##### Table of Contents







UNITED STATES SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549


FORM 10-Q




þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934


For the quarterly period ended July 29, 2006


or


o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934


For the transition period from  to


Commission File Number: 1-14770





PAYLESS SHOESOURCE, INC .




DELAWARE
    
    43-1813160(State or other jurisdiction of
    
    (I.R.S. Employerincorporation or organization)
    
    Identification No.)


3231 SOUTHEAST SIXTH AVENUE, TOPEKA, KANSAS
    
    66607-2207(Address of principal executive offices)
    
    (Zip Code)





þ o




þ o o


o þ















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##### 



PAYLESS SHOESOURCE, INC.
FORM 10-Q
FOR THE FISCAL QUARTER ENDED JULY 29, 2006
INDEX
 PagePART I  FINANCIAL INFORMATIONItem 1.
    
    Financial Statements.Condensed Consolidated Balance Sheets as of July 29, 2006, July 30, 2005 and January 28, 2006
    
    
    3Condensed Consolidated Statements of Earnings for the 13 Weeks and 26 Weeks Ended July 29, 2006 and July 30, 2005
    
    
    4Condensed Consolidated Statements of Cash Flows for the 26 Weeks Ended July 29, 2006 and July 30, 2005
    
    
    5Notes to Condensed Consolidated Financial Statements
    
    
    6Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations.
    
    
    26Item 3.
    
    Quantitative and Qualitative Disclosures About Market Risk.
    
    
    33Item 4.
    
    Controls and Procedures.
    
    
    34PART II  OTHER INFORMATIONItem 1.
    
    Legal Proceedings.
    
    
    34Item 1A.
    
    Risk Factors.
    
    
    35Item 2.
    
    Unregistered Sales of Equity Securities and Use of Proceeds.
    
    
    35Item 6.
    
    Exhibits.
    
    
    36Signatures
    
    
    37CertificationCertificationCertificationCertification
  2




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##### Table of Contents



PART I  FINANCIAL INFORMATION
 
 ITEM 1  FINANCIAL STATEMENTS
 PAYLESS SHOESOURCE, INC. AND SUBSIDIARIES
 
 CONDENSED CONSOLIDATED BALANCE SHEETS
 (UNAUDITED)
 July 29,
    
    
    July 30,
    
    
    January 28,(dollars in millions)
    
    2006
    
    
    2005
    
    
    2006ASSETSCurrent Assets:Cash and cash equivalents
    
    $
    403.6
    
    
    $
    307.8
    
    
    $
    378.9Short-term investments
    
    
    39.0
    
    
    
    53.2
    
    
    
    59.0Restricted cash
    
    
    2.0
    
    
    
    2.0
    
    
    
    2.0Inventories
    
    
    350.9
    
    
    
    361.9
    
    
    
    333.0Current deferred income taxes
    
    
    20.1
    
    
    
    22.4
    
    
    
    20.2Other current assets
    
    
    65.0
    
    
    
    56.8
    
    
    
    59.8Current assets of discontinued operations
    
    
    1.1
    
    
    
    2.9
    
    
    
    1.6Total current assets
    
    
    881.7
    
    
    
    807.0
    
    
    
    854.5Property and Equipment:Land
    
    
    7.7
    
    
    
    7.7
    
    
    
    7.7Property, buildings and equipment
    
    
    1,218.0
    
    
    
    1,189.2
    
    
    
    1,186.3Accumulated depreciation and amortization
    
    
    (833.7
    )
    
    
    (797.9
    )
    
    
    (807.9
    )Property and equipment, net
    
    
    392.0
    
    
    
    399.0
    
    
    
    386.1Favorable leases, net
    
    
    15.7
    
    
    
    19.9
    
    
    
    18.2Deferred income taxes
    
    
    29.4
    
    
    
    35.1
    
    
    
    27.5Goodwill
    
    
    5.9
    
    
    
    5.9
    
    
    
    5.9Other assets
    
    
    46.1
    
    
    
    22.5
    
    
    
    22.3Total Assets
    
    $
    1,370.8
    
    
    $
    1,289.4
    
    
    $
    1,314.5LIABILITIES AND SHAREOWNERS EQUITYCurrent Liabilities:Current maturities of long-term debt
    
    $
    0.9
    
    
    $
    1.6
    
    
    $
    0.4Notes payable
    
    
    2.0
    
    
    
    2.0
    
    
    
    2.0Accounts payable
    
    
    154.8
    
    
    
    147.9
    
    
    
    168.9Accrued expenses
    
    
    180.9
    
    
    
    163.8
    
    
    
    163.8Current liabilities of discontinued operations
    
    
    2.4
    
    
    
    6.2
    
    
    
    3.4Total current liabilities
    
    
    341.0
    
    
    
    321.5
    
    
    
    338.5Long-term debt
    
    
    201.7
    
    
    
    204.3
    
    
    
    204.2Other liabilities
    
    
    117.9
    
    
    
    98.0
    
    
    
    109.3Minority interest
    
    
    10.8
    
    
    
    8.4
    
    
    
    10.5Commitments and contingencies (Note 14)Total shareowners equity
    
    
    699.4
    
    
    
    657.2
    
    
    
    652.0Total Liabilities and Shareowners Equity
    
    $
    1,370.8
    
    
    $
    1,289.4
    
    
    $
    1,314.5
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PAYLESS SHOESOURCE, INC. AND SUBSIDIARIES
 
 CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
 (UNAUDITED)
 13 Weeks Ended
    
    
    26 Weeks EndedJuly 29,
    
    
    July 30,
    
    
    July 29,
    
    
    July 30,(dollars and shares in millions, except per share)
    
    2006
    
    
    2005
    
    
    2006
    
    
    2005Net sales
    
    $
    706.4
    
    
    $
    693.9
    
    
    $
    1,401.2
    
    
    $
    1,389.1Cost of sales
    
    
    462.5
    
    
    
    458.8
    
    
    
    901.6
    
    
    
    909.6Gross margin
    
    
    243.9
    
    
    
    235.1
    
    
    
    499.6
    
    
    
    479.5Selling, general and administrative expenses
    
    
    194.4
    
    
    
    200.9
    
    
    
    394.1
    
    
    
    397.6Restructuring charges
    
    
    0.3
    
    
    
    
    
    
    
    0.3
    
    
    
    0.7Operating profit from continuing operations
    
    
    49.2
    
    
    
    34.2
    
    
    
    105.2
    
    
    
    81.2Interest expense
    
    
    4.5
    
    
    
    5.0
    
    
    
    9.4
    
    
    
    9.9Interest income
    
    
    (5.2
    )
    
    
    (2.6
    )
    
    
    (10.0
    )
    
    
    (4.3
    )Earnings from continuing operations before income taxes and minority interest
    
    
    49.9
    
    
    
    31.8
    
    
    
    105.8
    
    
    
    75.6Provision for income taxes
    
    
    17.3
    
    
    
    10.1
    
    
    
    36.8
    
    
    
    22.6Earnings from continuing operations before minority interest
    
    
    32.6
    
    
    
    21.7
    
    
    
    69.0
    
    
    
    53.0Minority interest, net of income taxes
    
    
    (0.2
    )
    
    
    0.1
    
    
    
    (0.2
    )
    
    
    0.5Net earnings from continuing operations
    
    
    32.4
    
    
    
    21.8
    
    
    
    68.8
    
    
    
    53.5Earnings (loss) from discontinued operations, net of income taxes and minority interest
    
    
    0.1
    
    
    
    (1.9
    )
    
    
    (0.3
    )
    
    
    (3.4
    )Net earnings
    
    $
    32.5
    
    
    $
    19.9
    
    
    $
    68.5
    
    
    $
    50.1Basic earnings per share:Earnings from continuing operations
    
    $
    0.49
    
    
    $
    0.32
    
    
    $
    1.03
    
    
    $
    0.79Loss from discontinued operations
    
    
    
    
    
    
    (0.03
    )
    
    
    
    
    
    
    (0.05
    )Basic earnings per share
    
    $
    0.49
    
    
    $
    0.29
    
    
    $
    1.03
    
    
    $
    0.74Diluted earnings per share:Earnings from continuing operations
    
    $
    0.48
    
    
    $
    0.32
    
    
    $
    1.02
    
    
    $
    0.79Loss from discontinued operations
    
    
    
    
    
    
    (0.03
    )
    
    
    (0.01
    )
    
    
    (0.05
    )Diluted earnings per share
    
    $
    0.48
    
    
    $
    0.29
    
    
    $
    1.01
    
    
    $
    0.74Basic Weighted Average Shares Outstanding
    
    
    66.5
    
    
    
    67.5
    
    
    
    66.5
    
    
    
    67.3Diluted Weighted Average Shares Outstanding
    
    
    67.6
    
    
    
    68.0
    
    
    
    67.6
    
    
    
    67.4
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PAYLESS SHOESOURCE, INC. AND SUBSIDIARIES
 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 (UNAUDITED)
 26 Weeks EndedJuly 29,
    
    
    July 30,(dollars in millions)
    
