##### Table of Contents



SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (D)
OF THE SECURITIES EXCHANGE ACT OF 1934 For The Quarterly Period Ended April 30, 2005 Commission File Number 1-14770 PAYLESS SHOESOURCE, INC.  DELAWARE
    
    43-1813160(State or other jurisdiction of
    
    (I.R.S. Employerincorporation or organization)
    
    Identification Number)
 3231 SOUTHEAST SIXTH AVENUE, TOPEKA, KANSAS
    
    66607-2207(Address of principal executive offices)
    
    (Zip Code)
 (785) 233-5171
(Registrants telephone number,
including area code) 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 and (2)
has been subject to such filing requirements for the past 90 days. YES þ      NO o Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of
the Securities Exchange Act of 1934). YES þ      NO o Indicate the number of shares outstanding of each of the issuers classes of common stock, as of
the latest practicable date. Common Stock, $.01 par value
67,387,723 shares as of June 3, 2005




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TABLE OF CONTENTS  PART I  FINANCIAL INFORMATIONITEM 1  FINANCIAL STATEMENTSITEM 2  MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSITEM 3  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKITEM 4  CONTROLS AND PROCEDURESPART II  OTHER INFORMATIONITEM 1  LEGAL PROCEEDINGSITEM 2  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDSITEM 4  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERSITEM 6  EXHIBITSSIGNATURESINDEX TO EXHIBITSCertification Pursuant to Section 302Certification Pursuant to Section 302Certification Pursuant to Section 906Certification Pursuant to Section 906    Table of Contents  
 PART I  FINANCIAL INFORMATION 
 ITEM 1  FINANCIAL STATEMENTS PAYLESS SHOESOURCE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED) (dollars in millions) April 30,
    
    
    May 1,
    
    
    January 29,2005
    
    
    2004
    
    
    2005ASSETSCurrent Assets:Cash and cash equivalents
    
    $
    303.3
    
    
    $
    121.3
    
    
    $
    289.6Marketable securities, available for sale
    
    
    
    
    
    
    4.0
    
    
    
    5.0Restricted cash
    
    
    2.0
    
    
    
    33.5
    
    
    
    3.0Inventories
    
    
    383.9
    
    
    
    422.2
    
    
    
    345.3Current deferred income taxes
    
    
    20.9
    
    
    
    16.7
    
    
    
    21.9Other current assets
    
    
    56.9
    
    
    
    64.9
    
    
    
    56.6Current assets of discontinued operations
    
    
    4.8
    
    
    
    27.4
    
    
    
    8.5Total current assets
    
    
    771.8
    
    
    
    690.0
    
    
    
    729.9Property and Equipment:Land
    
    
    8.3
    
    
    
    8.0
    
    
    
    8.0Buildings and leasehold improvements
    
    
    662.8
    
    
    
    682.5
    
    
    
    673.3Furniture, fixtures and equipment
    
    
    522.8
    
    
    
    504.2
    
    
    
    509.8Property under capital leases
    
    
    3.8
    
    
    
    4.6
    
    
    
    3.8Total property and equipment
    
    
    1,197.7
    
    
    
    1,199.3
    
    
    
    1,194.9Accumulated depreciation and amortization
    
    
    (785.8
    )
    
    
    (777.4
    )
    
    
    (772.6
    )Property and equipment, net
    
    
    411.9
    
    
    
    421.9
    
    
    
    422.3Favorable leases, net
    
    
    20.8
    
    
    
    26.9
    
    
    
    21.7Deferred income taxes
    
    
    35.6
    
    
    
    33.7
    
    
    
    36.4Goodwill
    
    
    5.9
    
    
    
    5.9
    
    
    
    5.9Other assets
    
    
    23.1
    
    
    
    21.7
    
    
    
    23.5Noncurrent assets of discontinued operations
    
    
    
    
    
    
    28.2
    
    
    
    0.1Total Assets
    
    $
    1,269.1
    
    
    $
    1,228.3
    
    
    $
    1,239.8LIABILITIES AND SHAREOWNERS EQUITYCurrent Liabilities:Current maturities of debt
    
    $
    1.5
    
    
    $
    0.9
    
    
    $
    0.3Notes payable
    
    
    2.0
    
    
    
    33.5
    
    
    
    3.0Accounts payable
    
    
    169.8
    
    
    
    126.5
    
    
    
    160.3Accrued expenses
    
    
    158.2
    
    
    
    140.1
    
    
    
    159.7Current liabilities of discontinued operations
    
    
    5.0
    
    
    
    6.0
    
    
    
    15.0Total current liabilities
    
    
    336.5
    
    
    
    307.0
    
    
    
    338.3Long-term debt
    
    
    204.3
    
    
    
    202.6
    
    
    
    204.3Other liabilities
    
    
    95.8
    
    
    
    85.8
    
    
    
    93.6Noncurrent liabilities of discontinued operations
    
    
    
    
    
    
    4.7
    
    
    
    Minority interest
    
    
    8.6
    
    
    
    13.1
    
    
    
    8.6Commitments and contingencies
    
    
    
    
    
    
    
    
    
    
    Total shareowners equity
    
    
    623.9
    
    
    
    615.1
    
    
    
    595.0Total Liabilities and Shareowners Equity
    
    $
    1,269.1
    
    
    $
    1,228.3
    
    
    $
    1,239.8
 See Notes to Condensed Consolidated Financial Statements. 2




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PAYLESS SHOESOURCE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
(UNAUDITED) (dollars and shares in millions, except per share ) 13 Weeks EndedApril 30, 2005
    
    
    May 1, 2004Net sales
    
    $
    695.2
    
    
    $
    692.3Cost of sales
    
    
    450.8
    
    
    
    475.5Gross margin
    
    
    244.4
    
    
    
    216.8Selling, general and administrative expenses
    
    
    196.7
    
    
    
    188.4Restructuring charges
    
    
    0.7
    
    
    
    Operating profit from continuing operations
    
    
    47.0
    
    
    
    28.4Interest expense
    
    
    4.9
    
    
    
    5.4Interest income
    
    
    (1.7
    )
    
    
    (1.0
    )Earnings from continuing operations before
income taxes and minority interest
    
    
    43.8
    
    
    
    24.0Provision for income taxes
    
    
    12.5
    
    
    
    8.0Earnings from continuing operations before
minority interest
    
    
    31.3
    
    
    
    16.0Minority interest, net of income taxes
    
    
    0.4
    
    
    
    1.9Net earnings from continuing operations
    
    
    31.7
    
    
    
