                                 January 2, 1999           %     January 3, 1998           %
                                                                 ---------------        ------   ---------------         -----
                                                                         (Dollars in thousands, except per share amounts)

<S>                                                                 <C>                  <C>        <C>                  <C> 
Net sales ....................................................      $ 308,353            100.0      $ 450,199            100.0
Gross profit .................................................         70,682             22.9        120,941             26.9
Selling, general and administrative expenses .................         92,683             30.1        127,261             28.3
Royalty income ...............................................         20,175              6.5         22,569              5.0
Restructuring expenses .......................................             --               --          1,537              0.3
Earnings (loss) from operations ..............................         (1,826)            (0.6)        14,712              3.3
(Credit) on investment in unconsolidated subsidiary ..........             --               --        (12,537)            (2.8)
Interest expense, net ........................................         17,525              5.7         15,374              3.4
Other expense ................................................            596              0.2          3,026              0.7
Earnings (loss) from continuing operations before income tax..        (19,947)            (6.5)         8,849              2.0
Income tax expense ...........................................          3,572              1.2         13,154              2.9
Loss from continuing operations ..............................        (23,519)            (7.6)        (4,305)            (1.0)
Basic and diluted loss per share from continuing operations ..      $   (1.36)              --      $   (0.25)              --
Extraordinary (gain) loss, net of tax ........................           (704)            (0.2)           744              0.2
Net loss .....................................................      $ (22,815)            (7.4)     $  (5,049)            (1.1)

Basic and diluted net loss per share .........................      $   (1.32)                      $   (0.29)
</TABLE> 

Net Sales

     Net sales for Fiscal 1998 decreased to $308.4 million from $450.2 million
in Fiscal 1997, a 31.5% reduction. The $141.8 million net sales reduction in
Fiscal 1998 is attributable to decreases of 53.7%, 51.1%, 37.7% and 2.8% in the
basketball, children's, cross training and athletic originals categories,
respectively, compared to Fiscal 1997. These decreases were partially offset by
a $7.0 million increase in the Company's new action sports category.

     Net sales in the United States decreased 41.5% to $166.6 million for Fiscal
1998 from $284.9 million for Fiscal 1997. Net sales decreased 14.2%
internationally to $141.8 million for Fiscal 1998 from $165.3 million for Fiscal
1997. Net sales in the Europe, Middle East and Africa ("E.M.E.A."), Pacific and
Latin America regions were down 3.8%, 15.8% and 57.1%, respectively.

     The athletic footwear and apparel industry has struggled through a slowdown
in branded athletic sales, particularly in the adult's and children's basketball
and cross training product categories. The difficult industry conditions have
been exacerbated by the excessive levels of athletic footwear inventory in the
marketplace. The domestic market also has suffered from the over capacity due to
significant retail expansion during a period of softening consumer demand. This
change in preference has adversely affected the Company's business, as well as
that of many of its competitors. The Company's basketball and cross training
categories have been significantly impacted along with the children's category
which, in large part, has been comprised of "takedowns" from these categories.
The athletic originals category is more closely aligned with the global consumer
preference and has been affected to a lesser extent. Also adversely affecting
the industry environment was the financial turmoil in the Asia Pacific and Latin
America regions which has negatively impacted consumer spending. This
industry-wide softening has resulted in an oversupply of branded athletic
footwear in the global marketplace, which continued into 1999.

Gross Profit

     Gross profit decreased to $70.7 million in Fiscal 1998 from $120.9 million
in Fiscal 1997, a 41.5% decline. The industry downturn and related volume
decreases accounted for the majority of the gross profit reduction over the
period. As a percentage of net sales, gross profit fell to 22.9% in Fiscal 1998
compared to 26.9% for the prior year period. The 

                                       13
<PAGE>
 
decline was caused primarily by the highly promotional and over-inventoried
environment that has led to reduced demand in the Company's performance
categories and has resulted in price reductions for basketball, children's and
cross training products. The Company's efforts to reduce inventory levels
through the clearance of product from past seasons have also contributed to the
decline.

Selling, General and Administrative Expenses

     In order to address the current industry conditions, the Company took
aggressive actions in 1998 to reduce its operating expenses. Selling, general
and administrative expenses, which are primarily comprised of direct selling,
advertising, and promotion expenses in addition to employee salaries and
benefits and other overhead costs, decreased $34.6 million to $92.7 million for
Fiscal 1998 from $127.3 million for Fiscal 1997, a 27.2% decrease. This
reduction was mainly attributable to decreased spending in global selling,
marketing, advertising and promotion activities, as well as staff reductions to
partially offset the effects of the industry downturn. Also contributing to the
reduction in selling, general and administrative charges in 1998 was a gain of
$9.3 million resulting from the termination of the post-retirement medical
benefit plan and a gain of $1.6 million resulting from pension curtailment
related to workforce reductions. These gains were partially offset by a $1.8
million severance charge related to workforce reduction in 1998. As a percentage
of net sales, selling, general and administrative expenses increased to 30.1%
for Fiscal 1998 from 28.3% for the prior year.

Royalty Income

     Royalty income decreased 10.6% to $20.2 million in Fiscal 1998 from $22.6
million in Fiscal 1997. International royalty income, which represented 84.8% of
the Company's total royalty income, declined 8.8%. The reduction was primarily
attributable to decreases of 25.3% and 40.6% in the Southeast Asia and E.M.E.A.
regions, respectively. Domestic royalty income decreased by 19.4% to $3.1
million for Fiscal 1998. The decreases are representative of the slowdown in the
athletic footwear business and were exacerbated by the deterioration of the
economies in Southeast Asia and the strength of the U.S. dollar worldwide. These
declines were partially offset by an 11.9% improvement in royalty income derived
from Japan. As a percentage of net sales, royalty income increased to 6.5% in
Fiscal 1998 compared to 5.0% in the prior year.

Restructuring Expenses

     In the fourth quarter of Fiscal 1997, the Company established pretax
restructuring reserves of $2.1 million related to a workforce reduction and the
elimination of certain unprofitable retail stores. This restructuring charge was
partially offset by the reversal of previously written-off expenses relating to
the closing of the Mission, Texas manufacturing facility in the first quarter of
Fiscal 1997.

     At January 2, 1999, there were no remaining restructuring reserves. See
Note 4 to the Consolidated Financial Statements of the Company included herein.

Earnings (Loss) from Operations

     The Company recorded a loss from operations in Fiscal 1998 of $1.8 million,
compared to earnings from operations of $14.7 million in Fiscal 1997. This
change was primarily due to the factors discussed above.

Credit on Investment in Unconsolidated Subsidiary

     In Fiscal 1997, the Company recorded a pretax credit totaling $13.2 million
related to the settlement of certain claims by the Company related to the
Company's 1995 acquisition of Apex One, Inc. ("Apex"). This amount was partially
offset by additional Apex-related legal and settlement costs incurred in the
fourth quarter of Fiscal 1997, finalizing all remaining outstanding litigation
relating to the Company's investment in Apex. The net activity for Fiscal 

                                       14
<PAGE>
 
1997 was a net credit on investment in unconsolidated subsidiary of $12.5
million. At January 2, 1999, there were no remaining claims against the Company
related to its 1995 acquisition of Apex. See Note 3 to the Consolidated
Financial Statements of the Company included herein.

Interest Expense

     Interest expense for Fiscal 1998 increased 13.6% to $17.5 million from
$15.4 million in Fiscal 1997. The increase reflects higher borrowing levels in
Fiscal 1998 compared to Fiscal 1997 and the reversal of $1.4 million of interest
payments previously paid into escrow on the subordinated notes issued to former
owners of Apex and subsequently surrendered to the Company upon settlement of
the Company's claims against them in 1997.

Other Expense

     Other expense for Fiscal 1998 of $0.6 million was comprised primarily of
foreign exchange losses offset by the $1.0 million gain on the sale of the
Company's Reynosa, Mexico manufacturing facility. The Fiscal 1997 expense of
$3.0 million was primarily related to foreign exchange losses attributable to
the appreciation of the U.S. dollar. Since the third quarter 1997, the Company
has entered into foreign exchange contracts and currency options as part of a
strategy to reduce its exposure to foreign currency fluctuations.

Income Tax Expense

     Income tax expense, excluding the effect of extraordinary items, for Fiscal
1998 was $3.6 million, compared to $13.2 million for Fiscal 1997. As of January
2, 1999, the Company's gross deferred tax assets were $54.1 million, which was
the result of net operating loss carryforwards and other future tax deductible
items totaling $133.2 million. Although the period to use these deferred tax
assets is 11 to 20 years for tax purposes, the accounting guidance requires that
a shorter time frame be used to assess the probability of their realization. As
a result of the uncertainty caused by the industry downturn which began in the
last half of Fiscal 1997 and the related oversupply of inventory in the
marketplace in Fiscal 1998, the Company incurred a charge to income tax expense
of $9.4 million to increase its deferred tax valuation allowance to a total of
$30.8 million.

Extraordinary (Gain) Loss

     During Fiscal 1998, the Company reported an extraordinary gain of $0.7
million, net of tax. The extraordinary gain related to the cancellation of
outstanding subordinated notes the Company exchanged for newly issued secured
notes, net of financing fees that were written off in connection with the debt
transactions. During Fiscal 1997, the Company entered into a new $150.0 million
secured credit agreement replacing its former credit agreement. In connection
with the repayment of the former credit agreement, the Company wrote-off
deferred financing fees of $1.3 million which resulted in an extraordinary loss
net of tax of $0.7 million.

Net Loss

     Due to the factors described above, the Company recorded a net loss of
$22.8 million in Fiscal 1998 compared to a $5.0 million net loss in Fiscal 1997.

Net Loss Per Share

     The Company recorded a net loss per share of $1.32 in Fiscal 1998 compared
to a net loss per share of $0.29 in Fiscal 1997. The weighted average number of
outstanding shares in Fiscal 1998 was 17,319,377 versus 17,271,911 in Fiscal
1997.

                                       15
<PAGE>
 
Comparison of Fiscal 1997 and Fiscal 1996

     The following table sets forth certain items related to operations and such
items as a percentage of net sales for Fiscal 1997 and Fiscal 1996:

<TABLE> 
<CAPTION> 
                                                                                  Fiscal Year Ended
                                                             ------------------------------------------------------------
                                                              January 3, 1998      %       December 28, 1996        %
                                                                 --------        -----     -----------------      -----
                                                                  (Dollars in thousands, except per share amounts)

<S>                                                              <C>             <C>           <C>                <C> 
Net sales...............................................         $450,199        100.0         $349,335           100.0 
Gross profit............................................          120,941         26.9           86,237            24.7 
Selling, general and administrative expenses............          127,261         28.3          114,888            32.9 
Royalty income..........................................           22,569          5.0           27,638             7.9 
Restructuring expenses (credit).........................            1,537          0.3           (1,177)           (0.3)
Earnings from operations................................           14,712          3.3              164             0.0 
Loss (credit) on investment in unconsolidated subsidiary          (12,537)        (2.8)          (1,362)           (0.4)
Interest expense........................................           15,374          3.4           17,776             5.1 
Income tax expense (benefit)............................           13,154          2.9           (4,134)           (1.2)
Loss from continuing operations.........................           (4,305)        (1.0)         (18,435)           (5.3)
Extraordinary loss......................................              744          0.2               --              -- 
Net loss................................................          $(5,049)        (1.1)       $ (18,435)           (5.3)

Net loss per share......................................          $ (0.29)                      $ (1.10)
</TABLE> 

Net Sales

     Net sales for Fiscal 1997 increased to $450.2 million from $349.3 million
in Fiscal 1996, a 28.9% improvement. The $100.9 million sales growth in Fiscal
1997 is attributable to increases of 44.3%, 40.1% and 8.5% in the athletic
originals, basketball and children's categories, respectively, compared to
Fiscal 1996. These gains were partially offset by a 1.1% decline in the cross
training category compared to the prior year.

     Net sales in the United States for Fiscal 1997 increased 46.8% and net
sales internationally increased 6.5% compared to the prior year. Net sales in
the Pacific region (Japan) improved 62.4% in Fiscal 1997 as a result of strong
demand for the Company's athletic originals products while net sales in the
Latin/South America region increased 3.2%. Net sales in the Europe, Middle East
and Africa region, and Canada recorded declines of 18.2% and 10.6%,
respectively, in Fiscal 1997. The strong U.S. dollar continued to have an
adverse affect on the Company's results. On a constant dollar basis, Fiscal 1997
international net sales would have increased 11.1% compared to Fiscal 1996.

Gross Profit

     Gross profit increased to $120.9 million in Fiscal 1997 from $86.2 million
in Fiscal 1996, a 40.3% improvement. As a percentage of net sales, gross profit
increased to 26.9% in Fiscal 1997 compared to 24.7% for the prior year period.
This improvement is primarily attributable to strong sales in the first half of
Fiscal 1997 in all categories as well as increasing consumer demand for the
Company's athletic originals products in the second half of the year, resulting
in greater manufacturing utilization and economic efficiencies at the Company's
U.S. factories. These gross profit gains were partially offset by weaker margins
in the second half of Fiscal 1997 in the basketball, training and children's
categories resulting from an oversupply of inventory in the market due to an
industry-wide slow down in athletic footwear sales.

Selling, General and Administrative Expenses

     Selling, general and administrative expenses, which are primarily comprised
of advertising, promotion and selling expenses in addition to employee salaries
and benefits and other overhead costs, increased $12.4 million to $127.3 million
for Fiscal 1997 from $114.9 million for Fiscal 1996, a 10.8% increase. This gain
was mainly attributable to increased spending in advertising, promotion, and
direct selling activities necessary to support the Fiscal 1997 sales 

                                       16
<PAGE>
 
growth in the United States and the Pacific region. As a percentage of net
sales, selling, general and administrative expenses decreased to 28.3% for
Fiscal 1997 from 32.9% for the prior year.

Royalty Income

     Royalty income decreased 18.1% to $22.6 million in Fiscal 1997 from $27.6
million in Fiscal 1996. As a percentage of net sales, royalty income declined to
5.0% in Fiscal 1997 compared to 7.9% in the prior year. International royalty
income, which represented 83.1% of the Company's total royalty income, declined
24.9% in Fiscal 1997 primarily as a result of a 37.5% reduction in the Pacific
region compared to Fiscal 1996. The Pacific region decline is primarily
attributable to streamlining the distribution of the Company's licensed products
and to the strengthening of the U.S. dollar. The decline in the Pacific region
was partially offset by increases of 141.6% in the Latin/South America region
and 33.4% in the Europe, Middle East and Africa region. United States royalty
income increased 42.7% to $3.8 million in Fiscal 1997 compared to Fiscal 1996.

Restructuring Expenses (Credit)

     The Company established pretax restructuring reserves of $2.1 million
related to a workforce reduction and the elimination of certain unprofitable
retail stores in the fourth quarter of Fiscal 1997. The restructuring reserves
represent fixed amounts to be paid out during 1998. This restructuring charge
was partially offset by the reversal of previously written-off expenses relating
to the re-opening of the Mission, Texas manufacturing facility in the first
quarter of Fiscal 1997. See Note 4 to the Consolidated Financial Statements of
the Company included herein.

Earnings from Operations

     The Company recorded earnings from operations in Fiscal 1997 of $14.7
million, compared to $0.2 million in Fiscal 1996. This change was primarily due
to the factors discussed above.

Loss (Credit) on Investment in Unconsolidated Subsidiary

     In the first quarter of Fiscal 1997, the Company recorded a pretax gain
totaling $13.1 million relating to the settlement of certain Apex-related
obligations. This amount was partially offset by additional Apex-related legal
and settlement costs incurred in the fourth quarter of Fiscal 1997, finalizing
all remaining outstanding litigation relating to the Company's investment in
Apex. The net activity for Fiscal 1997 was a net credit on investment in
unconsolidated subsidiary of $12.5 million. At January 3, 1998, there were no
remaining claims against the Company relating to its 1995 acquisition of Apex.
See Note 3 to the Consolidated Financial Statements of the Company included
herein.