    2006
    
    
    2005Operating Activities:Net earnings
    
    $
    68.5
    
    
    $
    50.1Loss from discontinued operations, net of income taxes and minority interest
    
    
    0.3
    
    
    
    3.4Net earnings from continuing operations
    
    
    68.8
    
    
    
    53.5Adjustments for non-cash items included in net earnings:Loss on impairment of and disposal of assets
    
    
    4.8
    
    
    
    5.2Depreciation and amortization
    
    
    44.9
    
    
    
    46.0Amortization of deferred financing costs
    
    
    0.5
    
    
    
    0.6Share-based compensation expense
    
    
    5.5
    
    
    
    0.3Deferred income taxes
    
    
    1.1
    
    
    
    0.9Minority interest, net of income taxes
    
    
    0.2
    
    
    
    (0.5
    )Income tax benefit from share-based compensation
    
    
    0.4
    
    
    
    0.8Accretion of investments
    
    
    (1.6
    )
    
    
    (0.4
    )Changes in working capital:Inventories
    
    
    (17.6
    )
    
    
    (16.6
    )Other current assets
    
    
    (8.6
    )
    
    
    (0.1
    )Accounts payable
    
    
    (15.1
    )
    
    
    (11.4
    )Accrued expenses
    
    
    15.9
    
    
    
    10.5Other assets and liabilities, net
    
    
    (1.2
    )
    
    
    4.7Net cash used in discontinued operations
    
    
    (0.8
    )
    
    
    (6.5
    )Cash flow provided by operating activities
    
    
    97.2
    
    
    
    87.0Investing Activities:Capital expenditures
    
    
    (52.8
    )
    
    
    (35.3
    )Proceeds from sale of property and equipment
    
    
    3.2
    
    
    
    0.8Restricted cash
    
    
    
    
    
    
    1.0Intangible asset additions
    
    
    (15.1
    )
    
    
    Purchases of investments
    
    
    (89.9
    )
    
    
    (71.5
    )Sales and maturities of investments
    
    
    111.5
    
    
    
    40.0Cash flow used in investing activities
    
    
    (43.1
    )
    
    
    (65.0
    )Financing Activities:Repayment of notes payable
    
    
    
    
    
    
    (1.0
    )Issuance of debt
    
    
    
    
    
    
    1.3Excess tax benefits from share-based compensation
    
    
    4.0
    
    
    
    Payment of deferred financing costs
    
    
    (0.2
    )
    
    
    Repayment of debt
    
    
    (2.1
    )
    
    
    Issuances of common stock
    
    
    25.1
    
    
    
    12.3Purchases of common stock
    
    
    (56.5
    )
    
    
    (2.4
    )Distributions to minority owners
    
    
    (1.0
    )
    
    
    Contributions by minority owners
    
    
    1.2
    
    
    
    0.5Cash flow (used in) provided by financing activities
    
    
    (29.5
    )
    
    
    10.7Effect of exchange rate changes on cash
    
    
    0.1
    
    
    
    1.8Increase in cash and cash equivalents
    
    
    24.7
    
    
    
    34.5Cash and cash equivalents, beginning of year
    
    
    378.9
    
    
    
    273.3Cash and cash equivalents, end of period
    
    $
    403.6
    
    
    $
    307.8Supplemental cash flow information:Interest paid
    
    $
    10.2
    
    
    $
    10.4Income taxes paid
    
    $
    14.1
    
    
    $
    16.9Non-cash investing and operating activities:Accrued capital additions
    
    $
    9.5
    
    
    $
    7.5Accrued intangible asset additions
    
    $
    10.0
    
    
    $
    
  5




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PAYLESS SHOESOURCE, INC. AND SUBSIDIARIES
 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (UNAUDITED)
 NOTE 1. INTERIM RESULTS.
  NOTE 2. SHARE-BASED COMPENSATION.
    6




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13 Weeks Ended
    
    
    26 Weeks Ended(dollars in millions, except per share amounts)
    
    July 30, 2005
    
    
    July 30, 2005Net earnings:As reported
    
    $
    19.9
    
    
    $
    50.1Add: Total stock-based employee compensation expense included in net earnings as reported, net of related income taxes
    
    
    2.4
    
    
    
    3.2Less: Total stock-based employee compensation expense determined under fair value based method for all awards, net of
related income taxes
    
    
    3.5
    
    
    
    4.6Pro forma
    
    $
    18.8
    
    
    $
    48.7Basic earnings per share:As reported
    
    $
    0.29
    
    
    $
    0.74Pro forma
    
    $
    0.27
    
    
    $
    0.72Diluted earnings per share:As reported
    
    $
    0.29
    
    
    $
    0.74Pro forma
    
    $
    0.27
    
    
    $
    0.72
 Equity Incentive Plans
      7




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8




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Stock Options and Stock-Settled SARs
    
    26 Weeks Ended July 29, 2006Weighted
    
    
    
    
    
    
    WeightedAverage Exercise
    
    
    Stock-Settled
    
    
    Average Exercise(units in thousands)
    
    Options
    
    
    Price
    
    
    SARs
    
    
    PriceOutstanding at beginning of period
    
    
    5,738
    
    
    $
    18
    
    
    
    
    
    
    $
    Granted
    
    
    470
    
    
    
    22
    
    
    
    875
    
    
    
    23Exercised
    
    
    (1,456
    )
    
    
    17
    
    
    
    
    
    
    
    Forfeited or expired
    
    
    (132
    )
    
    
    17
    
    
    
    (43
    )
    
    
    22Outstanding at end of period
    
    
    4,620
    
    
    $
    19
    
    
    
    832
    
    
    $
    23Exercisable or convertible at end of period
    
    
    2,675
    
    
    $
    18
    
    
    
    
    
    
    $
    Weighted average fair value of units granted (per unit)
    
    $
    10
    
    
    
    
    
    
    $
    9
 Nonvested Shares
    
    26 Weeks Ended July 29, 2006WeightedAverage Grant(shares in thousands)
    
    Nonvested Shares
    
    
    Date Fair ValueNonvested at beginning of period
    
    
    301
    
    
    $
    19Granted
    
    
    70
    
    
    
    23Vested
    
    
    (45
    )
    
    
    16Forfeited
    
    
    (6
    )
    
    
    19Nonvested at end of period
    
    
    320
    
    
    $
    21
 Cash-Settled SARs
    
    26 Weeks Ended July 29, 2006WeightedCash-Settled
    
    
    Average Exercise(shares in thousands)
    
    SARs
    
    
    PriceOutstanding at beginning of period
    
    
    108
    
    
    $
    17Granted
    
    
    98
    
    
    
    22Exercised
    
    
    (29
    )
    
    
    18Forfeited or expired
    
    
    (6
    )
    
    
    22Outstanding at end of period
    
    
    171
    
    
    $
    20Exercisable or convertible at end of period
    
    
    79
    
    
    $
    17Weighted average fair value of units granted (per unit)
    
    $
    9
 9




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Options Outstanding
    
    Options ExercisableWeighted
    
    
    
    
    
    
    
    
    
    
    
    
    
    WeightedAverage
    
    
    
    
    
    
    
    
    
    
    
    
    
    AverageRemaining
    
    Aggregate
    
    Weighted
    
    
    
    
    
    Remaining
    
    Aggregate
    
    WeightedRange of
    
    Number of
    
    Contractual Life
    
    Intrinsic Value
    
    Average
    
    Number
    
    Contractual Life
    
    Intrinsic Value
    
    AverageExercise Prices
    
    Outstanding
    
    (in years)
    
    (in thousands)
    
    Exercise Price
    
    Exercisable
    
    (in years)
    
    (in thousands)
    
    Exercise Price$   12-15
    
    
    393
    
    
    
    3
    
    
    $
    3,650
    
    
    $
    15
    
    
    
    389
    
    
    
    3
    
    
    $
    3,618
    
    
    $
    1516-18
    
    
    2,284
    
    
    
    5
    
    
    
    17,216
    
    
    
    17
    
    
    
    1,474
    
    
    
    5
    
    
    
    11,235
    
    
    
    1719-25
    
    
    1,943
    
    
    
    5
    
    
    
    4,415
    
    
    
    22
    
    
    
    812
    
    
    
    4
    
    
    
    1,355
    
    
    
    23
 Stock-settled SARs Outstanding
    
    Stock-settled SARs ExercisableWeighted
    
    
    
    
    
    
    
    
    
    
    
    
    
    WeightedAverage
    
    
    
    
    
    
    
    
    
    
    
    
    
    AverageRemaining
    
    Aggregate
    
    Weighted
    
    
    
    
    
    Remaining
    
    Aggregate
    
    WeightedRange of
    
    Number of
    
    Contractual Life
    
    Intrinsic Value
    
    Average
    
    Number
    
    Contractual Life
    
    Intrinsic Value
    
    AverageExercise Prices
    
    Outstanding
    
    (in years)
    
    (in thousands)
    
    Exercise Price
    
    Exercisable
    
    (in years)
    
    (in thousands)
    
    Exercise Price$   21-23
    
    
    770
    
    
    