    17.9Loss from discontinued operations, net of
income taxes and minority interest
    
    
    (1.5
    )
    
    
    (3.8
    )Net earnings
    
    $
    30.2
    
    
    $
    14.1Diluted earnings per shareEarnings from continuing operations
    
    $
    0.47
    
    
    $
    0.26Loss from discontinued operations
    
    
    (0.02
    )
    
    
    (0.05
    )Diluted earnings per share
    
    $
    0.45
    
    
    $
    0.21Basic earnings per shareEarnings from continuing operations
    
    $
    0.47
    
    
    $
    0.26Loss from discontinued operations
    
    
    (0.02
    )
    
    
    (0.05
    )Basic earnings per share
    
    $
    0.45
    
    
    $
    0.21Diluted Weighted Average Shares Outstanding
    
    
    67.2
    
    
    
    68.0Basic Weighted Average Shares Outstanding
    
    
    67.1
    
    
    
    67.9
 See Notes to Condensed Consolidated Financial Statements. 3




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PAYLESS SHOESOURCE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED) (dollars in millions) 13 Weeks EndedApril 30, 2005
    
    
    May 1, 2004Operating Activities:Net earnings
    
    $
    30.2
    
    
    $
    14.1Loss from discontinued operation, net of
income taxes and minority interest
    
    
    (1.5
    )
    
    
    (3.8
    )Net earnings from continuing operations
    
    
    31.7
    
    
    
    17.9Adjustments for non-cash items included
in net earnings:Loss on impairment of and disposal of assets
    
    
    2.4
    
    
    
    2.8Depreciation and amortization
    
    
    23.0
    
    
    
    24.6Amortization of deferred financing costs
    
    
    0.3
    
    
    
    0.2Amortization of unearned restricted stock
    
    
    0.2
    
    
    
    0.2Deferred income taxes
    
    
    1.7
    
    
    
    (0.8
    )Minority interest, net of income taxes
    
    
    (0.4
    )
    
    
    (1.9
    )Changes in working capital:Inventories
    
    
    (38.7
    )
    
    
    (48.0
    )Other current assets
    
    
    (1.2
    )
    
    
    (4.1
    )Accounts payable
    
    
    8.3
    
    
    
    (3.0
    )Accrued expenses
    
    
    (1.5
    )
    
    
    16.3Other assets and liabilities, net
    
    
    2.4
    
    
    
    6.9Net cash used in discontinued operations
    
    
    (7.7
    )
    
    
    (5.5
    )Cash flow provided by operating activities
    
    
    20.5
    
    
    
    5.6Investing Activities:Capital expenditures
    
    
    (13.8
    )
    
    
    (26.2
    )Purchases of marketable securities
    
    
    
    
    
    
    (4.0
    )Sales of marketable securities
    
    
    5.0
    
    
    
    10.0Cash flow used in investing activities
    
    
    (8.8
    )
    
    
    (20.2
    )Financing Activities:Repayment of notes payable
    
    
    (1.0
    )
    
    
    Restricted cash
    
    
    1.0
    
    
    
    Issuance of debt
    
    
    1.2
    
    
    
    Payment of deferred financing costs
    
    
    
    
    
    
    (0.1
    )Repayment of debt
    
    
    
    
    
    
    (0.3
    )Issuances of common stock
    
    
    0.7
    
    
    
    0.3Purchases of common stock
    
    
    (2.1
    )
    
    
    (0.7
    )Contributions by minority owners
    
    
    0.2
    
    
    
    Cash flow used in financing activities
    
    
    
    
    
    
    (0.8
    )Effect of exchange rate changes on cash
    
    
    2.0
    
    
    
    Increase (decrease) in cash and cash equivalents
    
    
    13.7
    
    
    
    (15.4
    )Cash and cash equivalents, beginning of year
    
    
    289.6
    
    
    
    136.7Cash and cash equivalents, end of period
    
    $
    303.3
    
    
    $
    121.3Cash paid (received) during the period for:Interest
    
    $
    9.3
    
    
    $
    9.8Income taxes
    
    $
    5.3
    
    
    $
    (0.3
    )
 See Notes to Condensed Consolidated Financial Statements. 4




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PAYLESS SHOESOURCE, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) NOTE 1. INTERIM RESULTS. These unaudited Condensed Consolidated Financial Statements of Payless
ShoeSource, Inc., a Delaware corporation, and subsidiaries (the Company) have been prepared in
accordance with the instructions to Form 10-Q of the United States Securities and Exchange
Commission and should be read in conjunction with the Notes to the Consolidated Financial
Statements (pages 33-66) in the Companys 2004 Annual Report on Form 10-K. Certain information and
footnote disclosures normally included in financial statements prepared in accordance with
generally accepted accounting principles have been condensed or omitted pursuant to such rules and
regulations. In the opinion of management, the unaudited Condensed Consolidated Financial
Statements are fairly presented and all adjustments (consisting only of normal recurring
adjustments) necessary for a fair statement of the results for the interim periods have been
included; however, certain items are included in these statements based upon estimates for the
entire year. The reporting period for operations in the Central American and South American Regions
is a December 31 year-end. The Central American Region is composed of operations in Costa Rica, the
Dominican Republic, El Salvador, Guatemala, Honduras, Nicaragua, Panama and Trinidad & Tobago. The
South American Region is composed of operations in Ecuador. The Company also has a 60-percent
ownership interest in a Japanese joint venture. Japanese operations are reported on a December 31
year-end. The effects of the one-month lag for the operations in the Central and South American
Regions and Japan are not significant to the Companys financial position and results of
operations. The results for the thirteen week period ended April 30, 2005, are not necessarily
indicative of the results that may be expected for the entire fiscal year ending January 28, 2006. NOTE 2. RESTRUCTURING CHARGES. During the second quarter of 2004, the Company initiated a
restructuring plan to build long-term shareowner value. The Company has substantially completed
the restructuring, which included: 1) closing all Parade stores, 2) sale of Chile and Peru
entities, 3) closing of 264 Payless ShoeSource stores, 4) ceasing all wholesale businesses with
no significant growth opportunity and 5) eliminating approximately 200 management and
administrative positions. As part of the restructuring, during the first quarter of 2005 the Company recorded a charge of
$2.9 million ($0.7 million relating to continuing operations and $2.2 million relating to
discontinued operations) primarily related to contract termination costs in excess of original
estimates. In accordance with Statement of Financial Accounting Standards (SFAS) No. 144, Accounting for
the Impairment or Disposal of Long-Lived Assets, the results of operations of Parade, Peru, Chile
and 26 Payless ShoeSource stores have been classified as discontinued operations in the Companys
condensed consolidated statements of earnings. In accordance with SFAS No. 146, Accounting for Costs Associated with Exit or Disposal
Activities, employee severance, contract termination and other exit costs are recorded at their
estimated fair value when they are incurred. Employee severance costs include estimates regarding
the amount of severance payments made to certain terminated associates, and contract termination
costs include estimates regarding the length of time required to sublease vacant space and expected
recovery rates. Actual results could vary from these estimates. The significant components of the restructuring charge incurred during the first quarter of 2005,
and the status of the restructuring-related liabilities, which are included in accrued expenses
($4.9 million) and current liabilities of discontinued operations ($4.7 million) in the condensed
consolidated balance sheets, are summarized below: Accrual Balance as of
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Accrual BalanceTotal Charges to
    