Interest Expense

     Interest expense for Fiscal 1997 decreased 13.5% to $15.4 million from
$17.8 million in Fiscal 1996. The decrease is primarily attributable to the
reversal of $1.4 million of interest payments paid into escrow relating to the
subordinated notes issued to the former owners of Apex, the write-off of
unamortized bank fees and the issuance of the convertible notes replacing other
higher-interest indebtedness. These decreases were partially offset by an
increase in interest payments due to higher borrowing levels in Fiscal 1997
compared to Fiscal 1996.

Income Tax Expense (Benefit)

     Income tax expense for Fiscal 1997 was $13.2 million, compared to an income
tax benefit of $4.1 million for Fiscal 1996. As of January 3, 1998, the
Company's gross deferred tax assets were $44.2 million, which is the result of
net operating loss carryforwards and other future tax deductible items totaling
$117.2 million. Although the period to use these deferred tax assets is 11 to 20
years for tax purposes, the accounting guidance requires that a shorter time
frame be used to assess the probability of their realization. As a result of the
uncertainty caused by the industry downturn and the 

                                       17
<PAGE>
 
related oversupply of inventory in the marketplace during the fourth quarter of
Fiscal 1997, the Company increased its deferred tax valuation allowance by $9.3
million to a total of $20.9 million.

Extraordinary Loss

     During Fiscal 1997, the Company entered into a new $150.0 million secured
credit agreement replacing its former credit agreement. In connection with the
repayment of the former credit agreement, the Company wrote-off deferred
financing fees of $1.3 million which resulted in an extraordinary loss net of
tax of $0.7 million.

Net Loss

     Due to the factors described above, the Company recorded a net loss of $5.0
million in Fiscal 1997 compared to an $18.4 million net loss in Fiscal 1996.

Net Loss Per Share

     The Company recorded a net loss per share of $0.29 in Fiscal 1997 compared
to a net loss per share of $1.10 in Fiscal 1996. The weighted average number of
outstanding shares in Fiscal 1997 was 17,271,911 versus 16,760,620 in Fiscal
1996.

Liquidity and Capital Resources

Cash Flow

     Net cash provided by operating activities was $0.6 million in Fiscal 1998
versus net cash required for operating activities of $48.1 million in Fiscal
1997. In Fiscal 1998, the net loss of $22.4 million (after giving effect to
adjustments for non-cash items) and requirements for changes in other long-term
assets and liabilities of $10.3 million, principally the reduction in the long
term liability due to the elimination of deferred postretirement medical
benefits, were offset by cash provided of $33.3 million from the reduction in
working capital needs fueled by significant reductions in receivables and
inventories. In Fiscal 1997, requirements for operating activities were
comprised of a net loss of $12.8 million (after giving effect to adjustments for
non-cash items), working capital needs of $32.7 million consisting principally
of receivables, inventories and payables, and other long-term assets and
liabilities of $2.6 million.

     Net cash used by investing activities was $3.6 million in Fiscal 1998.
Additions to property, plant and equipment of $4.8 million were partially offset
by proceeds received of $1.2 million from the disposal of assets, principally
the sale of a manufacturing facility in Reynosa, Mexico to accommodate the
Company's move to a larger leased facility. Net cash used from investing
activities was $5.9 million in Fiscal 1997 and consisted entirely of additions
to property, plant and equipment.

     Net cash provided by financing activities was $1.2 million for Fiscal 1998.
Net proceeds received from the issuance of Secured Notes (as defined below) of
$24.0 million and short term debt of $0.2 million generated by the asset based
financing arrangements in the Company's European subsidiaries were used to
reduce revolving debt by $23.0 million outstanding under the Credit Facility
(see Financing Arrangements below). Net cash provided by financing activities
was $52.8 million for Fiscal 1997. Cash was provided from the net proceeds from
the sale of 7% Convertible Subordinated Notes (see Financing Arrangements below)
in May 1997 of $76.4 million, net borrowings under the Credit Facility of $96.9
million and net proceeds from the exercise of stock options of $0.5 million.
This was partially offset by cash used from the decrease of short-term debt of
$3.2 million and the repayment of the Old Credit Facility (see Financing
Arrangements below) of $117.8 million.

                                       18
<PAGE>
 
Working Capital

     The Company's working capital position, net of cash, was $3.8 million on
January 2, 1999 versus $14.5 million on January 3, 1998.

     Total current assets, net of cash, decreased $38.4 million to $138.1
million at January 2, 1999 from $176.5 million in the prior year. The reduction
in receivables of $14.3 million and in inventories of $23.4 million is
reflective of the volume decrease in business activity and the Company's
emphasis on working capital management to keep these key asset categories in
line with the reduced sales. Prepaid expenses and other current assets decreased
$0.7 million. Total current liabilities decreased $27.7 million from $162.0
million at January 3, 1998 to $134.3 million at January 2, 1999. As discussed
above, revolving debt under the Credit Facility was reduced $23.0 million,
principally from the proceeds of the issuance of the Secured Notes. Payables and
accrued expenses decreased $5.2 million, due principally to the reduction in
business activity, while short term debt increased $0.5 million.

Financing Arrangements

     In September 1998, the Company issued $28.6 million aggregate principal
amount of 15% Senior Secured Notes (the "Secured Notes") due September 16, 2000
(the "Initial Maturity Date"). Interest on the Secured Notes is payable
quarterly in arrears. The Initial Maturity Date may be extended an additional 12
months at the Company's option upon written notification of its election to
extend and payment of a fee equal to 3% of the then outstanding principal amount
of the Secured Notes (the "First Extended Maturity Date"). The First Extended
Maturity Date may be extended to May 21, 2002, at the Company's option, upon
written notification of its election to extend and payment of an additional fee
equal to 3% of the then outstanding principal amount of the Secured Notes. The
Secured Notes were issued in two series: Series A in the aggregate principal
amount of $24.8 million (the "Series A Secured Notes") and Series B in the
aggregate principal amount of $3.8 million (the "Series B Secured Notes"). The
Secured Notes are redeemable at any time at face amount plus accrued interest.
The Secured Notes require compliance with customary affirmative and negative
covenants, including certain financial covenants, substantially the same as the
requirements contained in the Credit Facility.

     Upon issuance of the Series A Secured Notes the Company received gross
proceeds of $24.0 million after discount from the face amount. In connection
with the issuance of the Series A Secured Notes, the Company issued warrants to
purchase 360,000 shares of the Company's common stock to the purchasers and paid
funding fees to certain purchasers amounting to $0.4 million. The warrants were
valued at $1.22 per share, vest immediately and expire on March 16, 2003. The
Company paid a placement fee of 4% of the gross proceeds, or $1.0 million, with
respect to the Series A Secured Notes. The Series A Secured Notes carry a second
priority perfected lien on all real and personal, tangible and intangible assets
of the Company.

     The Series B Secured Notes were issued in exchange for the surrender of
$5.7 million face amount of Convertible Notes (see below), which were
subsequently cancelled by the Company. In connection with the issuance of the
Series B Secured Notes, the Company paid a placement fee of 2% of the face
amount, or $0.1 million. The Series B Secured Notes carry a third priority
perfected lien on all real and personal, tangible and intangible assets of the
Company.

     In May 1997, the Company issued $80.0 million of 7% Convertible
Subordinated Notes due June 1, 2004 (the "Convertible Notes"). As discussed
above, in September 1998 the Company received, and subsequently cancelled, $5.7
million of Convertible Notes in exchange for the issuance of the Series B
Secured Notes. The Convertible Notes are subordinated to all existing and future
Senior Indebtedness (as defined therein). The Convertible Notes are convertible
at any time prior to maturity, unless previously redeemed into common stock of
the Company, at the option of the holder, at a conversion price of $21.83 per
share, subject to adjustment in certain events. In addition, the Convertible
Notes may be redeemed, in whole or in part, at the option of the Company, at any
time on or after June 5, 2000, at redemption prices set forth therein plus
accrued interest to the date of redemption. Interest is payable semi-annually on
June 1 and

                                       19
<PAGE>
 
December 1, commencing on December 1, 1997. Proceeds from the Convertible Notes
were used to repay indebtedness under the Company's then existing credit
agreement (the "Old Credit Facility").

     Simultaneously with the issuance of the Convertible Notes in May 1997, the
Company entered into a new $150.0 million secured credit agreement (the "Credit
Facility") with BT Commercial Corporation ("BTCC") for revolving loans, letters
of credit, foreign exchange contracts and banker acceptances and repaid the Old
Credit Facility. In July 1997, BTCC, as agent, syndicated the Credit Facility to
a group of participating lenders (the "Banks"). In September 1998, the Credit
Facility was amended to decrease the commitment from $150.0 million to $120.0
million in conjunction with the issuance of the Secured Notes. The amount of
credit available to the Company at any time is limited by a borrowing base
formula, as defined in the Credit Facility, consisting primarily of U.S. and
Canadian accounts receivable and inventory (the "Borrowing Base"). The aggregate
of letters of credit, foreign exchange contracts and banker acceptances may not
exceed $80.0 million at any time; revolving loans are limited only by the Credit
Facility's maximum availability less any amounts outstanding for letters of
credit, foreign exchange contracts or banker acceptances.

     The Credit Facility is for a five-year term and, accordingly, has an
expiration date of May 21, 2002. However, the total revolving loans and banker
acceptances outstanding under the Credit Facility of $73.8 million are
classified as current due to the Company's lockbox arrangement (whereby payments
by the Company's customers are deposited in a lockbox controlled by the Banks)
and certain clauses contained in the Credit Facility regarding mandatory
repayment that involve subjective judgments by the Banks. This classification is
required by Emerging Issues Task Force 95-22, "Balance Sheet Classification of
Borrowings Outstanding under a Revolving Credit Agreement that Includes both a
Subjective Acceleration Clause and a Lockbox Arrangement".

     As of January 2, 1999, the Borrowing Base was $80.4 million. Utilization
under the Credit Facility at year end amounted to $76.1 million consisting of
revolving loans of $72.4 million, banker acceptances of $1.4 million and
outstanding letters of credit of $2.3 million. Accordingly, $4.3 million of the
maximum available Borrowing Base remained unutilized as of January 2, 1999.

     Revolving loans under the Credit Facility bear interest either at the Prime
Lending Rate (as defined therein) plus one percent (1.00%) per annum or at the
Adjusted LIBOR Rate (as defined therein) plus a margin of two and one-half
percent (2.50%) per annum. The foregoing LIBOR margin is subject to a reduction
based upon the Company achieving certain interest coverage ratios specified in
the Credit Facility. At January 2, 1999, revolving loans outstanding under the
Credit Facility bore interest of 7.79% based upon the weighted average of the
Prime Lending Rate and Adjusted LIBOR Rate. Obligations outstanding under the
Credit Facility are secured by first priority liens on substantially all of the
Company's U.S. and Canadian assets.

     The Credit Facility, as amended, requires compliance with customary
affirmative and negative covenants, including certain financial covenants. In
September 1998, the Company's Credit Facility was amended to permit the issuance
of the Secured Notes. The amendment decreased the commitment under the Credit
Facility from $150.0 million to $120.0 million, increased the annual collateral
management fee from $0.1 million to $0.125 million and changed a financial
performance covenant contained therein. As of January 2, 1999, the Company was
in compliance with its financial covenants and believes that it will remain in
compliance during 1999.

     Subsidiaries of the Company maintain asset based financing arrangements in
certain European countries with various lenders. In general, these financing
arrangements allow for borrowings based upon eligible accounts receivable and
inventory at varying advance rates and varying interest rates. Total short-term
borrowings outstanding under these financing arrangements were $9.6 million as
of January 2, 1999. Interest is payable at the respective lender's base rate
plus 1.5% (varying by country from 4.5% to 8.0%). Additionally, letters of
credit outstanding under these financing arrangements totaled $3.9 million at
year end. The obligations are secured by first priority liens on the respective
European assets being financed. In addition, Converse Inc. provided guarantees
with respect to the outstanding borrowings for certain of the financing
arrangements.

                                       20
<PAGE>
 
Capital Expenditures

     Capital expenditures were $4.8 million, $5.9 million and $5.3 million in
Fiscal 1998, Fiscal 1997 and Fiscal 1996, respectively. In Fiscal 1998,
investments were made in information technology and software, principally to
upgrade systems in the Company's European subsidiaries for $1.9 million, in
ongoing improvements in the Company's manufacturing processes at its facilities
in North Carolina, Texas and Mexico for $1.8 million and other various smaller
projects and expenditures for $1.1 million.

     Fiscal 1997 investments included $0.5 million on building improvements
primarily to upgrade the heating system at the corporate office, $0.5 million on
leasehold improvements primarily to open or remodel the Company's retail stores,
$1.6 million to maintain and upgrade the Company's manufacturing facilities in
North Carolina, Texas and Mexico, $0.7 million to maintain and upgrade the
Company's distribution facility in Charlotte, North Carolina, $1.2 million in
information technology to support improvements in networking and international
operations and $1.4 million on various smaller projects and improvements. In
Fiscal 1996, the Company spent $1.4 million on leasehold improvements primarily
to open or remodel the Company's retail stores, $1.0 million to maintain and
upgrade the Company's manufacturing facility in Lumberton, North Carolina, $0.9
million in information technology to support improvements in networking, retail
store operations and international operations, $0.9 million to upgrade the
Company's trade show booth and $1.1 million on various smaller projects and
improvements.

The Year 2000

     Background

     The "Year 2000 Problem" is the result of many existing computer programs
and embedded chip technology containing programming code in which calendar year
data is abbreviated by using only two digits rather than four to refer to a
year. As a result of this, some of these programs may fail to operate or may not
properly recognize a year that begins with "20" instead of "19." This may cause
such software to recognize a date using "00" as the year 1900 rather than the
year 2000. Even systems and equipment that are not typically thought of as
computer-related often contain embedded hardware or software that may improperly
interpret dates beginning with the year 2000.

     The Company's Year 2000 Project

     Converse began working on Year 2000 compliance issues in 1996 when it
established a Company-wide Year 2000 project team (the "Year 2000 Project Team")
to identify all potential non-compliant software, hardware and imbedded chip
technology and determine to what extent modification or replacement was
necessary to mitigate the Year 2000 Problem. The first task of the Year 2000
Project Team was to conduct an assessment of all internal hardware, software and
imbedded chip technology to determine Year 2000 compliance and to assess the
risks associated with non-compliance by the Company's vendors, suppliers and
customers. The Year 2000 Project Team divided the action steps necessary to
minimize any Year 2000 non-compliance into two distinct categories: internal
compliance of software, hardware and imbedded chip technology, and external
non-compliance by the Company's vendors, suppliers and customers.

     Internal Year 2000 Compliance. The Company began the process of executing
     -----------------------------
the necessary code changes and upgrading existing systems in 1996. As a result,
most of the Company's software, hardware and imbedded chip technology are
already Year 2000 compliant. The Year 2000 Project Team developed an ongoing
program designed to bring the remaining software, hardware and imbedded chip
technology at all of its domestic and international locations into Year 2000
compliance in time to minimize any significant detrimental affects on the
Company's business and operations. In many cases these upgrades were already
planned as part of ongoing business process improvements.

                                       21
<PAGE>
 
     Currently, the Company has completed approximately 90% of the work believed
to be required to bring all internal systems into compliance. Converse's current
target is to complete all remaining work by the end of the second quarter of
1999.

     External Year 2000 Compliance. The Year 2000 Project Team reviewed all
     -----------------------------
material relationships between Converse and each of its vendors and suppliers
and determined which ones were critical to Converse's business and operations.

     "Critical" Suppliers. Converse deemed 165 of its vendors and suppliers to
      -------------------
be "critical" to the Company's business and operations. Converse has sent each
of its critical suppliers a detailed Year 2000 readiness questionnaire and
checklist, followed in some cases by formal communication and/or site visits.
Response rate to date is 97%, with 93% of the respondents indicating all systems
have been or will be verified Year 2000 compliant. For those critical suppliers
that do not respond or that do not have adequate compliance plans, Converse is
developing contingency plans that assume an estimated level of noncompliance.
These plans may consist of early purchase of materials, components,
work-in-process or finished goods. Even so, these contingency plans are subject
to much uncertainty and may not be sufficient to mitigate any business
interruption. Thus, some material adverse impact to Converse may result from one
or more third parties regardless of Converse's defensive contingency plans.