    7
    
    
    $
    1,294
    
    
    $
    22
    
    
    
    
    
    
    
    
    
    
    $
    
    
    
    $
    24-27
    
    
    62
    
    
    
    7
    
    
    
    
    
    
    
    27
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
      Grant Date Fair Value
   10




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13 Weeks Ended
    
    26 Weeks EndedJuly 29,
    
    July 30,
    
    July 29,
    
    July 30,2006
    
    2005
    
    2006
    
    2005Risk-free interest rate
    
    
    5.0
    %
    
    
    3.8
    %
    
    
    4.9
    %
    
    
    3.8
    %Expected dividend yield
    
    
    
    %
    
    
    
    %
    
    
    
    %
    
    
    
    %Expected appreciation vehicle life (in years)
    
    
    6
    
    
    
    5
    
    
    
    6
    
    
    
    5Weighted-average expected volatility
    
    
    35
    %
    
    
    33
    %
    
    
    35
    %
    
    
    33
    %
     Compensation Expense
     13 Weeks Ended
    
    
    26 Weeks EndedJuly 29,
    
    
    July 30,
    
    
    July 29,
    
    
    July 30,(dollars in millions, except per share amounts)
    
    2006
    
    
    2005
    
    
    2006
    
    
    2005Cost of sales
    
    $
    0.8
    
    
    $
    0.3
    
    
    $
    1.5
    
    
    $
    0.4Selling, general and administrative expenses
    
    
    1.9
    
    
    
    3.5
    
    
    
    4.0
    
    
    
    4.6Share-based compensation expense before income taxes
    
    
    2.7
    
    
    
    3.8
    
    
    
    5.5
    
    
    
    5.0Tax benefit
    
    
    (1.0
    )
    
    
    (1.4
    )
    
    
    (2.0
    )
    
    
    (1.8
    )Share-based compensation expense after income taxes
    
    $
    1.7
    
    
    $
    2.4
    
    
    $
    3.5
    
    
    $
    3.2Effect on:Basic earnings per share
    
    $
    0.03
    
    
    $
    0.04
    
    
    $
    0.05
    
    
    $
    0.05Diluted earnings per share
    
    
    0.03
    
    
    
    0.04
    
    
    
    0.05
    
    
    
    0.05
 11




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NOTE 3. SHORT-TERM INVESTMENTS.
  July 29,
    
    
    July 30,
    
    
    January 28,(dollars in millions)
    
    2006
    
    
    2005
    
    
    2006Held-to-maturity securities:Commercial paper
    
    $
    38.3
    
    
    $
    31.4
    
    
    $
    58.5Agency securities
    
    
    
    
    
    
    15.6
    
    
    
    Certificates of deposit
    
    
    0.7
    
    
    
    5.0
    
    
    
    0.5Municipal obligations
    
    
    
    
    
    
    1.2
    
    
    
    Total short-term investments
    
    $
    39.0
    
    
    $
    53.2
    
    
    $
    59.0
  NOTE 4. RESTRUCTURING CHARGES.
     2006 ChargesTotal Charges
    
    
    Accrual Balance as of
    
    
    
    
    
    
    Accrual
    
    
    Cash
    
    
    Accrual Balance as of(dollars in millions)
    
    to Date
    
    
    January 28, 2006
    
    
    Costs Incurred
    
    
    Adjustments
    
    
    Payments
    
    
    July 29, 2006Employee severance costs
    
    $
    9.0
    
    
    $
    1.0
    
    
    $
    
    
    
    $
    
    
    
    $
    (0.4
    )
    
    $
    0.6Contract termination costs
    
    
    29.2
    
    
    
    5.5
    
    
    
    
    
    
    
    0.7
    
    
    
    (2.9
    )
    
    
    3.3Other exit costs
    
    
    5.1
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    43.3
    
    
    $
    6.5
    
    
    $
    
    
    
    $
    0.7
    
    
    $
    (3.3
    )
    
    $
    3.9Asset impairments and net disposal losses
    
    
    35.0Total Charges
    
    $
    78.3
    12




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##### Table of Contents



NOTE 5. DISCONTINUED OPERATIONS.
  13 Weeks Ended
    
    
    26 Weeks EndedJuly 29,
    
    
    July 30,
    
    
    July 29,
    
    
    July 30,(dollars in millions)
    
    2006
    
    
    2005
    
    
    2006
    
    
    2005Earnings (loss) from discontinued operations before income taxes
    
    $
    0.2
    
    
    $
    (3.0
    )
    
    $
    (0.4
    )
    
    $
    (5.5
    )Provision (benefit) for income taxes
    
    
    0.1
    
    
    
    (1.1
    )
    
    
    (0.1
    )
    
    
    (2.1
    )Earnings (loss) from discontinued operations, net of income taxes
    
    $
    0.1
    
    
    $
    (1.9
    )
    
    $
    (0.3
    )
    
    $
    (3.4
    )
  (dollars in millions)
    
    July 29, 2006
    
    
    July 30, 2005
    
    
    January 28, 2006AssetsCurrent assets:Current deferred income taxes
    
    $
    0.9
    
    
    $
    2.5
    
    
    $
    1.3Other current assets
    
    
    0.2
    
    
    
    0.4
    
    
    
    0.3Total current assets of discontinued operations
    
    $
    1.1
    
    
    $
    2.9
    
    
    $
    1.6LiabilitiesCurrent liabilities:Accrued expenses
    
    $
    2.4
    
    
    $
    6.2
    
    
    $
    3.4Total current liabilities of discontinued operations
    
    $
    2.4
    
    
    $
    6.2
    
    
    $
    3.4
 NOTE 6. INVENTORIES.
  NOTE 7. FAVORABLE LEASES.
  (dollars in millions)
    
    July 29, 2006
    
    
    July 30, 2005
    
    
    January 28, 2006Gross carrying amount
    
    $
    72.6
    
    
    $
    76.6
    
    
    $
    75.6Less: accumulated amortization
    
    
    (56.9
    )
    
    
    (56.7
    )
    
    
    (57.4
    )Carrying amount, end of period
    
    $
    15.7
    
    
    $
    19.9
    
    
    $
    18.2
  13 Weeks Ended
    
    26 Weeks Ended(dollars in millions)
    
    July 29, 2006
    
    July 30, 2005
    
    July 29, 2006
    
    July 30, 2005Amortization expense on favorable leases
    
    $
    0.7
    
    
    $
    0.8
    
    
    $
    1.5
    
    
    $
    1.7
  Year
    
    AmountRemainder of 2006
    
    $
    1.62007
    
    
    2.72008
    
    
    2.42009
    
    
    2.02010
    
    
    1.8
 13




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##### Table of Contents



NOTE 8. LONG-TERM DEBT AND LINE OF CREDIT.
   Year
    
    Percentage2008
    
    
    104.125
    %2009
    
    
    102.750
    %2010
    
    
    101.375
    %2011 and thereafter
    
    
    100.000
    %
 NOTE 9. PENSION PLAN.
   13 Weeks Ended
    
    
    26 Weeks Ended(dollars in millions)
    
    July 29, 2006
    
    
    July 30, 2005
    
    
    July 29, 2006
    
    
    July 30, 2005Components of pension expense:Service cost
    
    $
    0.2
    
    
    $
    0.2
    
    
    $
    0.4
    
    
    $
    0.4Interest cost
    
    
    0.3
    
    
    
    0.3
    
    
    
    0.7
    
    
    
    0.6Amortization of prior service cost
    
    
    0.1
    
    
    
    0.1
    
    
    
    0.2
    
    
    
    0.1Amortization of actuarial loss
    
    
    0.1
    
    
    
    
    
    
    
    0.1
    
    
    
    0.1Total
    
    $
    0.7
    
    
    $
    0.6
    
    
    $
    1.4
    
    
    $
    1.2
 NOTE 10. INCOME TAXES.
  14




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##### Table of Contents



NOTE 11. COMPREHENSIVE INCOME.
  13 Weeks Ended
    
    
    26 Weeks Ended(dollars in millions)
    
    July 29, 2006
    
    
    July 30, 2005
    
    
    July 29, 2006
    
    
    July 30, 2005Net earnings
    
    $
    32.5
    
    
    $
    19.9
    
    
    $
    68.5
    
    
    $
    50.1Foreign currency translation adjustments
    
    
    (0.6
    )
    
    
    1.2
    
    
    
    0.9
    
    
    
    1.1Total comprehensive income
    
    $
    31.9
    
    
    $
    21.1
    
    
    $
    69.4
    
    
    $
    51.2
  NOTE 12. EARNINGS PER SHARE.
  (dollars in millions, except per
    
    13 Weeks Ended
    
    
    26 Weeks Endedshare; shares in thousands)
    
    July 29, 2006
    
    
    July 30, 2005
    
    
    July 29, 2006
    
    
    July 30, 2005Net earnings from continuing operations
    
    $
    32.4
    
    
    $
    21.8
    
    
    $
    68.8
    
    
    $
    53.5Weighted average common shares outstanding  basic
    
    
    66,483
    
    
    