    
    January 29,
    
    
    2005 Charges
    
    
    
    
    
    
    as of(dollars in millions)
    
    Date
    
    
    2005
    
    
    Costs Incurred
    
    
    Accrual Adjustments
    
    
    Cash Payments
    
    
    April 30, 2005Asset impairments and net
disposal losses
    
    $
    34.7
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Employee severance costs
    
    
    9.4
    
    
    
    4.2
    
    
    
    
    
    
    
    0.1
    
    
    
    (1.8
    )
    
    
    2.5Contract termination costs
    
    
    23.5
    
    
    
    17.6
    
    
    
    
    
    
    
    2.2
    
    
    
    (12.7
    )
    
    
    7.1Other exit costs
    
    
    3.2
    
    
    
    
    
    
    
    0.6
    
    
    
    
    
    
    
    (0.6
    )
    
    
    Total
    
    $
    70.8
    
    
    $
    21.8
    
    
    $
    0.6
    
    
    $
    2.3
    
    
    $
    (15.1
    )
    
    $
    9.6
 5




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The Company expects that the payments of employee severance costs will be substantially
completed by June 2007. The remaining contract termination obligations primarily relate to lease
obligations for vacant space (certain lease terms extending through November 2013) resulting from
the store closings. The Payless and Parade stores located in Chile, Peru, Puerto Rico and Canada are components of the
Payless International Segment. The Parade and Payless stores located in the United States are
components of the Payless Domestic segment. The entire 2005 first quarter charge related to the
Payless Domestic segment. NOTE 3. DISCONTINUED OPERATIONS. In accordance with Statement of Financial Accounting Standards
(SFAS) No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, the results for
the thirteen weeks ended April 30, 2005 and May 1, 2004 of operations for Parade, Peru, Chile and
26 Payless closed stores are presented as discontinued operations. The following is a summary of
these results by segment: Thirteen Weeks Ended April 30, 2005 Payless
    
    
    Payless
    
    
    Payless(dollars in millions)
    
    Domestic
    
    
    International
    
    
    ConsolidatedNet sales
    
    $
    
    
    
    $
    
    
    
    $
    Loss from discontinued operations before income taxes
    
    
    (2.5
    )
    
    
    
    
    
    
    (2.5
    )Benefit for income taxes
    
    
    (1.0
    )
    
    
    
    
    
    
    (1.0
    )Loss from discontinued operations, net of income taxes
    
    $
    (1.5
    )
    
    $
    
    
    
    $
    (1.5
    )
 Thirteen Weeks Ended May 1, 2004 Payless
    
    
    Payless
    
    
    Payless(dollars in millions)
    
    Domestic
    
    
    International
    
    
    ConsolidatedNet sales
    
    $
    27.1
    
    
    $
    2.5
    
    
    $
    29.6Loss from discontinued operations before income taxes and minority interest
    
    
    (4.4
    )
    
    
    (1.7
    )
    
    
    (6.1
    )(Benefit) provision for income taxes
    
    
    (1.8
    )
    
    
    0.2
    
    
    
    (1.6
    )Loss from discontinued operations before minority interest
    
    
    (2.6
    )
    
    
    (1.9
    )
    
    
    (4.5
    )Minority interest, net of income taxes
    
    
    
    
    
    
    0.7
    
    
    
    0.7Loss from discontinued operations, net of income taxes and minority interest
    
    $
    (2.6
    )
    
    $
    (1.2
    )
    
    $
    (3.8
    )
 Additionally, the condensed consolidated balance sheets include the assets of Parade, Peru,
Chile and the 26 Payless closed stores presented as discontinued operations. As of April 30, 2005,
May 1, 2004 and January 29, 2005, the current and non-current assets and liabilities of
discontinued operations by financial reporting segment were as follows: April 30, 2005 Payless
    
    
    Payless
    
    
    Payless(dollars in millions)
    
    Domestic
    
    
    International
    
    
    ConsolidatedAssetsCurrent assets:Current deferred income taxes
    
    $
    4.2
    
    
    
    
    
    
    $
    4.2Other current assets
    
    
    0.6
    
    
    
    
    
    
    
    0.6Total current assets of discontinued operations
    
    $
    4.8
    
    
    $
    
    
    
    $
    4.8LiabilitiesCurrent liabilities:Accounts payable
    
    $
    0.3
    
    
    $
    
    
    
    $
    0.3Accrued expenses
    
    
    4.7
    
    
    
    
    
    
    
    4.7Total current liabilities of discontinued operations
    
    $
    5.0
    
    
    $
    
    
    
    $
    5.0
 6




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May 1, 2004 Payless
    
    
    Payless
    
    
    Payless(dollars in millions)
    
    Domestic
    
    
    International
    
    
    ConsolidatedAssetsCurrent assets:Cash and cash equivalents
    
    $
    0.2
    
    
    $
    1.0
    
    
    $
    1.2Inventories
    
    
    19.3
    
    
    
    2.9
    
    
    
    22.2Current deferred income taxes
    
    
    0.2
    
    
    
    
    
    
    
    0.2Other current assets
    
    
    2.5
    
    
    
    1.3
    
    
    
    3.8Total current assets of discontinued operations
    
    $
    22.2
    
    
    $
    5.2
    
    
    $
    27.4Property and equipment, net
    
    $
    15.7
    
    
    $
    6.7
    
    
    $
    22.4Favorable leases, net
    
    
    0.4
    
    
    
    
    
    
    
    0.4Deferred income taxes
    
    
    2.4
    
    
    
    
    
    
    
    2.4Other assets
    
    
    0.1
    
    
    
    2.9
    
    
    