     "Non-Critical" Suppliers. The Company sent letters to 2,193 suppliers and
      -----------------------
vendors deemed to be "non-critical" advising them of the Year 2000 Problem and
requesting that they address compliance. Non-compliance by such suppliers would
not have a material adverse affect on the Company.

     Costs Associated with Year 2000 Compliance.

     Through the end of 1998 the Company spent approximately $1.8 million on
incremental costs associated with the Year 2000 Problem. These costs consisted
of new hardware and software as well as the cost of contracted programmers and
the salaries and fringe benefits of employees dedicated to addressing the Year
2000 Problem. These costs have been funded through operating cash flows.
Approximately $0.8 million of this amount relates to hardware and software which
the Company has capitalized and the remainder has been expensed as incurred. The
Company estimates that an additional $0.7 million will be incurred during the
first half of 1999 to complete this process. These additional expenditures will
be comprised of some additional new hardware and software, as well as the cost
of contracted programmers and the salaries and benefits of employees dedicated
to addressing the Year 2000 Problem. These estimates are based on currently
available information and may change in the event of unforeseen future
developments.

     Risks Associated with the Year 2000 Problem.

     The failure to correct a material Year 2000 Problem could result in the
interruption in, or failure of, certain normal business activities or operations
of the Company. Such failures could materially and adversely affect the
Company's results of operations, liquidity and financial condition. Due to the
general uncertainty inherent in the Year 2000 Problem, resulting primarily from
uncertainty of the Year 2000 readiness of third-party vendors and suppliers, the
Company is unable at this time to determine whether the consequences of any Year
2000 failures will have a material impact on the Company. As discussed above,
Converse is dependent on a large number of vendors and suppliers in most of the
locations in which the Company operates to deliver a wide range of goods and
services. These vendors and suppliers, in turn, rely on many sub-tier vendors
and suppliers. Converse believes that this extended supply chain presents the
area of greatest risk of Year 2000 noncompliance, due to Converse's limited
ability to influence actions of some of these third parties and because of
Converse's inability to accurately estimate the level and impact of
noncompliance of third parties throughout the extended supply chain.

                                       22
<PAGE>
 
Impact of Recently Issued Accounting Pronouncements

     The Company has adopted Statement of Financial Accounting Standard No. 130,
"Reporting Comprehensive Income." This Statement establishes standards for
reporting and display of comprehensive income and its components in a full set
of general-purpose financial statements.

     The Company has adopted Statement of Financial Accounting Standard No. 131,
"Disclosure about Segments of an Enterprise and Related Information." This
Statement requires an enterprise to report financial and descriptive information
about its reportable operating income. Operating segments are components that
are evaluated regularly by chief operating decision makers in deciding how to
allocate resources and in assessing performance. This Statement requires a
business enterprise to report a measure of segment profit or loss, certain
specific revenue and expense items (including interest, depreciation, and income
taxes), and segment assets. It also establishes standards for related
disclosures about products and services, geographic areas, and major customers.

     The Company has adopted Statement of Financial Accounting Standard No. 132,
"Employers' Disclosures about Pensions and Other Postretirement Benefits." This
Statement revises employers' disclosures about pensions and other postretirement
plans. The Statement does not change the measurement or recognition of those
types of plans and, accordingly, will not have a material impact on the
Company's consolidated financial position or results of operations.

     The Financial Accounting Standards Board issued Statement No. 133,
"Accounting for Derivative Instruments and Hedging Activities." This Statement
requires that all derivative instruments be recorded on the balance sheet at
their fair value. Changes in the fair value of derivatives are recorded each
period in current earnings or other comprehensive income, depending on whether a
derivative is designated as part of a hedge transaction and, if it is, the type
of hedge transaction. This Statement is required to be adopted in the Company's
fiscal year end 2000. Management of the Company anticipates that, due to its
limited use of derivative instruments, the adoption of this Statement will not
have a significant effect on the Company's results of operations or its
financial position.

ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
-------------------------------------------------------------------

Interest Rate Risk

     The Company's exposure to market risk associated with changes in interest
rates relates primarily to its debt obligations. The Company's Credit Facility
bears interest at the Prime Lending Rate (as defined therein) plus 1% or the
adjusted LIBOR (as defined therein) plus 2.5%. The Company's foreign borrowings
also have variable interest rates. The Company's Convertible Notes and Secured
Notes bear fixed rates of interest. See Item 7 - Management's Discussion and
Analysis of Financial Condition and Results of Operations - Liquidity and
Capital Resources for further information. Converse does not use derivative
financial instruments to hedge its interest rate risks.

Foreign Currency Risk

     Converse sells its products in a number of countries throughout the world
and, as a result, is exposed to movements on foreign currency exchange rates.
Although Converse has some of its products manufactured outside of the United
States on a per order basis, these purchases are made in U.S. dollars. The major
foreign currency exposures involve the markets in Western Europe, Japan and
Australia. In order to protect against the volatility associated with earnings
currency translations of foreign subsidiaries and royalty income from sources
outside the United States, the Company uses forward foreign exchange contracts
and foreign currency options with durations of generally from three to twelve
months.

                                       23
<PAGE>
 
     As of January 2, 1999, the company had outstanding the following foreign
exchange forward contracts and currency options:

<TABLE> 
<CAPTION> 
                                                                 (currency per USD)
                                                    Notional          Average          Estimated
                                                     Amount        Contract Rate       Fair Value
                                                     ------        -------------       ----------
                                                               (Dollars in thousands)
<S>                                                 <C>            <C>                 <C> 
Foreign exchange sell forward contracts:
     Japanese Yen.............................      $9,887.4            115.87          $(394.3) 
     Australian Dollar........................      $1,978.5              1.57           $ 85.0  
     Spanish Pesetas..........................      $4,288.8            140.66           $ 33.4  

Foreign exchange buy forward contracts:
     Japanese Yen.............................      $5,170.2            114.74          $ 165.1  

Currency put options:
     British Pounds...........................      $1,480.0              0.63           $(55.0)*
     Italian Lira.............................      $6,052.8          1,681.69          $(111.9)*
     French Franc.............................      $6,710.6              5.72          $(149.0)*
     Danish Krone.............................      $2,946.6              6.51           $(72.7)*
     German Mark..............................      $5,885.7              1.70          $(107.7)*
     Dutch Gilders                                  $3,017.5              1.92           $(66.5)*
</TABLE> 

     * These amounts do not represent economic losses as out of-the-money
options would not be exercised.

Commodity Price Risk

     Raw materials used by the Company are subject to price volatility caused by
weather, supply conditions and other unpredictable factors. The Company does not
have a program of hedging activity to address these risks.

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
---------------------------------------------------

     The information required by this Item is submitted in a separate section of
this report. See Item 14 for index to financial statements required by this
Item.

ITEM 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
--------------------------------------------------------------------------------
DISCLOSURE
----------

     Not applicable.

                                       24
<PAGE>
 
                                    PART III
                                    --------

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
-------------------------------------------------------------

     The information required by this Item with respect to the Company's
directors is incorporated herein by reference to the Company's definitive proxy
statement for the Annual Meeting of Stockholders to be held on May 12, 1999,
which will be filed with the Securities and Exchange Commission on or before
April 30, 1999 (the "1999 Proxy Statement"). Information required by this Item
with respect to the Company's executive officers is set forth below.

Executive Officers of the Company

Name                          Age    Position
----                          ---    --------

Glenn N. Rupp..............   54     Chairman of the Board and
                                      Chief Executive Officer
Donald J. Camacho..........   48     Senior Vice President and
                                      Chief Financial Officer
Edward C. Frederick........   52     Senior Vice President,
                                      Research, Design and Development
Jack A. Green..............   53     Senior Vice President Administration,
                                      General Counsel and Secretary
Herbert R. Rothstein.......   57     Senior Vice President, Production
James E. Solomon...........   43     Senior Vice President, Sales and Marketing
Alistair M. Thorburn.......   41     Senior Vice President, International
James E. Lawlor............   44     Vice President, Finance and Treasurer

     Mr. Rupp was elected Chairman of the Board and Chief Executive Officer by
Converse's Board of Directors on April 11, 1996. From August 1994 to April 1996,
Mr. Rupp was the Acting Chairman of McKenzie Sports Products, Inc. and a
Strategic Planning Advisor for CRC Industries, Inc. Mr. Rupp was President and
Chief Executive Officer of Simmons Upholstered Furniture Inc. ("Simmons") from
August 1991 until May 1994. Prior to 1991, Mr. Rupp held various positions with
Wilson Sporting Goods Co., including President and Chief Executive Officer from
1987 to 1991. Mr. Rupp is also a director of Consolidated Papers, Inc. and
Johnson Worldwide Associates, Inc. In July 1994, a voluntary petition for
reorganization under Chapter 11 of the U.S. Bankruptcy Code was filed on behalf
of Simmons.

     Mr. Camacho has served as Senior Vice President and Chief Financial Officer
since September 1994. Previously, Mr. Camacho held the positions of Vice
President and Controller from 1992 to 1994, Controller from 1984 to 1992,
Assistant Controller from 1980 to 1984, and several other positions of
increasing responsibility since 1974.

     Dr. Frederick has served as Senior Vice President, Research, Design and
Development since April 1997. From February 1996 to April 1997, Dr. Frederick
was a consultant to Converse through his wholly-owned consulting company, Exeter
Research, Inc. ("Exeter") and held the title of Chief Product Executive of
Converse. Dr. Frederick has been the President of Exeter since 1987. Since 1995,
Dr. Frederick has also served as an Adjunct Professor in the Department of
Exercise Sciences, School of Public Health and Health Sciences, University of
Massachusetts. Dr. Frederick worked as a consultant for adidas in the fields of
development, design and technology from 1991 to 1996. Previously, Dr. Frederick
worked as the Director of Research for Nike from 1980 to 1986 and as a design
consultant for Nike from 1978 to 1980 and from 1986 to 1990.

                                       25
<PAGE>
 
     Mr. Green has served as Senior Vice President Administration, General
Counsel and Secretary since May 1998. Prior to that, Mr. Green served as Senior
Vice President, General Counsel and Secretary since August 1985, having joined
the Company as Vice President, Legal in 1983. Since 1996, Mr. Green has also
served as an Adjunct Professor at Emmanuel College in Boston, Massachusetts. Mr.
Green is a director of Arrow Mutual Liability Insurance Company.

     Mr. Rothstein has served as Senior Vice President, Production since January
1996. Previously, Mr. Rothstein was Senior Vice President, Sourcing from 1992 to
1996, Senior Vice President of Materials Management and Manufacturing from 1991
to 1992 and Vice President of Materials Management from 1988 to 1991. Before
joining Converse, Mr. Rothstein held several senior management positions with
Reebok International Ltd. from 1985 to 1988; Morse Shoe Inc. from 1973 to 1985,
BGS Shoe Corporation from 1969 to 1972 and Signet from 1964 to 1969.

     Mr. Solomon has served as Senior Vice President, Sales and Marketing since
May 1998. Prior to that, Mr. Solomon served as Senior Vice President, Marketing
since October 1996. Previously, Mr. Solomon worked for Lenox Inc. from August
1990 to September 1996 in a number of senior positions, including President and
Chief Operating Officer of the Dansk International Design division from May 1994
to September 1996 and Gorham, Kirk-Stieff, Dansk division from July 1991 to May
1994. He also has experience in the athletic footwear industry, having served as
Executive Vice President of Kangaroos USA from 1989 to 1990, Vice President,
Marketing of Avia Athletic Footwear from 1985 to 1988, and Group Product
Manager, New Balance Athletic Shoes from 1981 to 1983.

     Mr. Thorburn has served as Senior Vice President, International since
December 1993. Prior to joining the Company, Mr. Thorburn was Vice President
Europe/Asia Pacific for the Wilson Sporting Goods Co., Ltd. from 1987 to 1993.

     Mr. Lawlor has served as Vice President, Finance and Treasurer since June
1995. Previously, Mr. Lawlor held the positions of Vice President and Treasurer
from September 1994 to June 1995, Treasurer from 1984 to 1994 and other
positions of increasing responsibility since 1975.

ITEM 11.  EXECUTIVE COMPENSATION.
---------------------------------

     The information required by this Item is incorporated by reference from the
1999 Proxy Statement.

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
-------------------------------------------------------------------------

     The information required by this Item is incorporated by reference from the
1999 Proxy Statement.

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
---------------------------------------------------------

     The information required by this Item is incorporated by reference from the
1999 Proxy Statement.

                                       26
<PAGE>
 
                                     PART IV

ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
--------------------------------------------------------------------------

(a)  List of documents filed as part of this report.

     1.   Financial statements:

          The following consolidated financial statements are included in Item 8
          and presented as a separate section of this report: 

                                                                           Page
                                                                           ----

          Report of Independent Accountants                                 F-2

          Consolidated Balance Sheet at January 3, 1998 and January 2, 1999 F-3

          For each of the fiscal years ended December 28, 1996, 
          January 3, 1998 and January 2, 1999:

               Consolidated Statement of Operations                         F-4
               Consolidated Statement of Cash Flows                         F-5
               Consolidated Statement of Stockholders' Equity               F-6
                   and Comprehensive Income

          Notes to Consolidated Financial Statements                        F-7

     2.   Financial Statement Schedule:

               Schedule II - Valuation and Qualifying Accounts              F-25

          All other schedules are omitted because they are not applicable or
          because the required information is presented in the consolidated
          financial statements or notes thereto.

     3.   Exhibits

          3.1  Restated Certificate of Incorporation (3)

          3.2  By-laws (3)

          4.   Indenture dated as of May 21, 1997 between Converse and First
               Union National Bank, as Trustee, relating to Converse Inc. 7%
               Convertible Subordinated Notes due 2004 in the principal amount
               of $80.0 million, including the form of Note (12)

          10.1 Credit Agreement dated as of May 21, 1997, among Converse Inc.,
               its subsidiaries, BT Commercial Corporation, as agent, and the
               financial institutions party thereto (the "Credit Agreement")
               (12)

          10.2 Amendment Number One to Credit Agreement (12)

          10.3 Amendment Number Two to Credit Agreement (14)

                                       27
<PAGE>
 
          10.4   Amendment Number Three Credit Agreement (14)    
                                                                 
          10.5   Amendment Number Four to Credit Agreement (17)  
                                                                 
          10.6   Waiver Number One to Credit Agreement (15)      
                                                                 
          10.7   Waiver Number Two to Credit Agreement (16)      
                                                                 
          10.8   Amendment and Reaffirmation of Lease dated June 29, 1988,
                 between Godley Construction Company Inc. ("Godley") and
                 Converse Inc. and Lease Agreement dated as of March 26, 1974,
                 between Godley and Charlotte Footwear, Inc. (1)
                 
          10.9   Sublease Agreement dated as of September 28, 1993, between
                 Kmart Corporation and Converse Inc. (1)
                 
          10.10  Lease Agreement - Reynosa, Mexico (16)       
                                                              
          10.11  Registration Rights Agreement dated as of November 17, 1994,
                 between Apollo Interco Partners, L.P. and Converse Inc. (3)
                 
          10.12  Consulting Agreement dated as of November 17, 1994, between
                 Apollo Advisors, L.P. and Converse Inc. (3)
                 
          10.13  Amendment to Consulting Agreement Dated as of November 17, 1998
                 between Apollo Advisors L.P. and Converse Inc. (15)
                 
          10.14  Converse Inc. Executive Incentive Plan (1)          
                                                                     
          10.15  Converse Inc. Team Incentive Plan (1)               
                                                                     
          10.16  Converse Inc. Supplemental Executive Retirement Plan (6) 
                                                                          
          10.17  Converse Inc. 1994 Stock Option Plan, as Amended and Restated
                 as of February 25, 1998 (16)
                 
          10.18  Converse Inc. 1995 Non-Employee Director Stock Option Plan, as
                 amended and restated as of July 30, 1997 (13)
                 
          10.19  Converse Inc. Employee Stock Purchase Plan (16)     
                                                                     
          10.20  Agreement among Julius W. Erving, the Erving Group and Converse
                 Inc., dated October 1, 1984 as amended by an Amendment dated
                 September 16, 1988, a Second Amendment dated July 18, 1989, a
                 Third Amendment dated October 17, 1991, and a Fourth Amendment
                 dated February 7, 1994 (2)
                 
          10.21  Fifth Amendment to Agreement among Julius W. Erving, The Erving
                 Group, Inc. and Converse Inc.(5)
                 
          10.22  Sixth Amendment to Agreement among Julius W. Erving, the Erving
                 Group, Inc. and Converse Inc.(7)
                 
          10.23  Seventh Amendment to Agreement among Julius W. Erving, the
                 Erving Group, Inc. and Converse Inc.(7)

                                       28
<PAGE>
 
          10.24  Lease Agreement dated as of January 3, 1995 between Talbot
                 Operations Inc. and Converse Inc. (4)
                 
          10.25  Employment Agreement between Converse and Glenn N. Rupp (8)

          10.26  Employment Agreement between Converse and James E. Solomon (9)
                                                                             
          10.27  Employment Agreement between Converse and Donald J. Camacho 
                 (6)         
                 
          10.28  Form of Employment Agreement dated as of October 25, 1995,
                 between Converse and each of the following: Jack A. Green,
                 Herbert R. Rothstein, Alistair M. Thorburn, and James E. Lawlor
                 (6)
                 
          10.29  Employment Agreement between Converse and Edward C. Frederick
                 (11)

          10.30  Purchase Agreement dated June 1, 1997 between Converse and
                 Exeter Research, Inc. (12)
                 
          10.31  Senior Secured Note Purchase Agreement dated September 16, 
                 1998 (17)    
                 
          10.32  Senior Secured Note dated September 16, 1998 (17)    
                                                                      
          10.33  Warrant Agreement dated September 16, 1998 (17)      
                                                                      
          21.    List of subsidiaries*                                
                                                                      
          23.    Consent of PricewaterhouseCoopers LLP*               
                                                                      
          27.    Financial Data Schedule*                             

                 *      Filed herewith

     (1)  Filed as an Exhibit to Converse Inc. Form 10 dated October 14, 1994
          filed with the SEC on October 14, 1994, and incorporated by reference
          herein.