    67,451
    
    
    
    66,539
    
    
    
    67,279Net effect of dilutive stock options based on the
treasury stock method
    
    
    959
    
    
    
    472
    
    
    
    924
    
    
    
    81Dilutive shares due to nonvested shares
    
    
    116
    
    
    
    32
    
    
    
    106
    
    
    
    46Outstanding shares for diluted earnings per share
    
    
    67,558
    
    
    
    67,955
    
    
    
    67,569
    
    
    
    67,406Diluted earnings per share from continuing operations
    
    $
    0.48
    
    
    $
    0.32
    
    
    $
    1.02
    
    
    $
    0.79
  NOTE 13. SEGMENT REPORTING.
  15




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##### Table of Contents



Payless
    
    Payless
    
    Payless(dollars in millions)
    
    Domestic
    
    International
    
    Consolidated13 weeks ended July 29, 2006:Revenues from external customers
    
    $
    604.6
    
    
    $
    101.8
    
    
    $
    706.4Operating profit from continuing operations
    
    
    37.4
    
    
    
    11.8
    
    
    
    49.226 weeks ended July 29, 2006:Revenues from external customers
    
    $
    1,217.7
    
    
    $
    183.5
    
    
    $
    1,401.2Operating profit from continuing operations
    
    
    89.5
    
    
    
    15.7
    
    
    
    105.2Total assets
    
    
    1,204.8
    
    
    
    166.0
    
    
    
    1,370.813 weeks ended July 30, 2005:Revenues from external customers
    
    $
    602.2
    
    
    $
    91.7
    
    
    $
    693.9Operating profit from continuing operations
    
    
    25.4
    
    
    
    8.8
    
    
    
    34.226 weeks ended July 30, 2005:Revenues from external customers
    
    $
    1,217.2
    
    
    $
    171.9
    
    
    $
    1,389.1Operating profit from continuing operations
    
    
    69.0
    
    
    
    12.2
    
    
    
    81.2Total assets
    
    
    1,133.1
    
    
    
    156.3
    
    
    
    1,289.4
  NOTE 14. COMMITMENTS AND CONTINGENCIES.
  th th
  ®
 16




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##### Table of Contents



®
 NOTE 15. HURRICANES KATRINA, RITA, and WILMA.
  NOTE 16. IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS.
     17




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##### Table of Contents



NOTE 17. RELATED PARTY TRANSACTIONS.
  NOTE 18. SUBSEQUENT EVENT
  NOTE 19. SUBSIDIARY GUARANTORS OF SENIOR NOTES  CONDENSED CONSOLIDATING FINANCIAL INFORMATION.
     18




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##### Table of Contents



Parent
    
    
    Guarantor
    
    
    Non-guarantor(dollars in millions)
    
    Company
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    ConsolidatedASSETSCurrent Assets:Cash and cash equivalents
    
    $
    
    
    
    $
    332.1
    
    
    $
    71.5
    
    
    $
    
    
    
    $
    403.6Short-term investments
    
    
    
    
    
    
    38.3
    
    
    
    0.7
    
    
    
    
    
    
    
    39.0Restricted cash
    
    
    
    
    
    
    
    
    
    
    2.0
    
    
    
    
    
    
    
    2.0Inventories
    
    
    
    
    
    
    288.6
    
    
    
    67.0
    
    
    
    (4.7
    )
    
    
    350.9Current deferred income taxes
    
    
    
    
    
    
    14.6
    
    
    
    5.5
    
    
    
    
    
    
    
    20.1Other current assets
    
    
    36.0
    
    
    
    94.3
    
    
    
    60.8
    
    
    
    (126.1
    )
    
    
    65.0Current assets of discontinued operations
    
    
    
    
    
    
    1.1
    
    
    
    
    
    
    
    
    
    
    
    1.1Total current assets
    
    
    36.0
    
    
    
    769.0
    
    
    
    207.5
    
    
    
    (130.8
    )
    
    
    881.7Property and Equipment:Land
    
    
    
    
    
    
    7.7
    
    
    
    
    
    
    
    
    
    
    
    7.7Property, buildings and equipment
    
    
    
    
    
    
    1,072.1
    
    
    
    145.9
    
    
    
    
    
    
    
    1,218.0Accumulated depreciation and amortization
    
    
    
    
    
    
    (747.7
    )
    
    
    (86.0
    )
    
    
    
    
    
    
    (833.7
    )Property and equipment, net
    
    
    
    
    
    
    332.1
    
    
    
    59.9
    
    
    
    
    
    
    
    392.0Favorable leases, net
    
    
    
    
    
    
    15.7
    
    
    
    
    
    
    
    
    
    
    
    15.7Deferred income taxes
    
    
    
    
    
    
    23.6
    
    
    
    5.8
    
    
    
    
    
    
    
    29.4Goodwill
    
    
    
    
    
    
    5.9
    
    
    
    
    
    
    
    
    
    
    
    5.9Other assets
    
    
    1,248.1
    
    
    
    464.8
    
    
    
    1.8
    
    
    
    (1,668.6
    )
    
    
    46.1Total Assets
    
    $
    1,284.1
    
    
    $
    1,611.1
    
    
    $
    275.0
    
    
    $
    (1,799.4
    )
    
    $
    1,370.8LIABILITIES AND SHAREOWNERS EQUITYCurrent Liabilities:Current maturities of long-term debt
    
    $
    
    
    
    $
    0.4
    
    
    $
    0.5
    
    
    $
    
    
    
    $
    0.9Notes payable
    
    
    
    
    
    
    
    
    
    
    2.0
    
    
    
    
    
    
    
    2.0Accounts payable
    
    
    
    
    
    
    136.8
    
    
    
    75.2
    
    
    
    (57.2
    )
    
    
    154.8Accrued expenses
    
    
    102.3
    
    
    
    145.2
    
    
    
    7.0
    
    
    
    (73.6
    )
    
    
    180.9Current liabilities of discontinued operations
    
    
    
    
    
    
    2.4
    
    
    
    
    
    
    
    
    
    
    
    2.4Total current liabilities
    
    
    102.3
    
    
    
    284.8
    
    
    
    84.7
    
    
    
    (130.8
    )
    
    
    341.0Long-term debt
    
    
    480.5
    
    
    
    0.3
    
    
    
    4.0
    
    
    
    (283.1
    )
    
    
    201.7Other liabilities
    
    
    1.9
    
    
    
    100.5
    
    
    
    15.5
    
    
    
    
    
    
    
    117.9Minority interest
    
    
    
    
    
    
    
    
    
    
    10.8
    
    
    
    
    
    
    
    10.8Commitments and contingencies (Note 14)Total shareowners equity
    
    
    699.4
    
    
    
    1,225.5
    
    
    
    160.0
    
    
    
    (1,385.5
    )
    
    
    699.4Total Liabilities and Shareowners Equity
    
    $
    1,284.1
    
    
    $
    1,611.1
    
    
    $
    275.0
    
    
    $
    (1,799.4
    )
    
    $
    1,370.8
 19




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##### Table of Contents



Parent
    
    
    Guarantor
    
    
    Non-guarantor(dollars in millions)
    
    Company
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    ConsolidatedASSETSCurrent Assets:Cash and cash equivalents
    
    $
    
    
    
    $
    214.5
    
    
    $
    93.3
    
    
    $
    
    
    
    $
    307.8Short-term investments
    
    
    
    
    
    
    53.2
    
    
    
    
    
    
    
    
    
    
    
    53.2Restricted cash
    
    
    
    
    
    
    
    
    
    
    2.0
    
    
    
    
    
    
    
    2.0Inventories
    
    
    
    
    
    
    291.3
    
    
    
    74.3
    
    
    
    (3.7
    )
    
    
    361.9Current deferred income taxes
    
    
    
    
    
    
    22.3
    
    
    
    0.1
    
    
    
    
    
    
    
    22.4Other current assets
    
    
    23.1
    
    
    
    82.2
    
    
    
    21.7
    
    
    
    (70.2
    )
    
    
    56.8Current assets of discontinued operations
    
    
    
    
    
    
    2.9
    
    
    
    
    
    
    
    
    
    
    
    2.9Total current assets
    
    
    23.1
    
    
    
    666.4
    
    
    
    191.4
    
    
    
    (73.9
    )
    
    
    807.0Property and Equipment:Land
    
    
    
    
    
    
    7.7
    
    
    
    
    
    
    
    
    
    
    
    7.7Property, buildings and equipment
    
    
    
    
    
    
    1,050.9
    
    
    
    138.3
    
    
    
    
    
    
    
    1,189.2Accumulated depreciation and amortization
    
    
    
    
    
    
    (724.6
    )
    
    
    (73.3
    )
    
    
    
    
    
    
    (797.9
    )Property and equipment, net
    
    
    
    
    
    
    334.0
    
    
    
    65.0
    
    
    
    
    
    
    
    399.0Favorable leases, net
    
    
    
    
    
    
    19.9
    
    
    
    
    
    
    
    
    
    
    
    19.9Deferred income taxes
    
    
    
    
    