    3.0Total non-current assets of discontinued operations
    
    $
    18.6
    
    
    $
    9.6
    
    
    $
    28.2LiabilitiesCurrent liabilities:Accounts payable
    
    $
    2.6
    
    
    $
    1.2
    
    
    $
    3.8Accrued expenses
    
    
    1.9
    
    
    
    0.3
    
    
    
    2.2Total current liabilities of discontinued operations
    
    $
    4.5
    
    
    $
    1.5
    
    
    $
    6.0Other liabilities
    
    $
    4.7
    
    
    $
    
    
    
    $
    4.7Total non-current liabilities of discontinued operations
    
    $
    4.7
    
    
    $
    
    
    
    $
    4.7
 January 29, 2005 Payless
    
    
    Payless
    
    
    Payless(dollars in millions)
    
    Domestic
    
    
    International
    
    
    ConsolidatedAssetsCurrent assets:Current deferred income taxes
    
    $
    5.6
    
    
    $
    
    
    
    $
    5.6Other current assets
    
    
    2.9
    
    
    
    
    
    
    
    2.9Total current assets of discontinued operations
    
    $
    8.5
    
    
    $
    
    
    
    $
    8.5Other assets
    
    
    0.1
    
    
    
    
    
    
    
    0.1Total non-current assets of discontinued operations
    
    $
    0.1
    
    
    $
    
    
    
    $
    0.1LiabilitiesCurrent liabilities:Accounts payable
    
    $
    0.2
    
    
    $
    
    
    
    $
    0.2Accrued expenses
    
    
    14.8
    
    
    
    
    
    
    
    14.8Total current liabilities of discontinued operations
    
    $
    15.0
    
    
    $
    
    
    
    $
    15.0
 NOTE 4. STOCK-BASED COMPENSATION. The Company follows the disclosure provisions of
SFAS No. 148, Accounting for Stock-Based Compensation  Transition and Disclosure, an amendment of
FASB Statement No. 123. The Statement requires prominent disclosures in both annual and interim
financial statements regarding the method of accounting for stock-based employee compensation and
the effect of the method used on reported results. The Company accounts for stock compensation
awards under the intrinsic value method of Accounting Principles Board (APB) Opinion No. 25. APB
Opinion No. 25 requires compensation cost to be recognized based on the excess, if any, between the
quoted market price of the stock at the date of grant and the amount an employee must pay to
acquire the stock. All options awarded under all of the Companys plans are granted with an
exercise price equal to the fair market value on the date of the grant. SFAS 123, Accounting for Stock-Based Compensation, provides an alternative method of accounting
for stock-based compensation, which establishes a fair value based method of accounting for
employee stock options or similar equity instruments. The Company uses the Black-Scholes option
pricing model to estimate the grant date fair value of its 1996 and later option grants. The fair
value is recognized over the option vesting period. The following table presents the effect on net
earnings and earnings per share had the Company adopted the fair value based method of accounting
for stock-based compensation under SFAS No. 123, Accounting for Stock-Based Compensation. 7




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##### Table of Contents



(dollars in millions, except per share amounts) 13 Weeks EndedApril 30, 2005
    
    
    May 1, 2004Net earnings:As reported
    
    $
    30.2
    
    
    $
    14.1Add: Total stock-based employee compensation expense included in
net earnings as reported, net of related income taxes
    
    
    0.8
    
    
    
    0.5Less: Total stock-based employee compensation expense determined
under fair value based method for all awards, net of related
income taxes
    
    
    1.1
    
    
    
    1.2Pro forma
    
    $
    29.9
    
    
    $
    13.4Diluted earnings per share:As reported
    
    $
    0.45
    
    
    $
    0.21Pro forma
    
    $
    0.45
    
    
    $
    0.20Basic earnings per share:As reported
    
    $
    0.45
    
    
    $
    0.21Pro forma
    
    $
    0.45
    
    
    $
    0.20
 NOTE 5. INVENTORIES. Merchandise inventories in our stores are valued by the retail method and
are stated at the lower of cost, determined using the first-in, first-out (FIFO) basis, or market.
Prior to shipment to a specific store, inventories are valued at the lower of cost using the FIFO
basis, or market. Raw materials of $17.1 million, $13.5 million and $18.8 million are included in
inventories in the condensed consolidated balance sheets at April 30, 2005, May 1, 2004, and
January 29, 2005, respectively. NOTE 6. INTANGIBLES. SFAS No. 142, Goodwill and Other Intangible Assets requires that an
intangible asset that is acquired other than by business combination shall be initially recognized
and measured based on its fair value. This Statement also provides that goodwill and
indefinitely-lived intangible assets should not be amortized, but shall be tested for impairment
annually, or more frequently if circumstances indicate potential impairment, through a comparison
of fair value to its carrying amount. Intangible assets with finite lives will continue to be
amortized over their useful lives. No impairment loss was recorded during the first quarter of 2005
or 2004 related to goodwill. Favorable leases subject to amortization pursuant to SFAS 142 are as follows: (dollars in millions)
    
    April 30, 2005
    
    
    May 1, 2004
    
    
    January 29, 2005Gross carrying amount
    
    $
    77.4
    
    
    $
    84.8
    
    
    $
    78.2Less: accumulated amortization
    
    
    (56.6
    )
    
    
    (57.9
    )
    
    
    (56.5
    )Carrying amount, end of period
    
    $
    20.8
    
    
    $
    26.9
    
    
    $
    21.7
 Amortization expense on favorable leases was as follows: (dollars in millions) 13 Weeks EndedApril 30, 2005
    
    May 1, 2004Amortization expense on favorable leases
    
    $
    0.9
    
    
    $
    1.1
 The Company expects annual amortization expense for favorable leases for the next five years
to be as follows (dollars in millions): Year
    