     (2)  Filed as an Exhibit to Converse Inc. Form 10/A Amendment No. 1, filed
          with the SEC on November 8, 1994, and incorporated by reference
          herein.

     (3)  Filed as an Exhibit to Converse Inc. Form 10/A Amendment No. 2, filed
          with the SEC on November 23, 1994, and incorporated by reference
          herein.

     (4)  Filed as an Exhibit to Converse Inc. Annual Report on Form 10-K for
          the year ended December 31, 1994, and incorporated by reference
          herein.

     (5)  Filed as an Exhibit to Converse Inc. Quarterly Report on Form 10-Q for
          the quarter ended April 1, 1995, and incorporated by reference herein.

     (6)  Filed as an Exhibit to Converse Inc. Annual Report on Form 10-K for
          the year ended December 30, 1995, and incorporated by reference
          herein.

     (7)  Filed as an Exhibit to Converse Inc. Quarterly Report on Form 10-Q for
          the quarter ended March 30, 1996, and incorporated by reference
          herein.

     (8)  Filed as an Exhibit to Converse Inc. Quarterly Report on Form 10-Q for
          the quarter ended June 29, 1996, and 

                                       29
<PAGE>
 
          incorporated by reference herein.

     (9)  Filed as an Exhibit to Converse Inc. Quarterly Report on Form 10-Q for
          the quarter ended September 28, 1996, and incorporated by reference
          herein.
  
     (10) Filed as an Exhibit to Converse Inc. Annual Report on Form 10-K for
          the year ended December 28, 1996, and incorporated by reference
          herein.

     (11) Filed as an Exhibit to Converse Inc. Quarterly Report on Form 10-Q for
          the quarter ended March 29, 1997, and incorporated by reference
          herein.

     (12) Filed as an Exhibit to Converse Inc. Quarterly Report on Form 10-Q for
          the quarter ended June 28, 1997, and incorporated by reference herein.

     (13) Filed as an Exhibit to Converse Inc. Quarterly Report on Form 10-Q for
          the quarter ended September 29, 1997, and incorporated by reference
          herein.

     (14) Filed as an Exhibit to Converse Inc. Annual Report on Form 10-K for
          the year ended January 3, 1998, and incorporated herein by reference.

     (15) Filed as an Exhibit to Converse Inc. Quarterly Report on Form 10-Q for
          the quarter ended April 4, 1998, and incorporated herein by reference.

     (16) Filed as an Exhibit to Converse Inc. Quarterly Report on Form 10-Q for
          the quarter ended July 4, 1998, and incorporated herein by reference.

     (17) Filed as an Exhibit to Converse Inc. Quarterly Report on Form 10-Q for
          the quarter ended October 3, 1998, and incorporated herein by
          reference.

          (b)  No reports on Form 8-K were filed by the Company during the last
               quarter of Fiscal 1998.

          UPON WRITTEN REQUEST TO THE COMPANY'S SECRETARY, THE COMPANY WILL
          FURNISH SHAREHOLDERS WITH A COPY OF ANY OR ALL SUCH EXHIBITS REQUESTED
          AT A CHARGE OF TEN CENTS PER PAGE, WHICH REPRESENTS THE COMPANY'S
          REASONABLE EXPENSES IN FURNISHING SUCH EXHIBITS.


                                  SIGNATURES

     Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, in North Reading,
Massachusetts on March 19, 1999.

                                 CONVERSE INC.

                                               By:  /s/ Glenn N. Rupp         
                                                    ----------------------------
                                                    Glenn N. Rupp
                                                    Chairman of the Board and
                                                    Chief Executive Officer

                                      30
<PAGE>
 
     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
registrants and in the capacities and on the date indicated.

<TABLE> 
<CAPTION> 

Signature                                  Title                                                 Date
---------                                  -----                                                 ----
<S>                                        <C>                                                   <C> 
/s/ Glenn N. Rupp                          Chairman of the Board, Chief Executive Officer        March 19, 1999
---------------------------                and Director (Principal Executive Officer)
Glenn N. Rupp                              

/s/ Donald J. Camacho                      Senior Vice President and Chief Financial Officer     March 19, 1999
---------------------------                (Principal Financial and Accounting Officer)
Donald J. Camacho                          

/s/ Donald J. Barr                         Director                                              March 19, 1999
---------------------------
Donald J. Barr 

/s/ Leon D. Black                          Director                                              March 19, 1999
---------------------------
Leon D. Black

/s/ Julius W. Erving                       Director                                              March 19, 1999
---------------------------
Julius W. Erving

/s/ Robert H. Falk                         Director                                              March 19, 1999
---------------------------
Robert H. Falk

/s/ Gilbert Ford                           Director                                              March 19, 1999
---------------------------
Gilbert Ford

/s/ Michael S. Gross                       Director                                              March 19, 1999
---------------------------
Michael S. Gross

/s/ John J. Hannan                         Director                                              March 19, 1999
---------------------------
John J. Hannan

/s/ Joshua J. Harris                       Director                                              March 19, 1999
---------------------------
Joshua J. Harris

/s/ John H. Kissick                        Director                                              March 19, 1999
---------------------------
John H. Kissick

/s/ Richard B. Loynd                       Director                                              March 19, 1999
---------------------------
Richard B. Loynd

/s/ John J. Ryan, III                      Director                                              March 19, 1999
---------------------------
John J. Ryan, III

/s/ Michael D. Weiner                      Director                                              March 19, 1999
---------------------------
Michael D. Weiner
</TABLE> 
<PAGE>
 
                         CONVERSE INC. AND SUBSIDIARIES

                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

                                                                           Page
Report of Independent Accountants .......................................  F-2

Consolidated Balance Sheet...............................................  F-3

Consolidated Statement of Operations.....................................  F-4

Consolidated Statement of Cash Flows.....................................  F-5

Consolidated Statement of Stockholders' Equity and Comprehensive Income..  F-6

Notes to Consolidated Financial Statements...............................  F-7
<PAGE>
 
                        Report of Independent Accountants




To the Board of Directors and
Stockholders of Converse Inc.

     In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of operations, cash flows and stockholders' equity and
comprehensive income present fairly, in all material respects, the financial
position of Converse Inc. and its subsidiaries at January 3, 1998 and January 2,
1999, and the results of their operations and their cash flows for each of the
three years in the period ended January 2, 1999, in conformity with generally
accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.



/s/ PricewaterhouseCoopers LLP 
-------------------------------
PRICEWATERHOUSECOOPERS LLP


Boston, Massachusetts
February 23, 1999

                                      F-2
<PAGE>
 
                         CONVERSE INC. AND SUBSIDIARIES

                           CONSOLIDATED BALANCE SHEET

                (Dollars in thousands, except per share amounts)

<TABLE> 
<CAPTION> 
                                                                                  January 3, 1998    January 2, 1999
                                                                                  ---------------    ---------------
<S>                                                                               <C>                <C> 
ASSETS
Current assets:
  Cash and cash equivalents...................................................        $ 5,738            $ 3,274 
  Receivables, less allowances of $2,066 and $2,086, respectively.............         72,083             57,826 
  Inventories (Note 5)........................................................         94,681             71,292 
  Prepaid expenses and other current assets (Note 10).........................          9,713              8,962 
                                                                                -------------      -------------
    Total current assets......................................................        182,215            141,354 
Net property, plant and equipment (Note 6)....................................         20,086             20,838 
Other assets (Note 10)........................................................         32,393             32,814
                                                                                -------------      ------------- 
                                                                                     $234,694           $195,006 
                                                                                =============      =============
<CAPTION> 

LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY)
<S>                                                                             <C>                <C> 
Current liabilities:
  Short-term debt (Note 8)....................................................        $ 9,036            $ 9,557 
  Credit facility (Note 8)....................................................         96,844             73,833 
  Accounts payable............................................................         41,318             37,184 
  Accrued expenses (Note 7)...................................................         14,279             10,861 
  Income taxes payable (Note 10)..............................................            478              2,861 
                                                                                -------------      ------------- 
    Total current liabilities.................................................        161,955            134,296 
Long-term debt (Note 8).......................................................         80,000            101,799 
Current assets in excess of reorganization value (Note 2).....................         30,299             28,221 
Accrued postretirement benefits other than pensions (Note 11).................         10,422                 -- 
Commitments and contingencies (Note 14) 
Stockholders' equity (deficiency):
  Common stock, $1.00 stated value, 50,000,000 shares authorized, 17,317,956 
    and 17,319,556 shares issued and outstanding at January 3, 1998 and                   
    January 2, 1999, respectively.............................................         17,318             17,320 
  Preferred stock, no par value, 10,000,000 shares authorized, none issued and
    outstanding...............................................................             --                 -- 
  Additional paid-in capital..................................................          2,271              3,695 
  Unearned compensation.......................................................             --               (758)
  Retained deficit............................................................        (65,314)           (88,129)
  Accumulated other comprehensive income......................................         (2,257)            (1,438)
                                                                                -------------      ------------- 
    Total stockholders' equity (deficiency)...................................        (47,982)           (69,310)
                                                                                -------------      ------------- 
                                                                                     $234,694           $195,006 
                                                                                =============      =============
</TABLE> 


See accompanying notes to consolidated financial statements.

                                      F-3
<PAGE>
 
                         CONVERSE INC. AND SUBSIDIARIES

                      CONSOLIDATED STATEMENT OF OPERATIONS

                (Dollars in thousands, except per share amounts)


<TABLE> 
<CAPTION> 
                                                                            Fiscal Year Ended
                                                        --------------------------------------------------------
                                                          December 28, 1996  January 3, 1998   January 2, 1999
                                                          -----------------  ---------------   ---------------
<S>                                                       <C>                <C>               <C>   
Net sales ..............................................   $ 349,335           $ 450,199           $ 308,353

Cost of sales ..........................................     263,098             329,258             237,671
                                                           ----------          ----------          ---------- 
Gross profit ...........................................      86,237             120,941              70,682

Selling, general and administrative expenses ...........     114,888             127,261              92,683
Royalty income .........................................      27,638              22,569              20,175
Restructuring expense (credit) (Note 4) ................      (1,177)              1,537                  -- 
                                                           ----------          ----------          ---------- 
Earnings (loss) from operations ........................         164              14,712              (1,826)

Loss (credit) on investment in unconsolidated
subsidiary (Note 3) ....................................      (1,362)            (12,537)                 -- 
Interest expense .......................................      17,776              15,374              17,525
Other expense, net (Note 15) ...........................       6,319               3,026                 596
                                                           ----------          ----------          ---------- 
Earnings (loss) from continuing operations before
income taxes ...........................................     (22,569)              8,849             (19,947)

Income tax expense (benefit) (Note 10) .................      (4,134)             13,154               3,572
                                                           ----------          ----------          ---------- 
Loss from continuing operations ........................     (18,435)             (4,305)            (23,519)

Extraordinary (gain) loss, net of tax expense
(benefit) of $(576) and $437, respectively (Note 9) ....          --                 744                (704)
                                                           ----------          ----------          ---------- 

Net loss ...............................................   $ (18,435)          $  (5,049)          $ (22,815)
                                                           ==========          ==========          ==========
Net basic and diluted loss per share (Note 2):
   Continuing operations ...............................   $   (1.10)          $   (0.25)          $   (1.36)
   Extraordinary gain (loss) ...........................          --               (0.04)               0.04
                                                           ----------          ----------          ---------- 
   Net loss ............................................   $   (1.10)          $   (0.29)          $   (1.32)
                                                           ==========          ==========          ==========

Weighted average common shares outstanding (Note 2) ....      16,761              17,272              17,319
                                                           ==========          ==========          ==========
</TABLE> 


See accompanying notes to consolidated financial statements.

                                      F-4
<PAGE>
 
                         CONVERSE INC. AND SUBSIDIARIES

                      CONSOLIDATED STATEMENT OF CASH FLOWS
                (Dollars in thousands, except per share amounts)

<TABLE> 
<CAPTION> 
                                                                                      Fiscal Year Ended
                                                             -------------------------------------------------------
                                                                December 28, 1996  January 3, 1998  January 2, 1999
                                                                -----------------  ---------------  ---------------
<S>                                                                   <C>          <C>               <C>  
Cash flows from operating activities:
   Net loss .......................................................   $ (18,435)   $  (5,049)        $ (22,815) 
   Adjustments to reconcile net loss to net cash provided by                                                    
     (required for) operating activities:                                                                       
   Loss (credit) on investment in unconsolidated subsidiary, less                                               
     cash payments of $3,439, $8,064 and $0, respectively .........      (4,801)     (20,601)               --  
   Provision for restructuring actions, less cash payments of                                                   
     $5,316, $3,763 and $2,438, respectively ......................      (6,493)      (2,226)               --  
   Extraordinary loss on write-off of deferred financing fees .....          --        1,320               809  
   Extraordinary gain on cancellation of convertible notes ........          --           --            (1,950) 
   Depreciation of property, plant and equipment ..................       3,100        3,589             3,939  
   Amortization of intangible assets ..............................         539          548               468  
   Amortization of current assets in excess of reorganization value      (2,078)      (2,077)           (2,078) 
   Amortization of note discount/warrants .........................          --           --               189  
   Gain on sale of property, plant and equipment ..................          --           --            (1,042) 
   Amortization of deferred compensation ..........................          --           --               217  
   Deferred income taxes ..........................................      (5,614)      11,709              (162) 
Changes in assets and liabilities:                                                                              
   Receivables ....................................................        (759)     (12,359)           14,937  
   Inventories ....................................................      (5,844)      (8,775)           23,423  
   Prepaid expenses and other current assets ......................      10,859          114                30  
   Accounts payable and accrued expenses ..........................      16,889       (8,751)           (7,443) 
   Income taxes payable ...........................................       1,612       (2,929)            2,383  
   Other long-term assets and liabilities .........................       3,009       (2,620)          (10,347) 
                                                                      -----------  -----------       -----------
     Net cash (required for) provided from  operating activities ..      (8,016)     (48,107)              558  
                                                                      -----------  -----------       -----------
Cash flows from investing activities:                                                                           
   Proceeds from disposal of assets ...............................       5,101           --             1,169  
   Additions to property, plant and equipment .....................      (5,305)      (5,909)           (4,787) 
                                                                      -----------  -----------       -----------
     Net cash used by investing activities ........................        (204)      (5,909)           (3,618) 
                                                                      -----------  -----------       -----------
Cash flows from financing activities:                                                                           
   Net proceeds from exercise of stock options ....................       2,385          512                11  
   Net proceeds from (payment of) short-term debt .................         231       (3,236)              169  
   Net proceeds from (repayment of) old credit facility ...........       8,261     (117,765)               --  
   Net proceeds from (repayment of) new credit facility ...........          --       96,844           (23,011) 
   Net proceeds from issuance of senior secured notes .............          --           --            24,000  
   Net proceeds from bond issue ...................................          --       76,400                --  
                                                                      -----------  -----------       -----------
     Net cash provided by financing activities ....................      10,877       52,755             1,169  
                                                                      -----------  -----------       -----------
Effect of foreign currency rate fluctuations on cash and cash                                                   
equivalents .......................................................         513        1,091              (573) 
                                                                      -----------  -----------       -----------
Net increase (decrease) in cash and cash equivalents ..............       3,170         (170)           (2,464) 
Cash and cash equivalents at beginning of period ..................       2,738        5,908             5,738  
                                                                      -----------  -----------       -----------
Cash and cash equivalents at end of period ........................   $   5,908    $   5,738         $   3,274  
                                                                      ===========  ===========       ===========
Supplemental Disclosures:                                                                                       
   Cash payments for (refunds of) income taxes, net ...............   $ (10,150)   $   3,719         $   1,803  
                                                                      ===========  ===========       ===========
   Cash payments for interest .....................................   $  13,283    $  16,663         $  17,083  
                                                                      ===========  ===========       =========== 
</TABLE> 

See accompanying notes to consolidated financial statements.