    
    23.7
    
    
    
    11.4
    
    
    
    
    
    
    
    35.1Goodwill
    
    
    
    
    
    
    5.9
    
    
    
    
    
    
    
    
    
    
    
    5.9Other assets
    
    
    1,124.6
    
    
    
    456.8
    
    
    
    1.8
    
    
    
    (1,560.7
    )
    
    
    22.5Total Assets
    
    $
    1,147.7
    
    
    $
    1,506.7
    
    
    $
    269.6
    
    
    $
    (1,634.6
    )
    
    $
    1,289.4LIABILITIES AND SHAREOWNERS EQUITYCurrent Liabilities:Current maturities of long-term debt
    
    $
    
    
    
    $
    0.4
    
    
    $
    1.2
    
    
    $
    
    
    
    $
    1.6Notes payable
    
    
    
    
    
    
    
    
    
    
    2.0
    
    
    
    
    
    
    
    2.0Accounts payable
    
    
    
    
    
    
    124.6
    
    
    
    68.9
    
    
    
    (45.6
    )
    
    
    147.9Accrued expenses
    
    
    8.3
    
    
    
    164.1
    
    
    
    19.7
    
    
    
    (28.3
    )
    
    
    163.8Current liabilities of discontinued operations
    
    
    
    
    
    
    6.2
    
    
    
    
    
    
    
    
    
    
    
    6.2Total current liabilities
    
    
    8.3
    
    
    
    295.3
    
    
    
    91.8
    
    
    
    (73.9
    )
    
    
    321.5Long-term debt
    
    
    480.3
    
    
    
    0.7
    
    
    
    6.4
    
    
    
    (283.1
    )
    
    
    204.3Other liabilities
    
    
    1.9
    
    
    
    83.9
    
    
    
    12.3
    
    
    
    (0.1
    )
    
    
    98.0Minority interest
    
    
    
    
    
    
    
    
    
    
    8.4
    
    
    
    
    
    
    
    8.4Commitments and contingencies (Note 14)Total shareowners equity
    
    
    657.2
    
    
    
    1,126.8
    
    
    
    150.7
    
    
    
    (1,277.5
    )
    
    
    657.2Total Liabilities and Shareowners Equity
    
    $
    1,147.7
    
    
    $
    1,506.7
    
    
    $
    269.6
    
    
    $
    (1,634.6
    )
    
    $
    1,289.4
 20




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##### Table of Contents



Parent
    
    
    Guarantor
    
    
    Non-guarantor(dollars in millions)
    
    Company
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    ConsolidatedASSETSCurrent Assets:Cash and cash equivalents
    
    $
    
    
    
    $
    310.5
    
    
    $
    68.4
    
    
    $
    
    
    
    $
    378.9Short-term investments
    
    
    
    
    
    
    58.5
    
    
    
    0.5
    
    
    
    
    
    
    
    59.0Restricted cash
    
    
    
    
    
    
    
    
    
    
    2.0
    
    
    
    
    
    
    
    2.0Inventories
    
    
    
    
    
    
    271.3
    
    
    
    64.3
    
    
    
    (2.6
    )
    
    
    333.0Current deferred income taxes
    
    
    
    
    
    
    19.3
    
    
    
    0.9
    
    
    
    
    
    
    
    20.2Other current assets
    
    
    28.7
    
    
    
    82.7
    
    
    
    31.7
    
    
    
    (83.3
    )
    
    
    59.8Current assets of discontinued operations
    
    
    
    
    
    
    1.6
    
    
    
    
    
    
    
    
    
    
    
    1.6Total current assets
    
    
    28.7
    
    
    
    743.9
    
    
    
    167.8
    
    
    
    (85.9
    )
    
    
    854.5Property and Equipment:Land
    
    
    
    
    
    
    7.7
    
    
    
    
    
    
    
    
    
    
    
    7.7Property, buildings and equipment
    
    
    
    
    
    
    1,044.3
    
    
    
    142.0
    
    
    
    
    
    
    
    1,186.3Accumulated depreciation and amortization
    
    
    
    
    
    
    (728.8
    )
    
    
    (79.1
    )
    
    
    
    
    
    
    (807.9
    )Property and equipment, net
    
    
    
    
    
    
    323.2
    
    
    
    62.9
    
    
    
    
    
    
    
    386.1Favorable leases, net
    
    
    
    
    
    
    18.2
    
    
    
    
    
    
    
    
    
    
    
    18.2Deferred income taxes
    
    
    
    
    
    
    18.5
    
    
    
    9.0
    
    
    
    
    
    
    
    27.5Goodwill
    
    
    
    
    
    
    5.9
    
    
    
    
    
    
    
    
    
    
    
    5.9Other assets
    
    
    1,157.1
    
    
    
    405.5
    
    
    
    1.7
    
    
    
    (1,542.0
    )
    
    
    22.3Total Assets
    
    $
    1,185.8
    
    
    $
    1,515.2
    
    
    $
    241.4
    
    
    $
    (1,627.9
    )
    
    $
    1,314.5LIABILITIES AND SHAREOWNERS EQUITYCurrent Liabilities:Current maturities of long-term debt
    
    $
    
    
    
    $
    0.4
    
    
    $
    
    
    
    $
    
    
    
    $
    0.4Notes payable
    
    
    
    
    
    
    
    
    
    
    2.0
    
    
    
    
    
    
    
    2.0Accounts payable
    
    
    
    
    
    
    159.4
    
    
    
    66.3
    
    
    
    (56.8
    )
    
    
    168.9Accrued expenses
    
    
    51.5
    
    
    
    127.4
    
    
    
    14.0
    
    
    
    (29.1
    )
    
    
    163.8Current liabilities of discontinued operations
    
    
    
    
    
    
    3.4
    
    
    
    
    
    
    
    
    
    
    
    3.4Total current liabilities
    
    
    51.5
    
    
    
    290.6
    
    
    
    82.3
    
    
    
    (85.9
    )
    
    
    338.5Long-term debt
    
    
    480.4
    
    
    
    0.6
    
    
    
    6.4
    
    
    
    (283.2
    )
    
    
    204.2Other liabilities
    
    
    1.9
    
    
    
    94.9
    
    
    
    12.5
    
    
    
    
    
    
    
    109.3Minority interest
    
    
    
    
    
    
    
    
    
    
    10.5
    
    
    
    
    
    
    
    10.5Commitments and contingencies (Note 14)Total shareowners equity
    
    
    652.0
    
    
    
    1,129.1
    
    
    
    129.7
    
    
    
    (1,258.8
    )
    
    
    652.0Total Liabilities and Shareowners Equity
    
    $
    1,185.8
    
    
    $
    1,515.2
    
    
    $
    241.4
    
    
    $
    (1,627.9
    )
    
    $
    1,314.5
 21




---



##### Table of Contents



13 Weeks Ended July 29, 2006Parent
    
    
    Guarantor
    
    
    Non-guarantor(dollars in millions)
    
    Company
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    ConsolidatedNet sales
    
    $
    
    
    
    $
    635.8
    
    
    $
    213.0
    
    
    $
    (142.4
    )
    
    $
    706.4Cost of sales
    
    
    
    
    
    
    441.4
    
    
    
    160.5
    
    
    
    (139.4
    )
    
    
    462.5Gross margin
    
    
    
    
    
    
    194.4
    
    
    
    52.5
    
    
    
    (3.0
    )
    
    
    243.9Selling, general and administrative expense
    
    
    1.2
    
    
    
    167.5
    
    
    
    28.7
    
    
    
    (3.0
    )
    
    
    194.4Restructuring charges
    
    
    
    
    
    
    0.3
    
    
    
    
    
    
    
    
    
    
    
    0.3Operating (loss) profit from continuing operations
    
    
    (1.2
    )
    
    
    26.6
    
    
    
    23.8
    
    
    
    
    
    
    
    49.2Interest expense
    
    
    9.3
    
    
    
    
    
    
    
    0.5
    
    
    
    (5.3
    )
    
    
    4.5Interest income
    
    
    
    
    
    
    (9.9
    )
    
    
    (0.6
    )
    
    
    5.3
    
    
    
    (5.2
    )Equity in earnings of subsidiaries
    
    
    (39.3
    )
    
    
    (20.8
    )
    
    
    
    
    
    
    60.1
    
    
    
    Earnings from continuing operations before income
taxes and minority interest
    
    
    28.8
    
    
    
    57.3
    
    
    
    23.9
    
    
    
    (60.1
    )
    
    
    49.9(Benefit) provision for income taxes
    
    
    (3.7
    )
    
    
    18.1
    
    
    
    2.9
    
    
    
    
    
    
    
    17.3Earnings from continuing operations before
minority interest
    
    
    32.5
    
    
    
    39.2
    
    
    
    21.0
    
    
    
    (60.1
    )
    
    
    32.6Minority interest, net of income taxes
    
    
    
    
    
    
    
    
    
    
    (0.2
    )
    
    
    
    
    
    
    (0.2
    )Net earnings from continuing operations
    
    
    32.5
    
    
    
    39.2
    
    
    