    AmountRemainder of 2005
    
    $
    2.62006
    
    
    3.22007
    
    
    2.72008
    
    
    2.42009
    
    
    2.1
 8




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NOTE 7. LONG-TERM DEBT AND LINE OF CREDIT. In January 2004, the Company replaced its $150
million senior secured revolving credit facility (the Old Facility) with a new $200 million
senior secured revolving credit facility (the New Facility). Funds borrowed under the New
Facility are secured by domestic merchandise inventory and receivables. The Company may borrow up
to $200 million through the New Facility, subject to a sufficient borrowing base. The New Facility
bears interest at the London Inter-bank Offered Rate (LIBOR), plus a variable margin of 1.25
percent to 2.0 percent, or the base rate as defined in the agreement governing the New Facility.
The margin on the New Facility varies based upon certain borrowing levels specified in the
agreement governing the New Facility. The variable interest rate including the applicable variable
margin at April 30, 2005, was 4.5 percent. A monthly commitment fee of 0.30 percent per annum is
payable on the unborrowed balance. The New Facility is scheduled to expire in January 2008, with a
one-year extension to January 2009 at the Companys option. No amounts were drawn on the New
Facility as of April 30, 2005. Based on its borrowing base, the Company may borrow up to $200.0
million under its New Facility, less $19.7
million in outstanding letters of credit as of April 30, 2005. In July 2003, the Company sold $200.0 million of 8.25% Senior Subordinated Notes (the Notes) for
$196.7 million, due 2013. The discount of $3.3 million is being amortized to interest expense over
the life of the Notes. The Notes are guaranteed by all of the Companys domestic subsidiaries.
Interest on the Notes is payable semi-annually, beginning February 1, 2004. The Notes contain
various covenants including those that may limit the Companys ability to pay dividends, repurchase
stock, accelerate the retirement of other subordinated debt or make certain investments. As of
April 30, 2005, the Company was in compliance with all covenants. The proceeds of the Notes and
additional general funds were used to repay the entire $200.0 million term loan portion of the
Companys Old Facility. As of April 30, 2005, the fair value of the Notes was $206.0 million based
on recent trading activity of the Notes. On or after August 1, 2008, the Company may, on any one or
more occasions, redeem all or a part of the Notes at the redemption prices set forth below, plus
accrued and unpaid interest, if any, on the Notes redeemed, to the applicable redemption date: Year
    

    Percentage2008
    
    
    104.125
    %2009
    
    
    102.750
    %2010
    
    
    101.375
    %2011 and thereafter
    
    
    100.000
    %
 NOTE 8. PENSION PLAN. The Company has a nonqualified, supplementary defined benefit plan for
certain management employees. The plan is an unfunded, noncontributory plan and provides for
benefits based upon years of service and cash compensation during employment. Pension expense is based on information provided to an outside actuarial firm that uses assumptions
to estimate the total benefits ultimately payable to management employees and allocates this cost
to service periods. The actuarial assumptions used to calculate pension expense are reviewed
annually for reasonableness. The components of net periodic benefit costs for the plan were: (dollars in millions) 13 Weeks EndedApril 30, 2005
    
    
    May 1, 2004Components of pension expense:Service cost
    
    $
    0.2
    
    
    $
    0.2Interest cost
    
    
    0.3
    
    
    
    0.3Amortization of prior service cost
    
    
    
    
    
    
    0.1Amortization of actuarial loss
    
    
    0.1
    
    
    
    0.1Total
    
    $
    0.6
    
    
    $
    0.7
 9




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##### Table of Contents



NOTE 9. INCOME TAXES. The Companys effective income tax rate on continuing operations was
28.6 percent during the first quarter of 2005, including the benefit of released tax reserves
relating to favorable income tax audit settlements of $2.7 million. In total for fiscal 2005, the
effective income tax rate is expected to be approximately 35 percent, exclusive of the reserve
release which was discreet to the first quarter. The Companys effective income tax rate on
continuing operations was 33.3 percent in the first quarter of 2004. NOTE 10. COMPREHENSIVE INCOME. The following table shows the computation of comprehensive income: (dollars in millions) 13 Weeks EndedApril 30, 2005
    
    
    May 1, 2004Net earnings
    
    $
    30.2
    
    
    $
    14.1Other comprehensive loss:Foreign currency translation adjustments
    
    
    (0.1
    )
    
    
    (3.3
    )Total other comprehensive loss
    
    
    (0.1
    )
    
    
    (3.3
    )Total comprehensive income
    
    $
    30.1
    
    
    $
    10.8
 The changes in the Companys cumulative foreign currency translation adjustment were
not adjusted for income taxes, as they relate to specific indefinite investments in foreign
subsidiaries. NOTE 11. EARNINGS PER SHARE. Basic earnings per share are computed by dividing net earnings by the
weighted average number of shares of common stock outstanding during the period. Diluted earnings
per share include the effect of conversions of stock options and unearned restricted stock. The
calculation of diluted earnings per share for the thirteen-weeks ended April 30, 2005, and May 1,
2004, excludes the impact of 7,078,924 and 7,777,763 stock options, respectively, because to
include them would be anti-dilutive. The following table presents a reconciliation of the numerators and denominators of basic and
diluted earnings per share from continuing operations: (dollars and shares in millions, except per share ) 13 Weeks EndedApril 30, 2005
    
    
    May 1, 2004Diluted Computation:Net earnings from continuing operations
    
    $
    31.7
    
    
    $
    17.9Weighted average common shares outstanding
    
    
    67.1
    
    
    
    67.9Net effect of dilutive stock options and unearned
restricted stock based on the treasury stock method
    
    
    0.1
    
    
    
    0.1Outstanding shares for diluted earnings per share
    
    
    67.2
    
    
    
    68.0Diluted earnings per share from continuing operations
    
    $
    0.47
    
    
    $
    0.26Basic Computation:Net earnings from continuing operations
    
    $
    31.7
    
    
    $
    17.9Weighted average common shares outstanding
    
    
    67.1
    
    
    
    67.9Basic earnings per share from continuing operations
    
    $
    0.47
    
    
    $
    0.26
 10




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##### Table of Contents



NOTE 12. SEGMENT REPORTING. The Company and its subsidiaries are principally engaged in the
operation of retail locations offering family footwear and accessories. The Company operates its
business in two reportable business segments: Payless Domestic and Payless International. These
segments have been determined based on internal management reporting and management
responsibilities. The Payless Domestic segment includes retail operations in the United States,
Guam and Saipan and sourcing operations. The Payless International segment includes retail
operations in Canada, the South American Region, the Central American Region, Puerto Rico, the U.S.
Virgin Islands and operations in Japan. The Companys operations in its Central American Region,
its South American Region and Japan are operated as joint ventures in which the Company maintains a
60-percent ownership interest. Minority interest represents the Companys joint venture partners
share of net earnings or losses on applicable international operations. Certain management costs
for services performed by Payless Domestic and certain royalty fees and sourcing fees charged by
Payless Domestic are allocated to the Payless International segment. These total costs and fees
amounted to $4.4 million during the first quarter of 2005 and $3.6 million during the same period
in 2004. The Companys reporting period for its operations in the South American Region, the
Central American Region and Japan is a December 31 year-end. The effect of this one-month lag on
the Companys financial position and results of operations is not significant. Information on the
segments is as follows: (dollars in millions) Payless Domestic
    
    
    Payless International
    
    
    Payless ConsolidatedThirteen weeks ended April 30, 2005Revenues from external customers
    