                                      F-5
<PAGE>
 
                        CONVERSE INC. AND SUBSIDIARIES

                CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
                           AND COMPREHENSIVE INCOME
               (Dollars in thousands, except per share amounts)


<TABLE>
<CAPTION>
                                           Total                                Accumulated
                                       Stockholders'                Retained       Other                   Additional
                                          Equity    Comprehensive   Earnings   Comprehensive    Common       Paid-in      Unearned
                                       (Deficiency) Income (Loss)   (Deficit)      Income        Stock       Capital    Compensation
                                       ------------ -------------   ---------      ------        -----       -------    ------------
<S>                                     <C>                         <C>           <C>           <C>          <C>          <C>      
Balance, December 30, 1995 ............ $(22,685)                   $(41,830)     $ (1,075)     $ 16,692     $  3,528     $      --
Comprehensive income (loss)
  Net loss ............................  (18,435)    $ (18,435)      (18,435)
  Other comprehensive income (loss),
    net of tax ........................
      Foreign currency translation
      adjustments .....................     (133)         (133)                       (133)
                                                     ----------
Comprehensive income (loss) ...........                (18,568)
                                                     ==========
Exercise of common stock options ......    2,385                                                     521        1,864 
                                         --------                   ---------       -------     ---------    ---------   -----------
Balance, December 28, 1996 ............  (38,868)                    (60,265)       (1,208)       17,213        5,392            -- 
Comprehensive income (loss) ...........
  Net loss ............................   (5,049)       (5,049)       (5,049)
  Other comprehensive income (loss),
    net of tax ........................
      Foreign currency translation
        adjustments ...................   (1,049)       (1,049)                     (1,049)
                                                     ----------
Comprehensive income (loss) ...........                 (6,098)
                                                     ==========
Exercise of common stock options ......      512                                                     105          407
Cancellation of common stock warrants
  (Note 3) ............................   (3,528)                                                              (3,528)
                                         --------                   ---------       -------     ---------    ---------   -----------
Balance, January 3, 1998 ..............  (47,982)                    (65,314)       (2,257)       17,318        2,271            -- 
Comprehensive income (loss) ...........
  Net loss ............................  (22,815)      (22,815)      (22,815)
  Other comprehensive income (loss),
    net of tax ........................
      Foreign currency translation
        adjustments ...................      819           819                         819
                                                     ----------
Comprehensive income (loss) ...........              $ (21,996)
                                                     ==========
Exercise of common stock options ......       11                                                       2            9
Issuance of common stock warrants
    (Note 8) ..........................      440                                                                  440
Issuance of restricted stock (Note 12)        --                                                                  975          (975)
Amortization of unearned compensation .      217                                                                                217
                                        ---------                   ---------     ---------     ---------    ---------   -----------
Balance, January 2, 1999 .............. $(69,310)                   $(88,129)     $ (1,438)     $ 17,320     $  3,695    $     (758)
                                        =========                   =========     =========     =========    =========   ===========
</TABLE>



See accompanying notes to consolidated financial statements.

                                      F-6
<PAGE>
 
                         CONVERSE INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (Dollars in thousands, except per share amounts)

1.   Summary of Business Operations

     Converse Inc. ("Converse" or the "Company") is a leading global designer,
manufacturer and marketer of high quality athletic footwear for men, women and
children. The Company is also a global licensor of sports apparel, accessories
and selected footwear. Converse's principal markets are the United States,
Europe and the Pacific Rim.

Distribution

     Prior to November 17, 1994, Converse was a wholly-owned subsidiary of
Furniture Brands International, Inc. ("Furniture Brands"), which until March 1,
1996 was named INTERCO INCORPORATED. On November 17, 1994, Furniture Brands
distributed to the holders of Furniture Brands common stock all outstanding
shares of common stock of Converse (the "Distribution").

2.   Significant Accounting Policies

     The major accounting policies of Converse are set forth below.

Fiscal year

     Converse's fiscal year end is the Saturday closest to December 31 in each
year. For 1998, Converse's fiscal year ended on January 2, 1999 ("Fiscal 1998"),
for 1997, Converse's fiscal year ended on January 3, 1998 ("Fiscal 1997") and
for 1996, Converse's fiscal year ended on December 28, 1996 ("Fiscal 1996").
Fiscal Years 1998 and 1996 include 52 weeks whereas Fiscal Year 1997 includes 53
weeks.

Basis of consolidation

     The consolidated financial statements include the accounts of Converse and
its subsidiaries. All material intercompany transactions are eliminated in
consolidation.

Management estimates

     The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
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.

Cash and cash equivalents

     Converse considers all short-term investments with an original maturity of
three months or less to be cash equivalents.

Fair value of financial instruments

     The carrying amount of cash, cash equivalents, trade receivables and trade
payables approximates their fair value because of the short maturity of these
financial instruments. Except for the Convertible Notes (See Note 8) at January
2, 1999, the carrying amount of the Company's long-term instruments approximates
fair value, which is estimated based on market values for similar instruments.
At January 2, 1999, the fair value of the $74.3 million Convertible Notes was
$24.6 million, as estimated using quoted market prices.

                                      F-7
<PAGE>
 
Inventories

     Inventories are stated at the lower of cost (first-in, first-out) or
market.

Property, plant and equipment

     Property, plant and equipment are recorded at cost when acquired.
Expenditures for improvements are capitalized while normal repairs and
maintenance are expensed as incurred. When properties are disposed of, the
related cost and accumulated depreciation or amortization are removed from the
accounts, and gains or losses on the dispositions are reflected in results of
operations. For financial reporting purposes, Converse utilizes the
straight-line method of computing depreciation and amortization while
accelerated methods are used for tax purposes. Such expense is computed based on
the estimated useful lives of the respective assets.

Current assets in excess of reorganization value

     In 1992, in connection with a reorganization under the bankruptcy code,
Furniture Brands and its domestic subsidiaries, including Converse, were
required to adopt "fresh-start" reporting. As a result of adopting "fresh-start"
reporting, Converse recorded current assets in excess of reorganization value of
approximately $41,553. This deferred credit is being amortized on a
straight-line basis over a 20 year period.

Foreign currency transactions

     Assets and liabilities of international operations are translated into U.S.
dollars at current exchange rates. Income and expense accounts are translated
into U.S. dollars at average rates of exchange prevailing during the period.
Adjustments resulting from the translation of foreign functional currency
financial statements into U.S. dollars are recorded in a separate component of
stockholders' equity. Other foreign currency transaction gains and losses are
included in the determination of net income.

     During Fiscal 1998, the Company used foreign exchange forward contracts and
foreign currency options to protect the Company from the effects of changes in
foreign exchange rates on the statement of operations. These instruments do not
qualify for hedge accounting. Option premiums are amortized over the respective
life of the instrument. Accordingly, as of January 2, 1999, unamortized currency
option premiums recorded on the consolidated balance sheet of the Company were
$225. During the year ended January 2, 1999, the Company recorded amortization
expense of $673 with respect to the currency options. At January 2, 1999, the
Company had open "out of the money" currency options totaling $26,100 and open
foreign exchange forward contracts totaling $21,300 with a maximum remaining
term to maturity of less than one year. The Company recorded unrealized losses
totaling $111 on these open forward contracts for the year ended January 2,
1999. The Company recorded realized gains of $128 and $124 on exercised currency
options and closed forward contracts, respectively, during the year ended
January 2, 1999.

Revenue recognition

     Revenue from the sale of product is recognized at the time of shipment.
Royalty income is recognized by Converse when all events have occurred to
establish the royalty amount payable to the Company (typically, when sales are
made by the licensees to retail distribution in their respective territories or,
in the case of certain footwear license agreements whereby royalties are payable
based upon factory cost, when shipment is made from the manufacturer to the
licensee).

Advertising

     Advertising production costs are expensed the first time an advertisement
is run. Media placement costs are expensed the first time the advertising
appears.

                                      F-8
<PAGE>
 
Endorsement contracts

     Accounting for endorsement contracts is based upon specific contract
provisions. Generally, endorsement payments are expensed uniformly over the term
of the contract after giving recognition to periodic performance compliance
provisions of the contracts.

Earnings per share

     In February 1997, Statement of Financial Accounting Standards No. 128,
"Earnings per Share" ("SFAS No. 128") was issued which supersedes the old
methodology for calculation of earnings per share, as promulgated under
Accounting Principles Board Opinion No. 15. SFAS No. 128 requires presentation
of "basic" earnings per share (which excludes dilution as a result of
unexercised stock options and convertible subordinated debentures) and "diluted"
earnings per share. The Statement was adopted in Fiscal 1997, and all prior
periods were retroactively restated. For the fiscal years ended, December 28,
1996, January 3, 1998 and January 2, 1999 basic and diluted earnings per share
are the same.

Concentration of risk

    Converse purchases dyed canvas raw material primarily from two dye houses.
A change in dye houses could cause a delay in manufacturing; however, management
does not expect such a change to impact long-term supply due to the existence of
alternative suppliers.

     Financial instruments which potentially expose the Company to concentration
of credit risk include trade accounts receivable and foreign currency options
and forward contracts. Concentration of credit risk with respect to trade
accounts receivable is limited due to the large number of customers and their
international dispersion. In addition, the Company maintains reserves for
potential credit losses, and such losses, in the aggregate, have not exceeded
management expectations. Concentration of credit risk with respect to foreign
currency options and forward contracts is limited because the Company maintains
these financial instruments with various major financial institutions. The
Company performs periodic evaluations of the relative credit standing of these
financial institutions and limits the amount of credit exposure with any
institution.

Reclassifications

     Certain amounts in the prior year financial statements and related notes
have been reclassified to conform with the Fiscal 1998 presentation.

3.   Investment in Unconsolidated Subsidiary

     On May 18, 1995, Converse consummated the acquisition of Apex One, Inc.
("Apex"). Under the terms of the Securities Purchase Agreement, the total
consideration paid by Converse to the sellers in exchange for 100% of the
outstanding common stock consisted of: (i) subordinated promissory notes in the
aggregate principal amount of $11,000 discounted to $9,644 at a rate of 12%; and
(ii) warrants, expiring May 18, 2000, to purchase 1,750,000 shares of Converse
common stock at an exercise price of $11.40 with an aggregate value of $3,528 at
the date of the acquisition.

     Subsequent to the acquisition of Apex, Converse, through its integration of
Apex's information systems and in-depth review of Apex operating procedures and
financial condition, determined that the operating losses of Apex and its weak
financial position could not be corrected without additional significant
investment or financing. On August 11, 1995, Converse's Board of Directors voted
to cease funding Apex's operations as of that date.

     As a result of this decision, Apex ceased operations and was unable to meet
its obligations and on September 14, 1995 filed for Chapter 11 bankruptcy
protection. Because Converse's control of Apex was temporary in nature, its
investment in Apex was recorded as an unconsolidated equity investment. During
1995, Converse recorded a loss of $52,160 on this unconsolidated subsidiary,
comprised primarily of: (i) the Company's initial investment in Apex; (ii)
additional funding advances; (iii) contractual obligations, bank guarantees,
professional fees and other closing costs; and (iv) loss on the sale of Apex
inventory purchased by Converse for sale to independent third parties.

                                      F-9
<PAGE>
 
     During 1996, the Company recorded a $1,362 credit on investment in
unconsolidated subsidiary which was comprised of: (i) an additional loss of $515
relating to unanticipated credits issued to customers to settle claims of
discrepancies on shipments of the Apex inventory; and (ii) a credit of $1,877
relating to the Company's entering into agreements with two of the former owners
of Apex to settle certain obligations for less than originally anticipated,
resulting in an adjustment of the accrual recorded in 1995 for the loss on
investment in unconsolidated subsidiary.

     In the first quarter of 1997, the Company prevailed in a breach of warranty
lawsuit brought against several former owners of Apex. Subsequently, the Company
entered into settlement agreements with substantially all of the former owners
of Apex. As a result of these settlements in the first quarter, the Company
recorded a credit on investment in unconsolidated subsidiary of $13,051. In the
fourth quarter of 1997, the Company recorded a loss on investment in
unconsolidated subsidiary of $514 relating to the settlement of outstanding
litigation with the one remaining former Apex owner and final settlement of a
vendor suit against the Company. The net activity for Fiscal 1997 was a credit
on investment in unconsolidated subsidiary of $12,537. At January 3, 1998, there
were no remaining claims by or against the Company relating to its 1995
acquisition of Apex, and one former owner of Apex continues to hold subordinated
notes issued by Converse in the amount of $774. This amount is included within
accrued expenses in the accompanying consolidated balance sheet.

4.   Restructuring Charges

     During 1995, Converse recorded restructuring charges of $14,182 relating
primarily to initiatives aimed at reducing future operating costs. Principal
costs included in the charge were: (i) contract termination costs relating to
licensed apparel and certain marketing activities; (ii) estimated losses on the
sale or disposal of assets, including a writedown for the proposed sale of a
warehouse facility in Chester, South Carolina; (iii) costs for employee
severance and related benefits for the termination of 140 employees; and (iv)
lease termination costs relating to the shutdown of the manufacturing facility
in Mission, Texas and a distribution facility in the United Kingdom.

     During the second quarter of 1996, the Company sold the warehouse facility
in Chester, South Carolina. Proceeds from this sale exceeded the Company's
estimate, resulting in a reversal of $2,209 of restructuring reserves. During
the third quarter of 1996, certain contracts were terminated on terms more
advantageous than originally anticipated resulting in a reversal of $1,000 of
restructuring accruals. In addition, while implementing its fourth quarter 1995
restructuring plans, the Company incurred additional severance charges of $1,000
and $356 in the third and fourth quarters of 1996, respectively, and additional
asset write-offs of $676 during the fourth quarter of 1996. Such additional
charges were in excess of previously estimated amounts.

     During the first quarter of 1997, the Company re-opened the manufacturing
facility located in Mission, Texas for cutting and limited production due to an
unexpected increase in demand for athletic originals products. Accordingly, the
remaining lease termination restructuring reserve of $563 was reversed into
income. During the fourth quarter of 1997, the Company recorded a restructuring
charge of $2,100. The costs included in the charge were primarily: (i) employee
severance and related benefits of $1,192 for the termination of 35 employees;
(ii) costs of $464 related to the closing of three unprofitable retail stores;
and (iii) termination costs of $444 related to marketing endorser contracts.

     During 1998 all remaining restructuring liabilities were paid out. At
January 2, 1999, there were no remaining restructuring liabilities.