    20.8
    
    
    
    (60.1
    )
    
    
    32.4Earnings from discontinued operations, net of income
taxes and minority interest
    
    
    
    
    
    
    0.1
    
    
    
    
    
    
    
    
    
    
    
    0.1Net earnings
    
    $
    32.5
    
    
    $
    39.3
    
    
    $
    20.8
    
    
    $
    (60.1
    )
    
    $
    32.5
 13 Weeks Ended July 30, 2005Parent
    
    
    Guarantor
    
    
    Non-guarantor(dollars in millions)
    
    Company
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    ConsolidatedNet sales
    
    $
    
    
    
    $
    631.7
    
    
    $
    193.3
    
    
    $
    (131.1
    )
    
    $
    693.9Cost of sales
    
    
    
    
    
    
    435.4
    
    
    
    151.5
    
    
    
    (128.1
    )
    
    
    458.8Gross margin
    
    
    
    
    
    
    196.3
    
    
    
    41.8
    
    
    
    (3.0
    )
    
    
    235.1Selling, general and administrative expense
    
    
    1.7
    
    
    
    174.2
    
    
    
    28.0
    
    
    
    (3.0
    )
    
    
    200.9Restructuring charges
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Operating (loss) profit from continuing operations
    
    
    (1.7
    )
    
    
    22.1
    
    
    
    13.8
    
    
    
    
    
    
    
    34.2Interest expense
    
    
    7.9
    
    
    
    0.4
    
    
    
    0.2
    
    
    
    (3.5
    )
    
    
    5.0Interest income
    
    
    
    
    
    
    (5.8
    )
    
    
    (0.3
    )
    
    
    3.5
    
    
    
    (2.6
    )Equity in earnings of subsidiaries
    
    
    (26.1
    )
    
    
    (12.5
    )
    
    
    
    
    
    
    38.6
    
    
    
    Earnings from continuing operations before income
taxes and minority interest
    
    
    16.5
    
    
    
    40.0
    
    
    
    13.9
    
    
    
    (38.6
    )
    
    
    31.8(Benefit) provision for income taxes
    
    
    (3.4
    )
    
    
    12.0
    
    
    
    1.5
    
    
    
    
    
    
    
    10.1Earnings from continuing operations before
minority interest
    
    
    19.9
    
    
    
    28.0
    
    
    
    12.4
    
    
    
    (38.6
    )
    
    
    21.7Minority interest, net of income taxes
    
    
    
    
    
    
    
    
    
    
    0.1
    
    
    
    
    
    
    
    0.1Net earnings from continuing operations
    
    
    19.9
    
    
    
    28.0
    
    
    
    12.5
    
    
    
    (38.6
    )
    
    
    21.8Loss from discontinued operations, net of income
taxes and minority interest
    
    
    
    
    
    
    (1.9
    )
    
    
    
    
    
    
    
    
    
    
    (1.9
    )Net earnings
    
    $
    19.9
    
    
    $
    26.1
    
    
    $
    12.5
    
    
    $
    (38.6
    )
    
    $
    19.9
 22




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##### Table of Contents



26 Weeks Ended July 29, 2006Parent
    
    
    Guarantor
    
    
    Non-guarantor(dollars in millions)
    
    Company
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    ConsolidatedNet sales
    
    $
    
    
    
    $
    1,278.1
    
    
    $
    416.5
    
    
    $
    (293.4
    )
    
    $
    1,401.2Cost of sales
    
    
    
    
    
    
    859.4
    
    
    
    329.1
    
    
    
    (286.9
    )
    
    
    901.6Gross margin
    
    
    
    
    
    
    418.7
    
    
    
    87.4
    
    
    
    (6.5
    )
    
    
    499.6Selling, general and administrative expense
    
    
    2.3
    
    
    
    344.3
    
    
    
    54.0
    
    
    
    (6.5
    )
    
    
    394.1Restructuring charges
    
    
    
    
    
    
    0.3
    
    
    
    
    
    
    
    
    
    
    
    0.3Operating (loss) profit from continuing operations
    
    
    (2.3
    )
    
    
    74.1
    
    
    
    33.4
    
    
    
    
    
    
    
    105.2Interest expense
    
    
    18.2
    
    
    
    0.6
    
    
    
    0.5
    
    
    
    (9.9
    )
    
    
    9.4Interest income
    
    
    
    
    
    
    (18.8
    )
    
    
    (1.1
    )
    
    
    9.9
    
    
    
    (10.0
    )Equity in earnings of subsidiaries
    
    
    (81.7
    )
    
    
    (27.9
    )
    
    
    
    
    
    
    109.6
    
    
    
    Earnings from continuing operations before income
taxes and minority interest
    
    
    61.2
    
    
    
    120.2
    
    
    
    34.0
    
    
    
    (109.6
    )
    
    
    105.8(Benefit) provision for income taxes
    
    
    (7.3
    )
    
    
    38.2
    
    
    
    5.9
    
    
    
    
    
    
    
    36.8Earnings from continuing operations before
minority interest
    
    
    68.5
    
    
    
    82.0
    
    
    
    28.1
    
    
    
    (109.6
    )
    
    
    69.0Minority interest, net of income taxes
    
    
    
    
    
    
    
    
    
    
    (0.2
    )
    
    
    
    
    
    
    (0.2
    )Net earnings from continuing operations
    
    
    68.5
    
    
    
    82.0
    
    
    
    27.9
    
    
    
    (109.6
    )
    
    
    68.8Loss from discontinued operations, net of income
taxes and minority interest
    
    
    
    
    
    
    (0.3
    )
    
    
    
    
    
    
    
    
    
    
    (0.3
    )Net earnings
    
    $
    68.5
    
    
    $
    81.7
    
    
    $
    27.9
    
    
    $
    (109.6
    )
    
    $
    68.5
 26 Weeks Ended July 30, 2005Parent
    
    
    Guarantor
    
    
    Non-guarantor(dollars in millions)
    
    Company
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    ConsolidatedNet sales
    
    $
    
    
    
    $
    1,274.7
    
    
    $
    357.9
    
    
    $
    (243.5
    )
    
    $
    1,389.1Cost of sales
    
    
    
    
    
    
    862.7
    
    
    
    284.9
    
    
    
    (238.0
    )
    
    
    909.6Gross margin
    
    
    
    
    
    
    412.0
    
    
    
    73.0
    
    
    
    (5.5
    )
    
    
    479.5Selling, general and administrative expense
    
    
    2.3
    
    
    
    347.6
    
    
    
    53.2
    
    
    
    (5.5
    )
    
    
    397.6Restructuring charges
    
    
    
    
    
    
    0.7
    
    
    
    
    
    
    
    
    
    
    
    0.7Operating (loss) profit from continuing operations
    
    
    (2.3
    )
    
    
    63.7
    
    
    
    19.8
    
    
    
    
    
    
    
    81.2Interest expense
    
    
    15.2
    
    
    
    0.7
    
    
    
    0.7
    
    
    
    (6.7
    )
    
    
    9.9Interest income
    
    
    
    
    
    
    (10.2
    )
    
    
    (0.8
    )
    
    
    6.7
    
    
    
    (4.3
    )Equity in earnings of subsidiaries
    
    
    (61.4
    )
    
    
    (18.6
    )
    
    
    
    
    
    
    80.0
    
    
    
    Earnings from continuing operations before income
taxes and minority interest
    
    
    43.9
    
    
    
    91.8
    
    
    
    19.9
    
    
    
    (80.0
    )
    
    
    75.6(Benefit) provision for income taxes
    
    
    (6.2
    )
    
    
    27.0
    
    
    
    1.8
    
    
    
    
    
    
    
    22.6Earnings from continuing operations before
minority interest
    
    
    50.1
    
    
    
    64.8
    
    
    
    18.1
    
    
    
    (80.0
    )
    
    
    53.0Minority interest, net of income taxes
    
    
    
    
    
    
    
    
    
    
    0.5
    
    
    
    
    
    
    
    0.5Net earnings from continuing operations
    
    
    50.1
    
    
    
    64.8
    
    
    
    18.6
    
    
    
    (80.0
    )
    
    
    53.5Loss from discontinued operations, net of income
taxes and minority interest
    
    
    
    
    
    
    (3.4
    )
    
    
    
    
    
    
    
    
    
    
    (3.4
    )Net earnings
    
    $
    50.1
    
    
    $
    61.4
    
    
    $
    18.6
    
    
    $
    (80.0
    )
    
    $
    50.1
 23




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##### Table of Contents



Parent
    
    
    Guarantor
    
    
    Non-Guarantor(dollars in millions)
    
    Company
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    ConsolidatedOperating Activities:Net earnings
    
    $
    68.5
    
    
    $
    81.7
    
    
    $
    27.9
    
    
    $
    (109.6
    )
    
    $
    68.5Loss from discontinued operations, net of income taxes
and minority interest
    
    
    
    
    
    
    0.3
    
    
    
    
    
    
    
    
    
    
    
    0.3Net earnings from continuing operations
    
    
    68.5
    
    
    