    $
    615.0
    
    
    $
    80.2
    
    
    $
    695.2Operating profit from continuing
operations
    
    
    43.6
    
    
    
    3.4
    
    
    
    47.0Total assets
    
    
    1,111.3
    
    
    
    157.8
    
    
    
    1,269.1Thirteen weeks ended May 1, 2004Revenues from external customers
    
    $
    622.2
    
    
    $
    70.1
    
    
    $
    692.3Operating profit from continuing
operations
    
    
    25.7
    
    
    
    2.7
    
    
    
    28.4Total assets
    
    
    1,004.3
    
    
    
    224.0
    
    
    
    1,228.3
 Total assets for the Payless Domestic segment include $5.9 million in goodwill as of April 30,
2005, and May 1, 2004. NOTE 13. FOREIGN CURRENCY TRANSLATION. Local currencies are the functional currencies for all
subsidiaries. Accordingly, assets and liabilities of foreign subsidiaries are translated at the
rate of exchange at the balance sheet date. Adjustments from the translation process are
accumulated as part of other comprehensive income (loss) and are included as a separate component
of shareowners equity. The changes in foreign currency translation adjustments were not adjusted
for income taxes since they relate to indefinite term investments in non-United States
subsidiaries. Income and expense items of these subsidiaries are translated at average rates of
exchange. NOTE 14. CONTINGENCIES. On or about December 20, 2001, a First Amended Complaint was filed against
the Company in the U.S. District Court for the District of Oregon, captioned Adidas America, Inc.
and Adidas-Salomon AG v. Payless ShoeSource, Inc. The First Amended Complaint seeks injunctive
relief and unspecified monetary damages for trademark and trade dress infringement, unfair
competition, deceptive trade practices and breach of contract. The Company believes it has
meritorious defenses to claims asserted in the lawsuit and has filed an answer and a motion for
summary judgment which the court granted in part. An estimate of the possible loss, if any, or the
range of loss cannot be made. On or about January 20, 2000, a complaint was filed against the Company in the U.S. District Court
for the District of New Hampshire, captioned Howard J. Dananberg, D.P.M. v. Payless ShoeSource,
Inc. The Complaint seeks injunctive relief, unspecified treble monetary damages, attorneys fees,
interest and costs for patent infringement. The Company believes it has meritorious defenses to
claims asserted in the lawsuit. An estimate of the possible loss, if any, or the range of loss
cannot be made. NOTE 15. IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS. In March 2005, the Financial Accounting
Standards Board (FASB) issued FASB Interpretation No. 47, Accounting for Conditional Asset
Retirement Obligations  An Interpretation of FASB Statement No. 143 (FIN47). FIN47 clarifies
the term conditional asset retirement obligation as used in SFAS No. 143 and addresses the diverse
accounting practices that have developed with respect to the timing of liability recognition for
legal obligations associated with the retirement of a tangible long-lived asset when the timing and
(or) method of settlement of the obligation are conditional on a future event. In addition, FIN47
clarifies that an entity is required to recognize a liability for the fair value of a conditional
asset retirement obligation when incurred if the liabilitys fair value can be reasonably
estimated. FIN47 is effective no later than the end of fiscal year ending January 28, 2006. The
Company is currently evaluating the impact of FIN47 on its financial statements. 11




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##### Table of Contents



In December 2004, the FASB issued SFAS 153, Exchanges of Nonmonetary Assets, an amendment of APB
Opinion No. 29 (SFAS 153). SFAS 153 was issued primarily to improve the comparability of
accounting for exchanges of nonmonetary assets with the International Accounting Standards Board.
SFAS 153 requires that exchanges of nonmonetary assets be measured based on the fair value of the
assets exchanged. APB Opinion No. 29 included some exceptions to measuring exchanges at fair
value. SFAS 153 is effective for non-monetary asset exchanges occurring in fiscal periods
beginning after June 15, 2005, though early adoption is encouraged. The application of SFAS 153 is
not expected to have a material impact on the Companys consolidated financial statements. In
December 2004, the FASB issued SFAS 123(R), Share-Based Payment (SFAS 123(R)). SFAS 123(R)
provides accounting guidance for stock-based payments to employees. SFAS 123(R) revises SFAS 123
by eliminating the choice of using the recognition and measurement provisions of APB No. 25 and
requiring all companies to use the fair value method of measuring stock compensation expense. SFAS
123(R) clarifies and expands SFAS 123s guidance in several areas, including measuring fair value,
classifying an award as equity or liability, attributing compensation cost to reporting periods as
well as adding several new disclosure requirements. SFAS 123(R) also changes the accounting for
the tax effects of options, including the presentation of the tax effects on the consolidated
statements of cash flows.
SFAS 123(R) is effective for the first interim reporting period of the
Companys 2006 fiscal year. The Company is in the process of evaluating the statements impact on
its consolidated financial statements. In November 2004, the FASB issued SFAS 151, Inventory Costs. SFAS 151 requires that fixed
production costs be allocated to inventory based on the normal capacity of production facilities
and that unallocated overheads be recognized as an expense in the periods in which they are
incurred. In addition, other items such as abnormal freight, handling costs and amounts of wasted
materials require treatment as current-period charges rather than a portion of the inventory cost.
SFAS 151 is effective for inventory costs incurred during periods beginning after June 15, 2005.
The application of SFAS 151 is not expected to have a material impact on the Companys consolidated
financial statements. The American Jobs Creation Act of 2004 (the Act) was signed into law on October 22, 2004. The
FASB issued FASB Staff Position 109-2 in December 2004, which requires the recording of tax expense
if and when an entity decides to repatriate foreign earnings subject to the Act. On May 25, 2005,
the Company repatriated $25 million pursuant to the act. As of April 30, 2005, the Company
anticipates that it will repatriate between $45 million and $65 million pursuant to the Act. NOTE 16. SUBSEQUENT EVENT. On May 26, 2005, the Company announced a CEO succession plan and
entered into a letter agreement with its Chief Executive Officer, Steven J. Douglass, confirming
certain matters with respect to Mr. Douglass separation from the Company when his successor
commences employment. The letter agreement serves as Mr. Douglass notice of resignation upon his
separation from all director, officer and employee positions that he holds with the Company, its
subsidiaries and its affiliates. The Company expects to record a second quarter pre-tax charge
that is currently estimated to be approximately $7 million in connection with its obligations under
a previous employment agreement with the company. NOTE 17. SUBSIDIARY GUARANTORS OF SENIOR NOTES  CONDENSED CONSOLIDATING FINANCIAL
INFORMATION. The Company has issued Notes guaranteed by all of its domestic subsidiaries
(the Guarantor Subsidiaries). The Guarantor Subsidiaries are direct or indirect wholly owned
domestic subsidiaries of the Company. The guarantees are full and unconditional, to the extent
allowed by law, and joint and several. The following supplemental financial information sets forth, on a consolidating basis, the
condensed statements of earnings (loss) and cash flows for Payless ShoeSource, Inc., a Delaware
corporation (the Parent Company), for the Guarantor Subsidiaries and for the Companys
non-guarantor subsidiaries (the Non-guarantor Subsidiaries) and the Company for the thirteen-week
periods ended April 30, 2005, and May 1, 2004, and the related condensed consolidating balanced
sheets as of April 30, 2005, May 1, 2004, and January 29, 2005. The intercompany investment for
each subsidiary is recorded by its parent in Other Assets. The Non-guarantor Subsidiaries are made up of the Companys retail operations in the Central
American and South American Regions, Canada, Saipan, Puerto Rico and Japan and the Companys
sourcing organization in Hong Kong, Taiwan, China, Indonesia and Brazil. The operations in the
Central American and South American Regions use a December 31 year-end. Operations in the Central
American Region, the South American Region and Japan are included in our results on a one-month lag
relative to results from other regions. The effect of this one-month lag on our financial position
and results of operations is not significant. Under the indenture governing the Notes, the Companys subsidiaries in Singapore and Japan are
designated as unrestricted. The effect of these subsidiaries on the Companys financial position
and results of operations and cash flows is not significant. 12