5.   Inventories

     Inventories are summarized as follows:

<TABLE>
<CAPTION>
                                                      January 3, 1998    January 2, 1999
                                                      ---------------    ---------------
        <S>                                           <C>                <C>     
        Retail merchandise......................          $  5,245            $  4,535 
        Finished products.......................            81,311              57,365 
        Work-in-process.........................             4,560               5,009 
        Raw materials...........................             3,565               4,383 
                                                          --------            -------- 
                                                          $ 94,681            $ 71,292 
                                                          ========            ======== 
</TABLE>

                                      F-10
<PAGE>
 
6.   Property, Plant and Equipment

     Property, plant and equipment consisted of the following:

<TABLE>
<CAPTION>
                                                       Estimated
                                                        Useful
                                                     Life (Years)   January 3, 1998   January 2, 1999
                                                     ------------   ---------------   ---------------
        <S>                                          <C>            <C>               <C>     
        Building and leasehold improvements             5 - 10           $  7,832          $  8,129
        Machinery and equipment...............          3 - 11             12,012            14,139
        Furniture and fixtures................          5 - 8               2,944             3,049
        Office and computer equipment.........             7                8,381            10,171
                                                                         --------          --------
                                                                           31,169            35,488
        Less accumulated depreciation.........                             11,083            14,650
                                                                         --------          --------
                                                                         $ 20,086          $ 20,838
                                                                         ========          ========
</TABLE>


7.   Accrued Expenses

     Accrued expenses consisted of the following:

<TABLE>
<CAPTION>
                                                                    January 3, 1998   January 2, 1999
                                                                    ---------------   ---------------
      <S>                                                          <C>                <C>      
      Employee compensation............................                 $  3,325           $  2,944 
      Advertising and promotion........................                    2,520              1,730 
      Accrued interest.................................                    1,155              1,410 
      Restructuring charges............................                    2,438               -- 
      Other ...........................................                    4,841              4,777 
                                                                         --------          --------
                                                                         $14,279            $10,861 
                                                                         ========          ========
</TABLE>

8.   Debt

     Debt consisted of the following:

<TABLE>
<CAPTION>
                                                                    January 3, 1998   January 2, 1999
                                                                    ---------------   ---------------
   <S>                                                              <C>               <C>   
   Current:
       Short-term debt.................................                  $ 9,036            $ 9,557 
       Credit facility.................................                  $96,844            $73,833 
   Long-Term:
       Senior secured notes (net of unamortized bond
       discount).......................................                       --            $27,534 
       Convertible subordinated notes..................                  $80,000            $74,265 
</TABLE>

Short-term debt

     Converse maintains asset based financing arrangements in certain European
countries with various lenders. In general, these financing arrangements allow
the Company to borrow against varying percentages of eligible customer
receivable balances based on pre-established credit lines, along with varying
percentages of inventory, as defined. Interest is payable at the respective
lender's base rate plus 1.5% (varying by country from 4.5% to 8.0% at January 2,
1999). The obligations are secured by a first priority lien on the respective
European assets being financed. In addition, Converse has provided guarantees of
these borrowings in certain of the European countries.

                                      F-11
<PAGE>
 
Credit facility

     Simultaneously with the issuance of the $80,000 principal amount of
Convertible Subordinated Notes (the "Convertible Notes") in May 1997 (see
below), the Company entered into a new $150,000 secured credit agreement (the
"Credit Facility") with BT Commercial Corporation ("BTCC") for revolving loans,
letters of credit, foreign exchange contracts and banker acceptances and repaid
the indebtedness under the Company's then existing credit agreement (the "Old
Credit Facility"). In July 1997, BTCC, as agent, syndicated the Credit Facility
to a group of participating lenders (the "Banks"). In September 1998, the Credit
Facility was amended to decrease the commitment from $150,000 to $120,000 in
conjunction with the issuance of the Secured Notes (see below). The amount of
credit available to the Company at any time is limited by a borrowing base
formula, as defined in the Credit Facility, consisting primarily of U.S. and
Canadian accounts receivable and inventory (the "Borrowing Base"). The aggregate
of letters of credit, foreign exchange contracts and banker acceptances may not
exceed $80,000 at any time; revolving loans are limited only by the Credit
Facility's maximum availability less any amounts outstanding for letters of
credit, foreign exchange contracts or banker acceptances.

     The Credit Facility is for a five-year term and, accordingly, has an
expiration date of May 21, 2002. However, the total revolving loans and banker
acceptances outstanding under the Credit Facility of $73,833 are classified as
current due to the Company's lockbox arrangement (whereby payments by the
Company's customers are deposited in a lockbox controlled by the Banks) and
certain clauses contained in the Credit Facility regarding mandatory repayment
that involve subjective judgments by the Banks. This classification is required
by Emerging Issues Task Force 95-22, "Balance Sheet Classification of Borrowings
Outstanding under a Revolving Credit Agreement that Includes both a Subjective
Acceleration Clause and a Lockbox Arrangement."

     As of January 2, 1999, the Borrowing Base was $80,440. Utilization under
the Credit Facility at year end amounted to $76,097 consisting of revolving
loans of $72,386, banker acceptances of $1,447 and outstanding letters of credit
of $2,264. Accordingly, $4,343 of the maximum available Borrowing Base remained
unutilized as of January 2, 1999.

     Revolving loans under the Credit Facility bear interest either at the Prime
Lending Rate (as defined therein) plus one percent (1.00%) per annum or at the
Adjusted LIBOR Rate (as defined therein) plus a margin of two and one-half
percent (2.50%) per annum. The foregoing LIBOR margin is subject to reduction
based upon the Company achieving certain interest coverage ratios specified in
the Credit Facility. At January 2, 1999, revolving loans outstanding under the
Credit Facility bore interest of 7.79% based upon the weighted average of the
Prime Lending Rate and Adjusted LIBOR Rate. Obligations outstanding under the
Credit Facility are secured by first priority liens on substantially all of the
Company's U.S. and Canadian assets. The Credit Facility requires compliance with
customary affirmative and negative covenants, including certain financial
covenants. In September 1998, the Company's Credit Facility was amended to
permit the issuance of the Secured Notes as discussed below. The amendment
decreased the commitment under the Credit Facility from $150,000 to $120,000,
increased the annual collateral management fee from $100 to $125 and changed a
financial performance covenant contained therein. As of January 2, 1999, the
Company was in compliance with its financial covenants and believes that it will
remain in compliance during 1999.

     The Credit Facility provides for customary ongoing fees including an unused
line fee of .50% per annum on the unutilized portion of the credit commitment
and fees with respect to documentary or stand-by letters of credit varying from
1.25% to 2.25% per annum on the outstanding face amount of the respective
credit. The Company is obligated to pay BTCC, as agent for the Credit Facility,
an annual collateral management fee of $125.

     In May 1997, the Company paid a funding fee with respect to the Credit
Facility of 2% of the total commitment, or $3,000, to BTCC. In September 1998, a
fee of $150 was paid to the Banks with respect to the above-referenced
amendment. The Company has capitalized these fees (adjusted for a write-off to
extraordinary loss of $442 in the funding fee when the commitment was reduced
from $150,000 to $120,000 in September 1998) and is amortizing these costs over
the term of the Credit Facility. Accordingly, unamortized financing fees
relating to the Credit Facility, recorded in other assets on the consolidated
balance sheet of the Company, were $1,765 at January 2, 1999. Any unamortized
costs relating to an amendment fee of $150 incurred in November 1997 and a
waiver fee of $100 incurred in May 1998, originally capitalized, were written
off to extraordinary loss in September 1998.

                                      F-12
<PAGE>
 
Senior secured notes

     In September 1998, the Company issued $28,643 aggregate principal amount of
15% Senior Secured Notes (the "Secured Notes") due September 16, 2000 (the
"Initial Maturity Date"). Interest on the Secured Notes is payable quarterly in
arrears. The Initial Maturity Date may be extended an additional 12 months at
the Company's option upon written notification of its election to extend and
payment of a fee equal to 3% of the then outstanding principal amount of the
Secured Notes (the "First Extended Maturity Date"). The First Extended Maturity
Date may be extended to May 21, 2002 at the Company's option upon written
notification of its election to extend and payment of an additional fee equal to
3% of the then outstanding principal amount of the Secured Notes. The Secured
Notes were issued in two series: Series A in the aggregate principal amount of
$24,858 (the "Series A Secured Notes") and Series B in the aggregate principal
amount of $3,785 (the "Series B Secured Notes"). The Secured Notes are
redeemable at any time at face amount plus accrued interest. The Secured Notes
require compliance with customary affirmative and negative covenants, including
certain financial covenants, substantially the same as the requirements
contained in the Credit Facility.

     Upon issuance of the Series A Secured Notes the Company received gross
proceeds of $24,000 after discount from the face amount of $858. The Company is
amortizing this discount over 24 months to the Initial Maturity Date.
Accordingly, the unamortized note discount was $733 on January 2, 1999. In
connection with the issuance of the Series A Secured Notes, the Company issued
warrants to purchase 360,000 shares of the Company's common stock to the
purchasers and paid funding fees to certain purchasers amounting to $350. The
warrants were valued at $1.22 per share, vest immediately and expire on March
16, 2003. The total warrant valuation, $440, is considered additional bond
discount and is being amortized over a 24 month period to the Initial Maturity
Date. As of January 2, 1999, the unamortized warrant cost was $376. The Company
paid a placement fee of 4% of the gross proceeds, or $960, with respect to the
Series A Secured Notes. The Series A Secured Notes carry a second priority
perfected lien on all real and personal, tangible and intangible assets of the
Company.

     The Series B Secured Notes were issued in exchange for the surrender of
$5,735 face amount of Convertible Notes (see below), which were subsequently
cancelled by the Company. In connection with the issuance of the Series B
Secured Notes, the Company paid a placement fee of 2% of the face amount, or
$76. The Series B Secured Notes carry a third priority perfected lien on all
real and personal, tangible and intangible assets of the Company.

     The Company has capitalized the fees and expenses associated with the
issuance of the Secured Notes and is amortizing these costs over a 24 month
period to the Initial Maturity Date. Accordingly, total unamortized financing
fees and expenses relating to the Secured Notes, recorded in other assets on the
consolidated balance sheet of the Company, were $1,419 at January 2, 1999.

Convertible subordinated notes

     On May 21, 1997, the Company completed the sale of $80,000 of Convertible
Notes due June 1, 2004. As discussed above, in September 1998 the Company
received, and subsequently cancelled, $5,735 of Convertible Notes in exchange
for the issuance of the Series B Secured Notes. The Convertible Notes are
subordinated to all existing and future Senior Indebtedness (as defined
therein). The Convertible Notes are convertible at any time prior to maturity,
unless previously redeemed into common stock of the Company, at the option of
the holder, at a conversion price of $21.83 per share, subject to adjustment in
certain events. In addition, the Convertible Notes may be redeemed, in whole or
in part, at the option of the Company, at any time on or after June 5, 2000 at
the redemption prices set forth therein plus accrued interest to the date of
redemption. Interest is payable semi-annually on June 1 and December 1,
commencing on December 1, 1997. The Company capitalized deferred note issuance
costs of $3,673 in conjunction with the issuance of the Convertible Notes. These
deferred costs are being amortized over the seven year life of the Convertible
Notes. Unamortized bond issue fees of $151 with respect to the Convertible Notes
exchanged in September 1998 were written off as an extraordinary loss in 1998.
Accordingly, unamortized convertible note issuance costs, recorded as other
assets on the consolidated balance sheet of the Company, were $2,685 at January
2, 1999.

                                      F-13
<PAGE>
 
Subordinated notes (Apex)

     On May 18, 1995, in conjunction with Converse's acquisition of 100% of the
outstanding common stock of Apex (see Note 3), Converse issued subordinated
notes in the face amount of $11,000, discounted at a rate of 12%, to $9,644.
During Fiscal 1997 substantially all of these notes were returned to Converse in
connection with the settlement of the Apex litigation. The Company had accrued
$1,354 of interest expense related to these notes which was included as
restricted cash on the December 28, 1996 balance sheet. In connection with the
settlement of the subordinated notes, this interest expense was reversed in
Fiscal 1997.

Total interest expense consisted of the following:

<TABLE>
<CAPTION>
                                                         Fiscal Year Ended
                                       ----------------------------------------------------
                                       December 28, 1996  January 3, 1998   January 2, 1999
                                       -----------------  ---------------   ---------------
<S>                                    <C>                <C>               <C>   
Interest on short-term debt, Credit
  Facility and Old Credit Facility.        $ 11,368            $  9,777         $  7,829  
Interest on Convertible Notes .....              --               3,508            5,346  
Interest on subordinated notes ....             880              (1,354)              --  
Amortization of Convertible Notes                                                         
  issuance costs ..................              --                 320              668  
Credit line fees ..................           1,518               1,819            1,380  
Amortization of Old                                                                       
  Credit Facility financing fees ..           1,767                 694               --  
Old Credit Facility amendment                                                             
  and other fees ..................           2,243                 240               --  
Amortization of Credit Facility                                                           
  financing fees ..................              --                 370              604  
Amortization of Secured Notes                                                             
  issuance costs ..................              --                  --              421  
Interest on Secured Notes .........              --                  --            1,277  
                                           --------            --------         --------  
                                           $ 17,776            $ 15,374         $ 17,525  
                                           ========            ========         ========  
</TABLE>

9.   Extraordinary (Gain) Loss

     In May 1997, the Company entered into the Credit Facility and repaid the
Old Credit Facility. In connection with the repayment of the Old Credit
Facility, the Company wrote-off deferred financing fees of $1,320 in the second
quarter of Fiscal 1997. This write-off is presented as an extraordinary loss of
$744, net of income tax benefit of $576, on the statement of operations.

     During the third quarter of Fiscal 1998, the Company reported an
extraordinary gain of $704, net of tax of $437. The extraordinary gain related
to the issuance of Series B Secured Notes of $3,785 in exchange for the
surrender of $5,735 face amount of Convertible Notes which were subsequently
cancelled, net of financing fees of $809 which were written off.

10.  Income Taxes

     The domestic and foreign components of income (loss) from continuing
operations before income taxes were as follows:

<TABLE>
<CAPTION>
                                                      Fiscal Year Ended
                                  -------------------------------------------------------
                                  December 28, 1996    January 3, 1998    January 2, 1999
                                  -----------------    ---------------    ---------------
         <S>                      <C>                  <C>                <C>      
         Domestic.............        $(17,967)             $ 29,730          $ (4,040)
         Foreign..............          (4,602)              (20,881)          (15,907)
                                      --------              --------          -------- 
                                      $(22,569)             $  8,849          $(19,947)
                                      ========              ========          ======== 
</TABLE> 

                                      F-14
<PAGE>
 
     Income tax expense (benefit) related to continuing operations was comprised
of the following:

<TABLE>
<CAPTION>
                                                   Fiscal Year Ended
                                -----------------------------------------------------
                                December 28, 1996   January 3, 1998   January 2, 1999
                                -----------------   ---------------   ---------------
<S>                             <C>                 <C>               <C>
Current:
         Federal.............        $(3,617)            $     --        $    -- 
         State...............            299                  362            501 
         Foreign.............          3,571                2,336          2,848 
                                     -------              -------        ------- 
                                         253                2,698          3,349 
                                     -------              -------        ------- 
Deferred:                                     
         Federal.............         (3,906)               8,574            281 
         State...............           (481)               1,882            (58)
                                     -------              -------        ------- 
                                      (4,387)              10,456            223 
                                     -------              -------        ------- 
                                     $(4,134)             $13,154        $ 3,572 
                                     =======              =======        ======= 
</TABLE>

     The following table reconciles the differences between the Federal
corporate statutory rate and Converse's effective income tax rate:

<TABLE>
<CAPTION>
                                                                       Fiscal Year Ended
                                                    -----------------------------------------------------
                                                    December 28, 1996   January 3, 1998   January 2, 1999
                                                    -----------------   ---------------   ---------------
<S>                                                 <C>                 <C>               <C>    
Federal corporate statutory tax rate (benefit) .           (35.0)%           35.0%            (35.0)%
State taxes (benefit), net of Federal tax effect            (2.9)            13.9              (0.9) 
Foreign income taxes ...........................            10.1               --               8.5  
Valuation allowance ............................            12.7            105.0              47.2  
Other ..........................................            (3.2)            (5.3)             (1.9) 
                                                       --------------   --------------     ------------
Effective income tax (benefit) rate ............           (18.3)%          148.6%             17.9% 
                                                       ==============   ==============     ============
</TABLE>

     Deferred income taxes reflect the effect of temporary differences between
the tax basis of assets and liabilities and the reported amounts of assets and
liabilities for financial reporting purposes net of any valuation allowance.
Converse's deferred tax assets and liabilities at January 3, 1998 and January 2,
1999, consisted of the following:

<TABLE>
<CAPTION>
                                                                      January 3, 1998    January 2, 1999
                                                                      ---------------    ---------------
<S>                                                                   <C>                <C>     
Deferred tax assets:
         Tax benefit of loss carryforwards.........................       $ 36,526           $ 53,236 
         Fair value adjustments....................................          3,234              2,574 
         Employee postretirement benefits other than pensions......          4,012                 --
         Expense accruals..........................................          1,539              2,132 
         Receivable, inventory and other reserves..................          2,660              2,262 
         Depreciation..............................................          1,604                714 
                                                                          --------           -------- 
             Gross deferred tax assets.............................         49,575             60,918 
Deferred tax liabilities:
         Employee pension plans....................................           (627)            (1,272)
         Other.....................................................         (4,739)            (5,527)
                                                                          --------           -------- 
             Net deferred tax assets before valuation allowance....         44,209             54,119 
         Valuation allowance.......................................        (20,877)           (30,756)
                                                                          --------           -------- 
             Net deferred tax assets...............................       $ 23,332           $ 23,363 
                                                                          ========           ======== 
</TABLE>

                                      F-15
<PAGE>
 
     The net deferred tax assets are included in the consolidated balance sheet
as follows:

                                               January 3, 1998  January 2, 1999
                                               ---------------  ---------------
Prepaid expenses and other current assets....      $ 2,063          $ 1,142 
Other assets.................................       21,269           22,221 
                                                   -------          ------- 
                                                   $23,332          $23,363 
                                                   =======          ======= 



     Statement of Financial Accounting Standards No. 109, "Accounting for Income
Taxes," requires that a valuation allowance be recorded against deferred tax
assets for which there is a greater than fifty percent chance that the tax
assets will not be realized. Although the period to use these deferred tax
assets is 11 to 20 years for tax purposes, the accounting guidance requires that
a shorter time frame be used to assess the probability of their realization.
Converse believes its deferred tax assets will be realized; however, as a result
of the uncertainty caused by the industry downturn which began in the second
half of Fiscal 1997 and the related oversupply of inventory in the marketplace
during the fourth quarter of Fiscal 1997, the Company increased its deferred tax
valuation allowance by $9,292 to a total of $20,977 at January 3, 1998.