    82.0
    
    
    
    27.9
    
    
    
    (109.6
    )
    
    
    68.8Adjustments for non-cash items included in net earnings:Loss on impairment of and disposal of assets
    
    
    
    
    
    
    4.2
    
    
    
    0.6
    
    
    
    
    
    
    
    4.8Depreciation and amortization
    
    
    
    
    
    
    38.7
    
    
    
    6.2
    
    
    
    
    
    
    
    44.9Amortization of deferred financing costs
    
    
    0.4
    
    
    
    0.1
    
    
    
    
    
    
    
    
    
    
    
    0.5Share-based compensation expense
    
    
    
    
    
    
    5.0
    
    
    
    0.5
    
    
    
    
    
    
    
    5.5Deferred income taxes
    
    
    
    
    
    
    (0.4
    )
    
    
    1.5
    
    
    
    
    
    
    
    1.1Minority interest, net of income taxes
    
    
    
    
    
    
    
    
    
    
    0.2
    
    
    
    
    
    
    
    0.2Income tax benefit of share-based compensation
    
    
    
    
    
    
    0.4
    
    
    
    
    
    
    
    
    
    
    
    0.4Accretion of investments
    
    
    
    
    
    
    (1.6
    )
    
    
    
    
    
    
    
    
    
    
    (1.6
    )Changes in working capital:Inventories
    
    
    
    
    
    
    (17.3
    )
    
    
    (2.4
    )
    
    
    2.1
    
    
    
    (17.6
    )Other current assets
    
    
    (7.3
    )
    
    
    (14.8
    )
    
    
    (29.3
    )
    
    
    42.8
    
    
    
    (8.6
    )Accounts payable
    
    
    
    
    
    
    (23.6
    )
    
    
    8.9
    
    
    
    (0.4
    )
    
    
    (15.1
    )Accrued expenses
    
    
    50.8
    
    
    
    18.8
    
    
    
    (9.2
    )
    
    
    (44.5
    )
    
    
    15.9Other assets and liabilities, net
    
    
    (81.0
    )
    
    
    (31.8
    )
    
    
    2.0
    
    
    
    109.6
    
    
    
    (1.2
    )Net cash used in discontinued operations
    
    
    
    
    
    
    (0.8
    )
    
    
    
    
    
    
    
    
    
    
    (0.8
    )Cash flow provided by operating activities
    
    
    31.4
    
    
    
    58.9
    
    
    
    6.9
    
    
    
    
    
    
    
    97.2Investing Activities:Capital expenditures
    
    
    
    
    
    
    (49.3
    )
    
    
    (3.5
    )
    
    
    
    
    
    
    (52.8
    )Proceeds from sale of property and equipment
    
    
    
    
    
    
    3.2
    
    
    
    
    
    
    
    
    
    
    
    3.2Intangible asset additions
    
    
    
    
    
    
    (15.1
    )
    
    
    
    
    
    
    
    
    
    
    (15.1
    )Purchases of investments
    
    
    
    
    
    
    (89.2
    )
    
    
    (0.7
    )
    
    
    
    
    
    
    (89.9
    )Sales and maturities of investments
    
    
    
    
    
    
    111.0
    
    
    
    0.5
    
    
    
    
    
    
    
    111.5Investment in subsidiaries
    
    
    
    
    
    
    (1.5
    )
    
    
    
    
    
    
    1.5
    
    
    
    Cash flow used in investing activities
    
    
    
    
    
    
    (40.9
    )
    
    
    (3.7
    )
    
    
    1.5
    
    
    
    (43.1
    )Financing Activities:Excess tax benefits from share-based compensation
    
    
    
    
    
    
    4.0
    
    
    
    
    
    
    
    
    
    
    
    4.0Payment of deferred financing costs
    
    
    
    
    
    
    (0.2
    )
    
    
    
    
    
    
    
    
    
    
    (0.2
    )Repayment of debt
    
    
    
    
    
    
    (0.2
    )
    
    
    (1.9
    )
    
    
    
    
    
    
    (2.1
    )Issuances of common stock
    
    
    25.1
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    25.1Purchases of common stock
    
    
    (56.5
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (56.5
    )Contribution by / distributions to parent
    
    
    
    
    
    
    
    
    
    
    1.5
    
    
    
    (1.5
    )
    
    
    Distributions to minority owners
    
    
    
    
    
    
    
    
    
    
    (1.0
    )
    
    
    
    
    
    
    (1.0
    )Contributions by minority owners
    
    
    
    
    
    
    
    
    
    
    1.2
    
    
    
    
    
    
    
    1.2Cash flow (used in) provided by financing activities
    
    
    (31.4
    )
    
    
    3.6
    
    
    
    (0.2
    )
    
    
    (1.5
    )
    
    
    (29.5
    )Effect of exchange rate changes on cash
    
    
    
    
    
    
    
    
    
    
    0.1
    
    
    
    
    
    
    
    0.1Increase in cash and cash equivalents
    
    
    
    
    
    
    21.6
    
    
    
    3.1
    
    
    
    
    
    
    
    24.7Cash and cash equivalents, beginning of year
    
    
    
    
    
    
    310.5
    
    
    
    68.4
    
    
    
    
    
    
    
    378.9Cash and cash equivalents, end of period
    
    $
    
    
    
    $
    332.1
    
    
    $
    71.5
    
    
    $
    
    
    
    $
    403.6
 24




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##### Table of Contents



Parent
    
    
    Guarantor
    
    
    Non-Guarantor(dollars in millions)
    
    Company
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    ConsolidatedOperating Activities:Net earnings
    
    $
    50.1
    
    
    $
    61.4
    
    
    $
    18.6
    
    
    $
    (80.0
    )
    
    $
    50.1Loss from discontinued operations, net of income taxes
and minority interest
    
    
    
    
    
    
    3.4
    
    
    
    
    
    
    
    
    
    
    
    3.4Net earnings from continuing operations
    
    
    50.1
    
    
    
    64.8
    
    
    
    18.6
    
    
    
    (80.0
    )
    
    
    53.5Adjustments for non-cash items included in net earnings:Loss on impairment of and disposal of assets
    
    
    
    
    
    
    5.0
    
    
    
    0.2
    
    
    
    
    
    
    
    5.2Depreciation and amortization
    
    
    
    
    
    
    41.6
    
    
    
    4.4
    
    
    
    
    
    
    
    46.0Amortization of deferred financing costs
    
    
    
    
    
    
    0.6
    
    
    
    
    
    
    
    
    
    
    
    0.6Share-based compensation expense
    
    
    0.3
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    0.3Deferred income taxes
    
    
    
    
    
    
    1.0
    
    
    
    (0.1
    )
    
    
    
    
    
    
    0.9Minority interest, net of income taxes
    
    
    
    
    
    
    
    
    
    
    (0.5
    )
    
    
    
    
    
    
    (0.5
    )Income tax benefit of stock-based compensation
    
    
    0.8
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    0.8Accretion of investments
    
    
    
    
    
    
    (0.4
    )
    
    
    
    
    
    
    
    
    
    
    (0.4
    )Changes in working capital:Inventories
    
    
    
    
    
    
    (14.2
    )
    
    
    (3.3
    )
    
    
    0.9
    
    
    
    (16.6
    )Other current assets
    
    
    (6.3
    )
    
    
    (31.6
    )
    
    
    28.5
    
    
    
    9.3
    
    
    
    (0.1
    )Accounts payable
    
    
    
    
    
    
    4.8
    
    
    
    (9.7
    )
    
    
    (6.5
    )
    
    
    (11.4
    )Accrued expenses
    
    
    1.1
    
    
    
    13.8
    
    
    
    (0.7
    )
    
    
    (3.7
    )
    
    
    10.5Other assets and liabilities, net
    
    
    (55.9
    )
    
    
    (18.3
    )
    
    
    (1.1
    )
    
    
    80.0
    
    
    
    4.7Net cash used in discontinued operations
    
    
    
    
    
    
    (6.5
    )
    
    
    
    
    
    
    
    
    
    
    (6.5
    )Cash flow (used in) provided by operating activities
    
    
    (9.9
    )
    
    
    60.6
    
    
    
    36.3
    
    
    
    
    
    
    
    87.0Investing Activities:Capital expenditures
    
    
    
    
    
    
    (34.2
    )
    
    
    (1.1
    )
    
    
    
    
    
    
    (35.3
    )Proceeds from sale of property and equipment
    
    
    
    
    
    
    0.8
    
    
    
    
    
    
    
    
    
    
    
    0.8Restricted cash
    
    
    
    
    
    
    
    
    
    
    1.0
    
    
    
    
    
    
    
    1.0Purchases of investments
    
    
    
    
    
    
    (71.5
    )
    
    
    
    
    
    
    
    
    
    
    (71.5
    )Sales and maturities of investments
    
    
    
    
    
    
    40.0
    
    
    
    
    
    
    
    
    
    
    
    40.0Investment in subsidiaries
    
    
    
    
    
    
    24.2
    
    
    
    
    
    
    
    (24.2
    )
    