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##### Table of Contents



CONDENSED CONSOLIDATING BALANCE SHEET
(UNAUDITED)
As of April 30, 2005 (dollars in millions) Parent
    
    
    Guarantor
    
    
    Non-guarantorCompany
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    ConsolidatedASSETSCurrent Assets:Cash and cash equivalents
    
    $
    
    
    
    $
    229.9
    
    
    $
    73.4
    
    
    $
    
    
    
    $
    303.3Restricted cash
    
    
    
    
    
    
    
    
    
    
    2.0
    
    
    
    
    
    
    
    2.0Inventories
    
    
    
    
    
    
    304.8
    
    
    
    84.1
    
    
    
    (5.0
    )
    
    
    383.9Current deferred income taxes
    
    
    
    
    
    
    20.9
    
    
    
    
    
    
    
    
    
    
    
    20.9Other current assets
    
    
    26.3
    
    
    
    51.8
    
    
    
    50.7
    
    
    
    (71.9
    )
    
    
    56.9Current assets of discontinued operations
    
    
    
    
    
    
    4.8
    
    
    
    
    
    
    
    
    
    
    
    4.8Total current assets
    
    
    26.3
    
    
    
    612.2
    
    
    
    210.2
    
    
    
    (76.9
    )
    
    
    771.8Property and Equipment:Land
    
    
    
    
    
    
    8.3
    
    
    
    
    
    
    
    
    
    
    
    8.3Buildings and leasehold improvements
    
    
    
    
    
    
    586.3
    
    
    
    76.5
    
    
    
    
    
    
    
    662.8Furniture, fixtures and equipment
    
    
    
    
    
    
    461.7
    
    
    
    61.1
    
    
    
    
    
    
    
    522.8Property under capital leases
    
    
    
    
    
    
    3.8
    
    
    
    
    
    
    
    
    
    
    
    3.8Total property and equipment
    
    
    
    
    
    
    1,060.1
    
    
    
    137.6
    
    
    
    
    
    
    
    1,197.7Accumulated depreciation and amortization
    
    
    
    
    
    
    (715.8
    )
    
    
    (70.0
    )
    
    
    
    
    
    
    (785.8
    )Property and equipment, net
    
    
    
    
    
    
    344.3
    
    
    
    67.6
    
    
    
    
    
    
    
    411.9Favorable leases, net
    
    
    
    
    
    
    20.8
    
    
    
    
    
    
    
    
    
    
    
    20.8Deferred income taxes
    
    
    
    
    
    
    24.4
    
    
    
    11.2
    
    
    
    
    
    
    
    35.6Goodwill, net
    
    
    
    
    
    
    5.9
    
    
    
    
    
    
    
    
    
    
    
    5.9Other assets
    
    
    1,090.1
    
    
    
    468.2
    
    
    
    1.8
    
    
    
    (1,537.0
    )
    
    
    23.1Total assets
    
    $
    1,116.4
    
    
    $
    1,475.8
    
    
    $
    290.8
    
    
    $
    (1,613.9
    )
    
    $
    1,269.1LIABILITIES AND SHAREOWNERS EQUITYCurrent Liabilities:Current maturities of long-term debt
    
    $
    
    
    
    $
    0.3
    
    
    $
    1.2
    
    
    $
    
    
    
    $
    1.5Notes payable
    
    
    
    
    
    
    
    
    
    
    2.0
    
    
    
    
    
    
    
    2.0Accounts payable
    
    
    
    
    
    
    151.6
    
    
    
    61.8
    
    
    
    (43.6
    )
    
    
    169.8Accrued expenses
    
    
    10.8
    
    
    
    159.9
    
    
    
    20.8
    
    
    
    (33.3
    )
    
    
    158.2Current liabilities of discontinued operations
    
    
    
    
    
    
    5.0
    
    
    
    
    
    
    
    
    
    
    
    5.0Total current liabilities
    
    
    10.8
    
    
    
    316.8
    
    
    
    85.8
    
    
    
    (76.9
    )
    
    
    336.5Long-term debt
    
    
    480.2
    
    
    
    0.8
    
    
    
    6.4
    
    
    
    (283.1
    )
    
    
    204.3Other liabilities
    
    
    1.5
    
    
    
    82.2
    
    
    
    19.9
    
    
    
    (7.8
    )
    
    
    95.8Minority interest
    
    
    
    
    
    
    
    
    
    
    8.6
    
    
    
    
    
    
    
    8.6Total shareowners equity
    
    
    623.9
    
    
    
    1,076.0
    
    
    
    170.1
    
    
    
    (1,246.1
    )
    
    
    623.9Total liabilities and shareowners equity
    
    $
    1,116.4
    
    
    $
    1,475.8
    
    
    $
    290.8
    
    
    $
    (1,613.9
    )
    
    $
    1,269.1
 13




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##### Table of Contents



CONDENSED CONSOLIDATING BALANCE SHEET
(UNAUDITED)
As of May 1, 2004 (dollars in millions) Parent
    