     During Fiscal 1998, the industry downturn continued. The Company assessed
the realizability of its deferred tax assets each quarter. In assessing the
realizability of the deferred tax assets, Converse has based its quarterly
judgments on estimated future earnings and the adoption of various business and
tax planning strategies. These tax planning strategies include the sale and
conversion of unprofitable foreign operations and anticipated enhancement of the
Company's financial structure. Converse continues to believe its deferred tax
assets will be realized. However, given the accounting guidance referred to
above and current industry conditions, the Company established additional
valuation allowances totaling $9,879 representing approximately the tax benefit
of the Fiscal 1998 quarterly losses.

     At January 2, 1999, Converse had operating loss carryforwards of $134,038.
The loss carryforwards expire between the years 2009 and 2018.

11.  Employee Benefits

     Converse sponsors or contributes to retirement plans covering substantially
all domestic employees. Converse has a defined benefit pension plan in addition
to other retirement plans and benefits. The annual cost for the defined benefit
plan is determined using the projected unit credit actuarial cost method which
includes significant actuarial assumptions and estimates which are subject to
change in the near term. Prior service cost is amortized on a straight-line
basis over the average remaining service period of employees expected to receive
benefits. In certain foreign countries, contributions are made to defined
contribution plans as well as to government sponsored plans, as required in the
respective jurisdictions. Liabilities and expenses related to these foreign
employees are not material.

Defined benefit pension plan

     Converse has a non-contributory defined benefit pension plan covering
substantially all salaried employees at its domestic operations. Retirement
benefits generally are based on years of service and final average compensation
with employees becoming vested upon completion of five years of service. The
plan is funded by company contributions to trust funds which are held for the
sole benefit of the employees. It is Converse's practice to fund pension costs
to the extent that such costs are tax deductible and in accordance with ERISA.
The assets of the plan are primarily comprised of equity securities and fixed
income investments. In Fiscal 1998, the net periodic pension costs were subject
to a $1,625 curtailment gain resulting from workforce reductions.

                                      F-16
<PAGE>
 
<TABLE>
<CAPTION>
                                                       December 28, 1996    January 3, 1998   January 2, 1999
                                                       -----------------    ---------------   ---------------
<S>                                                        <C>                 <C>                 <C>     
Change in benefit obligation
   Benefit obligation at beginning of year ......          $ 44,738            $ 46,781            $ 58,553
   Service cost .................................             1,410               1,751               1,718
   Interest cost ................................             3,375               3,769               3,851
   Curtailment (gains) ..........................                --                  --              (1,625)
   Actuarial loss (gain) ........................              (371)              8,731                 440
   Benefits paid ................................            (2,371)             (2,479)             (2,640)
                                                           --------            --------            --------
   Benefit obligation at end of year ............          $ 46,781            $ 58,553            $ 60,297
                                                           ========            ========            ======== 

Change in plan assets
   Fair value of plan assets at beginning of year          $ 44,853            $ 51,122            $ 59,507
   Actual return on plan assets .................             6,365              10,458               8,863
   Employer contribution ........................             2,275                 406                  -- 
   Benefits paid ................................            (2,371)             (2,479)             (2,640)
                                                           --------            --------            --------
   Fair value of plan assets at end of year .....          $ 51,122            $ 59,507            $ 65,730
                                                           ========            ========            ======== 

Reconciliation of Funded Status
   Benefit obligation at end of year ............          $(46,781)           $(58,553)           $(60,297)
   Fair value of plan assets as end of year .....            51,122              59,507              65,730
                                                           --------            --------            --------
   Funded status at end of year .................             4,341                 954               5,433
   Unrecognized prior service cost ..............               (82)                (75)                (62)
   Unrecognized net actuarial loss (gain) .......            (2,166)                895              (1,889)
                                                           --------            --------            --------
   Prepaid benefit cost .........................          $  2,093            $  1,774            $  3,482
                                                           ========            ========            ======== 

Weighted Average Assumptions
   Discount rate ................................              7.50%               7.00%               6.75%
   Expected return on plan assets ...............              9.50%               9.50%               9.50%
   Rate of compensation increase ................              4.50%               4.50%               4.75%


Components of Net Periodic Benefit Cost
   Service cost .................................          $  1,410            $  1,751            $  1,718
   Interest cost ................................             3,375               3,769               3,851
   Expected return on plan assets ...............            (4,248)             (4,788)             (5,646)
   Amortization of prior service costs ..........                (7)                 (7)                 (6)
   Curtailment gains ............................                --                  --              (1,625)
                                                           --------            --------            --------
   Net periodic benefit cost ....................          $    530            $    725            $ (1,708)
                                                           ========            ========            ======== 
</TABLE>


Defined benefit postretirement plan

     In addition to pension benefits, certain retired employees had previously
been provided with specified health care and life insurance benefits. Employees
who retired after a certain age with specified years of service were eligible
for these benefits if they agreed to contribute a portion of the cost. At
December 28, 1996 and January 3, 1998, the Company had an accrued postretirement
benefit obligation of $10,231 and $10,422, respectively. Net periodic
postretirement benefit cost totaled $221 and $215 for Fiscal 1996 and Fiscal
1997, respectively. Measurement of the Fiscal 1996 accumulated postretirement
benefit obligation was based upon a weighted average discount rate of 7.50%, a
15.0% annual rate of increase in the cost of health care benefits and an assumed
long-term rate of compensation increase of 4.5%. In Fiscal 1997, the accumulated
postretirement benefit obligation was measured based upon a weighted average
discount rate of 7.0%, a 9.0% annual rate of increase in the cost of health care
benefits and an assumed long-term rate of compensation increase of 4.0%.

                                      F-17
<PAGE>
 
     In the second quarter of Fiscal 1998, the Company announced its intentions
to cease the accrual of benefits to active employees under the plan. Unless the
employees were eligible for and elected to retire by December 31, 1998, all
vested benefits under the postretirement plan ceased to exist. As a result of
this action, the defined benefits for future services of a significant number of
plan participants were eliminated and the Company recognized a $3,284
curtailment gain.

     In the third quarter of Fiscal 1998, the Company notified retired employees
that their medical and life benefits would terminate on January 1, 1999 and the
employees would receive transition payments based on age and dependents. As a
result, the Company settled its obligations under the postretirement plan and
recorded a settlement gain of $5,990. The transition payments, totaling $587
will be made in three equal installments over a three-year period beginning
January 5, 1999. The accrual for these future payments is included in accrued
expenses on the consolidated balance sheet.

Other retirement plans and benefits

     Converse has a non-contributory defined contribution plan covering all
hourly employees with at least one year of service at its domestic manufacturing
and warehouse facilities. Contributions under this plan are fixed at $0.41 per
hour of service with a maximum contribution based on 2,000 hours per employee.
The defined contribution expense was $318, $625 and $975 for Fiscal 1996, 1997
and 1998, respectively.

     Converse also sponsors a savings plan. The total cost of this plan for
Fiscal 1996, 1997 and 1998 was $329, $333 and $325, respectively.

12.  Stock Option Plans

Converse 1994 stock option plan

     The Board of Directors of Converse adopted the Converse Inc. 1994 Stock
Option Plan (the "1994 Plan") as a means to encourage ownership of Converse
common stock by key employees and enable Converse to attract and retain the
services of outstanding employees in competition with other employers.

     The 1994 Plan authorizes grants to key employees, including executive
officers of Converse and its subsidiaries, and to its consultants, of incentive
and non-qualified options to purchase shares of common stock. In 1998, the 1994
Plan was amended by the Company's Board of Directors and Stockholders to permit
the granting of restricted stock in addition to stock options. The plan
administrator has discretion to grant non-qualified options at less than 100% of
the fair market value per share of the common stock of Converse on the date of
grant. Converse incentive stock options must be granted with an exercise price
of not less than 100% of the fair market value per share of common stock of
Converse on the date of grant. Option prices are payable in full and in cash,
upon the exercise of a stock option, and the proceeds are added to the general
funds of Converse. As of January 2, 1999, the number of shares of common stock
which may be issued under the 1994 Plan is 3,300,000 subject to adjustment upon
the occurrence of certain contingencies. The maximum number of shares with
respect to which options or restricted stock may be granted to any individual
during any calendar year and during the term of the 1994 Plan is 500,000 and
750,000, respectively. Options under the 1994 Plan generally expire nine years
from the grant date.

     The 1994 Plan will terminate in October 2004, subject to the right of the
Board of Directors to suspend or discontinue the 1994 Plan at any prior date and
the rights of holders of options to exercise options after such date in
accordance with the terms of such options.

                                      F-18
<PAGE>
 
     The following table summarizes stock option activity under the 1994 Plan:

<TABLE>
<CAPTION>
                                                                                              Weighted Average
                                                         Number of           Exercise          Exercise Price
                                                          Options         Price per Share         Per Share
                                                          -------         ---------------         ---------
<S>                                                      <C>              <C>      <C>              <C>   
 Outstanding at December 30, 1995...................     1,124,000        $5.00 -  $23.00         $   7.71
 Granted............................................     1,221,000        $4.00 -  $23.00             7.17
 Canceled...........................................      (520,200)       $5.00 -  $23.00            11.71
 Exercised..........................................      (246,000)       $5.00 -   $7.00             5.57
                                                        -----------  
 Outstanding at December 28, 1996...................     1,578,800        $4.00 -  $23.00             6.31
 Granted............................................       442,000       $10.94 -  $26.88            17.30
 Canceled...........................................      (127,250)       $5.27 -  $26.88             9.34
 Exercised..........................................      (104,800)       $4.00 -   $9.40             5.96
                                                        -----------  
 Outstanding at January 3, 1998.....................     1,788,750        $4.00 -  $26.88             8.85
 Granted............................................       438,000        $4.75 -   $7.50             7.43
 Canceled...........................................      (468,400)       $5.265 - $26.875           14.51
 Exercised..........................................        (1,600)                 $7.00             7.00
                                                        -----------  
 Outstanding at January 2, 1999.....................     1,756,750        $4.00 -  $26.875        $   6.99
                                                        ===========                               =========
 Exercisable at January 2, 1999.....................       675,350 
                                                        ===========
 Restricted stock outstanding at January 2, 1999....       200,000 
                                                        ===========
 Available for future grants........................       990,850 
                                                        ===========
</TABLE>

     The following table summarizes information about the 1994 Plan stock
options outstanding at January 2, 1999:

<TABLE>
<CAPTION>
                                        Options Outstanding                                 Options Exercisable
                         ----------------------------------------------------      ---------------------------------------
                                          Weighted Average                                                                
                           Number            Remaining                                   Number                           
   Range of              Outstanding at  Contractual Life    Weighted Average        Exercisable at     Weighted Average
Exercise Prices          January 2, 1999     (Years)          Exercise Price        January 2, 1999      Exercise Price
---------------          ---------------     -------          --------------        ---------------      --------------
<S>                          <C>                  <C>              <C>                    <C>                 <C> 
$4.00-$6.00                 720,750              6                 5.18                  320,150              5.20
$6.125-$8.645               848,000              7                 7.06                  259,200              6.88
$9.00-$13.00                138,000              6                10.88                   76,000             10.82
$15.00-$21.00                35,000              7                19.13                   15,000             18.53
$23.00-$26.875               15,000              6                25.58                    5,000             24.55
                         -----------                                                    ---------
                          1,756,750                                                      675,350
                         ===========                                                    =========
</TABLE>


     On September 5, 1996, Converse repriced certain stock options granted under
the 1994 Plan. Options to purchase 105,000 shares of common stock at prices
ranging from $5.00 to $23.00 per share were repriced to an exercise price of
$6.375 per share, which represented the closing price of Converse's common stock
on September 5, 1996. In connection with this repricing, options to purchase
45,000 shares of common stock were canceled. None of the repriced options had
vested prior to the repricing date and they did not begin to vest until
September 5, 1997. The above option activity table reflects all options at their
amended price and vesting terms. On February 25, 1998, Converse repriced certain
additional stock options granted under the 1994 Plan. Options to purchase
278,000 shares of common stock were repriced to an exercise price of $7.50 per
share, which exceeded the closing price of Converse's common stock on February
25, 1998. The original vesting schedules and expiration dates associated with
these stock options remained the same as the original grants. None of the
foregoing stock option grants had vested prior to the repricing date.

                                      F-19
<PAGE>
 
Converse 1995 non-employee director plan

     On March 22, 1995, the Board of Directors of Converse adopted the 1995
Non-Employee Director Plan (the "1995 Plan") as a means of fostering and
promoting the long-term financial success of Converse by attracting and
retaining Non-Employee Directors of outstanding ability.

     Converse has reserved an aggregate of 45,000 shares for issuance under the
1995 Plan. Options to purchase 22,500 of these shares were granted during 1995
at the fair market value on the date of grant of $9.88. No grants have been made
since this time. These stock options become exercisable in equal one-third
increments on the anniversaries of the grant date beginning on March 22, 1996
and expire ten years from the date of grant. No such options were exercised
since their grant and all options remain outstanding at January 3, 1998.

Restricted stock awards

     In 1998, the Company amended the 1994 Plan to permit the granting of
restricted stock. All restricted stock grants are subject to restrictions as to
continuous employment. The restricted stock vests 100% on the third anniversary
of the grant date. As there is no exercise payment associated with the
restricted stock awards, the cost of the awards, determined as the fair market
value of the shares on the date of grant, is charged to expense ratably over the
three year vesting period. In 1998, 200,000 shares of restricted stock were
granted in 1998, resulting in $975 of unearned compensation, of which $217 was
amortized in Fiscal 1998.

Employee stock purchase plan

     The Company adopted an Employee Stock Purchase Plan (the "ESPP") in 1998.
The company reserved 500,000 shares of common stock for issuance under the ESPP.
Eligible employees may invest up to $10 per year through payroll deductions. The
purchase price of the shares is equal to 85% of the lower of the fair market
value of the stock as of the first or last trading day of each purchase period.
The first purchase period began on October 1, 1998 and runs through February 28,
1999. Thereafter, each purchase period will run for six months.
There were no shares issued under the ESPP during 1998.