    
    Cash flow used in investing activities
    
    
    
    
    
    
    (40.7
    )
    
    
    (0.1
    )
    
    
    (24.2
    )
    
    
    (65.0
    )Financing Activities:Repayment of notes payable
    
    
    
    
    
    
    
    
    
    
    (1.0
    )
    
    
    
    
    
    
    (1.0
    )Issuance of debt
    
    
    
    
    
    
    0.1
    
    
    
    1.2
    
    
    
    
    
    
    
    1.3Issuances of common stock
    
    
    12.3
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    12.3Purchases of common stock
    
    
    (2.4
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2.4
    )Distributions to parent
    
    
    
    
    
    
    
    
    
    
    (24.2
    )
    
    
    24.2
    
    
    
    Contributions by minority owners
    
    
    
    
    
    
    
    
    
    
    0.5
    
    
    
    
    
    
    
    0.5Cash flow provided by (used in) financing activities
    
    
    9.9
    
    
    
    0.1
    
    
    
    (23.5
    )
    
    
    24.2
    
    
    
    10.7Effect of exchange rate changes on cash
    
    
    
    
    
    
    
    
    
    
    1.8
    
    
    
    
    
    
    
    1.8Increase in cash and cash equivalents
    
    
    
    
    
    
    20.0
    
    
    
    14.5
    
    
    
    
    
    
    
    34.5Cash and cash equivalents, beginning of year
    
    
    
    
    
    
    194.5
    
    
    
    78.8
    
    
    
    
    
    
    
    273.3Cash and cash equivalents, end of period
    
    $
    
    
    
    $
    214.5
    
    
    $
    93.3
    
    
    $
    
    
    
    $
    307.8
 25




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##### Table of Contents



ITEM 2  MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
          26




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27




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28




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##### Table of Contents



Second Quarter
    
    First Six Months2006
    
    2005
    
    2006
    
    2005Revenues
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Cost of sales
    
    
    65.5
    
    
    
    66.1
    
    
    
    64.3
    
    
    
    65.5Gross margin
    
    
    34.5
    
    
    
    33.9
    
    
    
    35.7
    
    
    
    34.5Selling, general and administrative expense
    
    
    27.5
    
    
    
    29.0
    
    
    
    28.1
    
    
    
    28.6Restructuring charges
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    0.1Operating profit from continuing operations
    
    
    7.0
    
    
    
    4.9
    
    
    
    7.6
    
    
    
    5.8Interest (income) expense, net
    
    
    (0.1
    )
    
    
    0.3
    
    
    
    
    
    
    
    0.4Earnings from continuing operations before income taxes and
minority interest
    
    
    7.1
    
    
    
    4.6
    
    
    
    7.6
    
    
    
    5.4Effective income tax rate*
    
    
    34.7
    
    
    
    31.8
    
    
    
    34.8
    
    
    
    29.9Earnings from continuing operations before minority interest
    
    
    4.6
    
    
    
    3.1
    
    
    
    4.9
    
    
    
    3.8Minority interest
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Earnings from continuing operations
    
    
    4.6
    
    
    
    3.1
    
    
    
    4.9
    
    
    
    3.8Loss from discontinued operations, net of income taxes and
minority interest
    
    
    
    
    
    
    (0.2
    )
    
    
    
    
    
    
    (0.2
    )Net Earnings
    
    
    4.6
    %
    
    
    2.9
    %
    
    
    4.9
    %
    
    
    3.6
    %
 
 *
    
    Percent of pre-tax earnings    Second Quarter
    
    First Six Months2006
    
    2005
    
    2006
    
    2005Net Sales
    
    
    1.8
    %
    
    
    (0.2
    )%
    
    
    0.9
    %
    
    
    0.1
    %Same-store Sales
    
    
    2.2
    
    
    
    1.5
    
    
    
    1.3
    
    
    
    2.1Average selling price per unit
    
    
    12.9
    
    
    
    6.3
    
    
    
    13.0
    
    
    
    5.9Unit volume
    
    
    (9.7
    )
    
    
    (6.4
    )
    
    
    (10.8
    )
    
    
    (5.4
    )Footwear average selling price per unit
    
    
    12.3
    
    
    
    5.4
    
    
    
    11.7
    
    
    
    4.2Footwear unit volume
    
    
    (8.3
    )
    
    
    (5.2
    )
    
    
    (8.4
    )
    
    
    (3.2
    )Non-footwear average selling price per unit
    
    
    7.4
    
    
    
    8.0
    
    
    
    7.3
    
    
    
    8.1Non-footwear unit volume
    
    
    (17.1
    )
    
    
    (11.9
    )
    
    
    (20.5
    )
    
    
    (13.6
    )
   29




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30




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##### Table of Contents



Second Quarter
    
    First Six Months(dollars in millions)
    
    2006
    
    2005
    
    2006
    
    2005Revenues from external customers
    
    $
    101.8
    
    
    $
    91.7
    
    
    $
    183.5
    
    
    $
    171.9Operating profit from continuing operations
    
    
    11.8
    
    
    
    8.8
    
    
    
    15.7
    
    
    
    12.2
      Cash Flow Provided by Operating Activities
  Cash Flow Used in Investing Activities
  Cash Flow (Used in) Provided by Financing Activities
   31




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##### Table of Contents



Year
    
    Percentage2008
    
    
    104.125
    %2009
    
    
    102.750
    %2010
    
    
    101.375
    %2011 and thereafter
    
    
    100.000
    %
   Financial Commitments
    July 29, 2006
    
    July 30, 2005
    
    January 28, 2006Current Ratio
    
    
    2.6
    
    
    
    2.5
    
    
    
    2.5Debt-Capitalization Ratio*
    
    
    22.7
    %
    
    
    24.0
    %
    
    
    24.0
    %
 
 *
    
    Debt-to-capitalization has been computed by dividing total debt by capitalization.
Total debt is defined as long-term debt including current maturities, notes payable
and borrowings under the revolving line of credit. Capitalization is defined as total
debt and shareowners equity. The debt-to-capitalization ratio, including the present
value of future minimum rental payments under operating leases as debt and as
capitalization, was 62.9%, 64.2% and 63.8% respectively, for the periods referred to
above. 32




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##### Table of Contents



Second Quarter
    
    First Six Months2006
    
    2005
    
    2006
    
    2005Beginning of period
    
    
    4,602
    
    
    
    4,646
    
    
    
    4,605
    
    
    
    4,640Stores opened
    
    
    38
    
    
    
    33
    
    
    
    90
    
    
    
    72Stores closed
    
    
    (56
    )
    
    
    (54
    )
    
    
    (111
    )
    
    
    (87
    )Ending store count
    
    
    4,584
    
    
    
    4,625
    
    
    
    4,584
    
    
    
    4,625
      
       33




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##### Table of Contents



Disclosure Controls and Procedures
   Changes in Internal Control over Financial Reporting
  
  
    th th
  34




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##### Table of Contents



®
 ®
 
   
    AverageTotal Number of
    
    Price
    
    Total Number of Shares Purchased
    
    Approximate Dollar Value of SharesShares Purchased(1)
    
    Paid per
    
    as Part of Publicly Announced Plans
    
    that May Yet Be Purchased Under thePeriod
    
    (in Thousands)
    
    Share
    
    or Programs(2)(in Thousands)
    
    Plans or Programs(3)(in Millions)04/30/06  05/27/06
    
    
    6
    
    
    $
    21.84
    
    
    
    
    
    
    $
    141.305/28/06  07/01/06
    
    
    739
    
    
    
    25.92
    
    
    
    729
    
    
    
    122.407/02/06  07/29/06
    
    
    430
    
    
    
    24.91
    
    
    
    428
    
    
    
    111.8Total
    
    
    1,175
    
    
    $
    25.52
    
    
    
    1,157
    
    
    $
    111.8
 
 (1)
    
    We repurchased an aggregate of 18 thousand shares of our common stock in
connection with our employee stock purchase and stock incentive plans.(2)
    
    In 2001, our Board of Directors approved the repurchase of our common stock having
a value of up to $250 million in the aggregate pursuant to the Program.(3)
    
    The timing and amount of share repurchases, if any, are limited by the terms of
our Credit Agreement and Senior Subordinated Notes. 35




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##### Table of Contents



Number
    
    Description31.1
    
    
    Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of
2002 of the Chief Executive Officer and President*31.2
    
    
    Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of
2002 of the Senior Vice President, Chief Financial Officer and
Treasurer*32.1
    
    
    Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002 of the Chief Executive Officer and President*32.2
    
    
    Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002 of the Senior Vice President, Chief Financial Officer and
Treasurer*
 
 *
    
    Filed herewith 36




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##### Table of Contents



PAYLESS SHOESOURCE, INC.Date: September 6, 2006
    
    By: /s/ Matthew E. RubelMatthew E. RubelChief Executive Officer and President(Principal Executive Officer)Date: September 6, 2006
    
    By: /s/ Ullrich E. PorzigUllrich E. PorzigSenior Vice PresidentChief Financial Officer and Treasurer(Principal Financial and Accounting Officer)
 37