Stock-based compensation

     The Company accounts for stock-based compensation using the method
prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees." Accordingly, no compensation cost has been recognized for
the Company's stock option plans. The Company has adopted the disclosure-only
provisions Statement of Financial Accounting Standards No. 123 "Accounting for
Stock-Based Compensation" ("SFAS 123"). Had compensation cost been determined
based on the fair value at the grant dates for awards in 1996, 1997, and 1998
consistent with the provisions of SFAS 123, the Company's net loss and loss per
share would have been increased to the pro forma amounts indicated below:

<TABLE>
<CAPTION>
                                                                         Fiscal Year Ended
                                            -----------------------------------------------------------------------
                                              December 28, 1996          January 3, 1998          January 2, 1999
                                              -----------------          ---------------          ---------------
<S>                                              <C>                        <C>                     <C>      
Net loss - as reported...................        $(18,435)                  $(5,049)                $(22,815)
Net loss - pro forma.....................         (19,559)                   (7,041)                 (24,493)
Basic and diluted loss per share
  as reported............................           (1.10)                    (0.29)                   (1.32)
Basic and diluted loss per share
  pro forma..............................           (1.17)                    (0.41)                   (1.41)
</TABLE>

                                      F-20
<PAGE>
 
     The fair value of options granted at date of grant was estimated using the
Black-Scholes model with the following weighted average assumptions:

<TABLE>
<CAPTION>
                                                        Fiscal Year Ended
                                 -----------------------------------------------------------
                                  December 28, 1996      January 3, 1998    January 2, 1999
                                  -----------------      ---------------    ---------------
<S>                                       <C>                  <C>                <C>   
Expected life (years)........              6.0                  6.0                6.0   
Interest rate................              6.27%                6.18%              5.12%
Volatility...................             65.00%               67.00%             59.44%
Dividend yield...............                --                   --                 --   
</TABLE>


     The weighted average grant date fair value of options granted during Fiscal
1996, Fiscal 1997 and Fiscal 1998 was $3.37, $12.20 and $3.07, respectively.

     The pro forma net income and earnings per share amounts reflected above do
not include a tax benefit for Fiscal 1996, 1997 or 1998 as a full valuation
allowance would have been provided against any such benefit. The pro forma
effect on net income for Fiscal 1996, Fiscal 1997 and Fiscal 1998 is not
necessarily indicative of future amounts as it does not take into consideration
pro forma compensation expense related to grants made prior to 1995 as SFAS 123
does not apply to awards prior to 1995.

13.   Lease Commitments

     Substantially all of Converse's retail outlets and certain other real
properties and equipment are operated under lease agreements expiring at various
dates through the year 2012. Leases covering retail outlets and equipment
generally require, in addition to stated minimums, contingent rentals based on
retail sales and equipment usage. Generally, the leases provide for renewal for
various periods at stipulated rates.

     Rental expense under operating leases was as follows:

<TABLE>
<CAPTION>
                                                       Fiscal Year Ended
                                    ------------------------------------------------------
                                     December 28, 1996  January 3, 1998   January 2, 1999
                                     -----------------  ---------------   ---------------
<S>                                       <C>                <C>               <C>   
Minimum rentals.....................      $4,244             $4,713            $4,510
Contingent rentals..................         825              1,588             1,763
                                          ------             ------            ------
                                          $5,069             $6,301            $6,273
                                          ======             ======            ======
</TABLE>

     Future minimum lease payments under operating leases are $4,870, $3,655,
$2,823, $2,085 and $4,112 for 1999 through 2003 and thereafter, respectively.

14.  Commitments and Contingencies

     Converse is or may become a defendant in a number of pending or threatened
legal proceedings in the ordinary course of its business. Converse believes the
ultimate outcome of any such proceedings will not have a material adverse effect
on its financial position or results of operations.

15.  Related Party Transactions

     In connection with the Distribution, Converse and Furniture Brands entered
into a Tax Sharing Agreement (the "Agreement") providing, among other things,
for an equal allocation between Furniture Brands and Converse of benefits
derived from a carryback of federal and state tax liabilities to periods prior
to completion of the Distribution. On February 21, 1996, Converse amended this
Tax Sharing Agreement with Furniture Brands, under which Converse agreed to
carryback certain federal income tax operating losses for the years ended
December 30, 1995 and December 28, 1996 to one or more Pre-Distribution tax
periods. For the year ended December 30, 1995, the amendment applied to the

                                      F-21
<PAGE>
 
first $41,000 of tax operating losses generated, which approximated the taxable
income available in the carryback period. For the year ended December 30, 1995,
tax operating losses of approximately $31,000 were carried back generating a tax
refund of $10,832. In accordance with the Agreement, as amended, Furniture
Brands paid Converse $8,000 on February 29, 1996 and in return Furniture Brands
was entitled to the full amount of the tax refund. Furniture Brands is not
entitled to any refund of the $8,000 payment in the event the ultimate tax
refund it receives from the Internal Revenue Service is less than anticipated.
In accordance with the agreement, Furniture Brands was also entitled to tax
refunds resulting from the carryback of approximately $10,000 of the Company's
Fiscal 1996 tax operating losses.

     The $2,832 excess of the Fiscal 1995 tax refund over Furniture Brands'
payment to Converse and the $3,616 tax refund associated with the aforementioned
$10,000 of 1996 tax operating losses of Converse being carried back to Furniture
Brands have been recorded by Converse as other expense in Fiscal 1995 and 1996,
respectively.

     In November 1995, Apollo Investment Fund, L.P. ("Apollo"), owner with its
affiliates of a majority of the outstanding common stock of the Company, caused
a standby letter of credit to be provided to the Banks to enable Converse to
borrow an additional $25,000 above its defined borrowing base under the Old
Credit Facility. The Company paid Apollo a fee of 3% of the face amount of the
letter of credit and a subsequent extension fee of $100. The standby letter of
credit arrangement ceased to exist upon the repayment of the Old Credit
Facility.

     On November 17, 1994, Converse entered into a consulting agreement with
Apollo Advisors, L.P., an affiliate of Apollo, pursuant to which Apollo
Advisors, L.P. provides corporate advisory, financial and other consulting
services to Converse. Fees under the agreement were initially payable at an
annual rate of $500 plus out-of-pocket expenses. During Fiscal 1997, this
agreement was amended to decrease the rate for the year ended January 3, 1998
from $500 to $375. The consulting agreement continues on a year-to-year basis
unless terminated by the Converse Board of Directors.

16.  Other Financial Data

     Items charged to earnings during Fiscal 1996, 1997 and 1998 included the
following:

<TABLE>
<CAPTION>
                                                                Fiscal Year Ended
                                         -------------------------------------------------------
                                          December 28, 1996   January 3, 1998   January 2, 1999
                                          -----------------   ---------------   ---------------
<S>                                            <C>                <C>                <C>    
     Advertising and promotion.........        $28,544            $34,887            $23,713
     Research and development..........         $6,503             $8,817             $7,659
</TABLE>

17.  Business Segment Information

     Converse adopted Statement of Financial Accounting Standards No. 131
"Disclosures about Segments of an Enterprise and Related Information" ("SFAS No.
131"), during the fourth quarter of 1998. SFAS No 131 established standards for
reporting information about business segments in annual financial statements and
requires selected information about operating segments in interim financial
reports issued to stockholders. Converse operates in one industry segment;
designing, manufacturing and marketing of athletic and leisure footwear, apparel
and accessories. Business segments are defined as components of an enterprise
about which separate financial information is available that is evaluated
regularly by the chief operating decision maker, or decision making group, in
deciding how to allocate resources and in assessing performance. Converse's
chief operating decision making group is the Company's Operating committee,
which is comprised of the Chairman and the lead executives of each of the
Company's business segments.

     The Company's business units have been aggregated into four reportable
segments [United States; Europe, Middle East, Africa; Asia Pacific; and Americas
(excluding Unites States)]. Each of these segments have separate management
teams and infrastructures and offer different products and services. The lead
executive for each business segment manages the profitability and cash flow of
each respective segment's various product lines and businesses. Converse has a
diversified customer base with one customer accounting for 12% of the Company's
net sales in Fiscal 1996, 14% in Fiscal 1997 and 19% in Fiscal 1998.

     The accounting policies of the reportable segments are the same as those
described in Note 2 of Notes to Consolidated Financial Statements except the
disaggregated financial results for Converse's business segments have been

                                      F-22
<PAGE>
 
prepared using a management approach, which is consistent with the basis and
manner in which Converse management internally disaggregates financial
information for the purposes of assisting in making internal operating
decisions. The Company evaluates the performance of its business segments based
on net sales, gross margin, royalty income, depreciation and amortization,
interest expense, other operating costs, other (income) expense, pretax profit
and total assets. The intersegment sales are accounted for based one established
sales prices between the related companies and pertain primarily to sales from
the United States to various foreign operations. For SFAS 131 disclosures, the
Company has allocated interest expense to each segment based on its respective
accounts receivable and inventory balances. Certain other operating costs have
been allocated based on gross footwear sales. The $9,300 gain related to the
termination of the post retirement medical benefit plan has been allocated fully
to the United States.

     Summarized financial information concerning the Company's reportable
business segments is shown in the following table. The information for Fiscal
1997 and 1996 has been restated from the prior year's presentation in order to
conform to the Fiscal 1998 presentation.

<TABLE>
<CAPTION>
                                                          Europe,                  Americas
                                                       Middle East,               (excluding
                                         United States    Africa    Asia Pacific United States)  Eliminations  Consolidated
                                         -------------    ------    ---------------------------  ------------  ------------
<S>                                       <C>           <C>           <C>           <C>           <C>           <C>      
Fiscal 1998
Net sales to customer ................    $ 166,555     $  72,603     $  59,719     $   9,476     $      --     $ 308,353
Intersegment net sales ...............       47,344            --            --            --       (47,344)           -- 
Gross margin .........................       35,376        15,973        17,697         1,636            --        70,682
Royalty income .......................        3,069         1,820        12,846         2,440            --        20,175
Depreciation and amortization ........        1,337           117           192            71            --         1,717
Net interest expense .................       10,060         4,523         2,157           785            --        17,525
Other operating costs ................       41,412        29,956        16,439         4,769            --        92,576
Other (income) expense ...............         (678)          (93)         (241)           (2)           --        (1,014)
                                          ---------     ---------     ---------     ---------     ---------     --------- 
Segment pretax profit (loss) .........    $ (13,686)    $ (16,710)    $  11,996     $  (1,547)    $      --     $ (19,947)
                                          =========     =========     =========     =========     =========     ========= 

Segment total assets .................      153,107        33,066         4,834         3,999            --       195,006
Segment long-lived assets ............       18,839         1,767           182            50            --        20,838
Segment capital expenditures .........        4,232           540            54            14            --         4,840

Fiscal 1997
Net sales to customer ................    $ 284,895     $  75,452     $  70,953     $  18,899     $      --     $ 450,199
Intersegment net sales ...............       44,890            --            --            --       (44,890)           -- 
Gross margin .........................       82,932        14,371        20,373         3,265            --       120,941
Royalty income .......................        3,809         3,060        13,331         2,369            --        22,569
Depreciation and amortization ........        1,271           112           160            86            --         1,629
Net interest expense .................       10,029         3,150         1,460           735            --        15,374
Other operating costs ................       70,945        34,085        15,551         6,581            --       127,162
Other (income) expense..Other inc./exp      (11,584)        2,645          (478)          (87)           --        (9,504)
                                          ---------     ---------     ---------     ---------     ---------     --------- 
Segment pretax profit (loss) .........    $  16,080     $ (22,561)    $  17,011     $  (1,681)    $      --     $   8,849
                                          =========     =========     =========     =========     =========     ========= 

Segment total assets .................      192,923        32,973         4,390         4,408            --       234,694
Segment long-lived assets ............       18,838         1,125            65            58            --        20,086
Segment capital expenditures .........        5,501           558            11            42            --         6,112

Fiscal 1996
Net sales to customer ................    $ 194,060     $  92,207     $  43,695     $  19,373     $      --     $ 349,335
Intersegment net sales ...............       63,095            --            --            --       (63,095)           -- 
Gross margin .........................       48,733        21,830        12,324         3,350            --        86,237
Royalty income .......................        2,670         2,294        21,338         1,336            --        27,638
Depreciation and amortization ........        1,087           130           127            73            --         1,417
Net interest expense .................       11,595         3,643         1,687           851            --        17,776
Other operating costs ................       61,507        35,262        12,758         5,484            --       115,011
Other (income) expense..Other inc./exp        1,638         1,167          (484)          (81)           --         2,240
                                          ---------     ---------     ---------     ---------     ---------     --------- 
Segment pretax profit (loss) .........    $ (24,424)    $ (16,078)    $  19,574     $  (1,641)    $      --     $ (22,569)
                                          =========     =========     =========     =========     =========     ========= 

Segment total assets .................    $ 177,767     $  32,305     $   8,495     $   4,036     $      --     $ 222,603
Segment long-lived assets ............       16,596         1,131            88            34            --        17,849
Segment capital expenditures .........        4,847           385            --            --            --         5,232
</TABLE>

                                      F-23
<PAGE>
 
18.  Quarterly Financial Information (Unaudited)

     Following is a summary of unaudited quarterly information:

<TABLE>
<CAPTION>
                                     First        Second         Third         Fourth
                                    Quarter       Quarter       Quarter       Quarter
                                    -------       -------       -------       -------
<S>                                <C>           <C>           <C>           <C>     
Year ended January 3, 1998:
Net sales ...................      $135,969      $103,324      $121,903      $ 89,003
Gross profit ................      $ 42,160      $ 30,885      $ 32,104      $ 15,792
Net earnings (loss) .........      $ 12,680      $      4      $    175      $(17,908)
                                   ========      ========      ========      ======== 
Net earnings (loss) per share      $   0.71      $   0.00      $   0.01      $  (1.03)
                                   ========      ========      ========      ======== 

<CAPTION>

                                     First        Second         Third         Fourth
                                    Quarter       Quarter       Quarter       Quarter
                                    -------       -------       -------       -------
<S>                                <C>           <C>           <C>           <C>     
Year ended January 2, 1999:
Net sales ...................      $ 95,240       $ 78,351       $ 78,286       $ 56,476
Gross profit ................      $ 27,815       $ 19,737       $ 16,044       $  7,086
Net earnings (loss) .........      $ (1,163)      $ (1,516)      $ (4,274)      $(15,862)
                                   ========       ========       ========       ======== 
Net earnings (loss) per share      $  (0.07)      $  (0.09)      $  (0.25)      $  (0.92)
                                   ========       ========       ========       ======== 
</TABLE>

                                      F-24
<PAGE>
 
                                   SCHEDULE II

                        VALUATION AND QUALIFYING ACCOUNTS

                          (Dollar amounts in thousands)



<TABLE>
<CAPTION>
                                                      Additions   
                                                     (Reversals)  
                                                      Charged to  
                                         Beginning    Costs and    Deductions       Ending
               Description                Balance      Expenses    (Additions)     Balance
               -----------                -------      --------    -----------     -------
<S>                                       <C>          <C>           <C>           <C>    
Year Ended December 28, 1996:
     Allowance for Doubtful Accounts...   $ 2,237      $   670       $   913       $ 1,994
     Inventory Reserve ................     7,216          306         1,951         5,571
     Deferred Tax Asset Valuation     
     Allowance ........................     6,650        4,934            --        11,584
                                      
Year Ended January 3, 1998:           
     Allowance for Doubtful Accounts...   $ 1,994      $ 1,074       $ 1,002       $ 2,066
     Inventory Reserve ................     5,571         (769)        1,840         2,962
     Deferred Tax Asset Valuation     
     Allowance ........................    11,584        9,293            --        20,877
                                      
Year Ended January 2, 1999:           
     Allowance for Doubtful Accounts...   $ 2,066      $ 1,073       $ 1,053       $ 2,086
     Inventory Reserve ................     2,962          410           327         3,045
     Deferred Tax Asset Valuation     
     Allowance ........................    20,877        9,406          (473)       30,756
</TABLE>

                                      F-25