    
    Guarantor
    
    
    Non-guarantorCompany
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    ConsolidatedASSETSCurrent Assets:Cash and cash equivalents
    
    $
    
    
    
    $
    88.2
    
    
    $
    33.1
    
    
    $
    
    
    
    $
    121.3Marketable securities, available for sale
    
    
    
    
    
    
    4.0
    
    
    
    
    
    
    
    
    
    
    
    4.0Restricted cash
    
    
    
    
    
    
    
    
    
    
    33.5
    
    
    
    
    
    
    
    33.5Inventories
    
    
    
    
    
    
    347.9
    
    
    
    80.2
    
    
    
    (5.9
    )
    
    
    422.2Current deferred income taxes
    
    
    
    
    
    
    16.6
    
    
    
    0.1
    
    
    
    
    
    
    
    16.7Other current assets
    
    
    9.0
    
    
    
    55.1
    
    
    
    38.8
    
    
    
    (38.0
    )
    
    
    64.9Current assets of discontinued operations
    
    
    
    
    
    
    22.1
    
    
    
    5.3
    
    
    
    
    
    
    
    27.4Total current assets
    
    
    9.0
    
    
    
    533.9
    
    
    
    191.0
    
    
    
    (43.9
    )
    
    
    690.0Property and Equipment:Land
    
    
    
    
    
    
    8.0
    
    
    
    
    
    
    
    
    
    
    
    8.0Buildings and leasehold improvements
    
    
    
    
    
    
    610.5
    
    
    
    72.0
    
    
    
    
    
    
    
    682.5Furniture, fixtures and equipment
    
    
    
    
    
    
    448.9
    
    
    
    55.3
    
    
    
    
    
    
    
    504.2Property under capital leases
    
    
    
    
    
    
    4.6
    
    
    
    
    
    
    
    
    
    
    
    4.6Total property and equipment
    
    
    
    
    
    
    1,072.0
    
    
    
    127.3
    
    
    
    
    
    
    
    1,199.3Accumulated depreciation and amortization
    
    
    
    
    
    
    (721.2
    )
    
    
    (56.2
    )
    
    
    
    
    
    
    (777.4
    )Property and equipment, net
    
    
    
    
    
    
    350.8
    
    
    
    71.1
    
    
    
    
    
    
    
    421.9Favorable leases, net
    
    
    
    
    
    
    26.9
    
    
    
    
    
    
    
    
    
    
    
    26.9Deferred income taxes
    
    
    
    
    
    
    26.7
    
    
    
    7.0
    
    
    
    
    
    
    
    33.7Goodwill, net
    
    
    
    
    
    
    5.9
    
    
    
    
    
    
    
    
    
    
    
    5.9Other assets
    
    
    1,091.5
    
    
    
    439.5
    
    
    
    0.7
    
    
    
    (1,510.0
    )
    
    
    21.7Non-current assets of discontinued operations
    
    
    
    
    
    
    18.6
    
    
    
    9.6
    
    
    
    
    
    
    
    28.2Total assets
    
    $
    1,100.5
    
    
    $
    1,402.3
    
    
    $
    279.4
    
    
    $
    (1,553.9
    )
    
    $
    1,228.3LIABILITIES AND SHAREOWNERS EQUITYCurrent Liabilities:Current maturities of long-term debt
    
    $
    
    
    
    $
    0.9
    
    
    $
    
    
    
    $
    
    
    
    $
    0.9Notes payable
    
    
    
    
    
    
    
    
    
    
    33.5
    
    
    
    
    
    
    
    33.5Accounts payable
    
    
    
    
    
    
    93.4
    
    
    
    61.2
    
    
    
    (28.1
    )
    
    
    126.5Accrued expenses
    
    
    2.9
    
    
    
    134.8
    
    
    
    18.2
    
    
    
    (15.8
    )
    
    
    140.1Current liabilities of discontinued operations
    
    
    
    
    
    
    4.4
    
    
    
    1.6
    
    
    
    
    
    
    
    6.0Total current liabilities
    
    
    2.9
    
    
    
    233.5
    
    
    
    114.5
    
    
    
    (43.9
    )
    
    
    307.0Long-term debt
    
    
    479.8
    
    
    
    1.8
    
    
    
    4.0
    
    
    
    (283.0
    )
    
    
    202.6Other liabilities
    
    
    
    
    
    
    128.7
    
    
    
    13.4
    
    
    
    (56.3
    )
    
    
    85.8Non-current liabilities of discontinued operations
    
    
    
    
    
    
    4.6
    
    
    
    0.1
    
    
    
    
    
    
    
    4.7Minority interest
    
    
    
    
    
    
    
    
    
    
    13.1
    
    
    
    
    
    
    
    13.1Commitments and contingencies
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total shareowners equity
    
    
    617.8
    
    
    
    1,033.7
    
    
    
    134.3
    
    
    
    (1,170.7
    )
    
    
    615.1Total liabilities and shareowners equity
    
    $
    1,100.5
    
    
    $
    1,402.3
    
    
    $
    279.4
    
    
    $
    (1,553.9
    )
    
    $
    1,228.3
 14




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##### Table of Contents



CONDENSED CONSOLIDATING BALANCE SHEET
(UNAUDITED)
As of January 29, 2005 (dollars in millions) Parent
    
    
    Guarantor
    
    
    Non-guarantorCompany
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    ConsolidatedASSETSCurrent Assets:Cash and cash equivalents
    
    $
    
    
    
    $
    210.8
    
    
    $
    78.8
    
    
    $
    
    
    
    $
    289.6Marketable securities, available for sale
    
    
    
    
    
    
    5.0
    
    
    
    
    
    
    
    
    
    
    
    5.0Restricted cash
    
    
    
    
    
    
    
    
    
    
    3.0
    
    
    
    
    
    
    
    3.0Inventories
    
    
    
    
    
    
    277.1
    
    
    
    71.0
    
    
    
    (2.8
    )
    
    
    345.3Current deferred income taxes
    
    
    
    
    
    
    21.9
    
    
    
    
    
    
    
    
    
    
    
    21.9Other current assets
    
    
    16.8
    
    
    
    50.6
    
    
    
    50.1
    
    
    
    (60.9
    )
    
    
    56.6Current assets of discontinued operations
    
    
    
    
    
    
    8.5
    
    
    
    
    
    
    
    
    
    
    
    8.5Total current assets
    
    
    16.8
    
    
    
    573.9
    
    
    
    202.9
    
    
    
    (63.7
    )
    
    
    729.9Property and Equipment:Land
    
    
    
    
    
    
    8.0
    
    
    
    
    
    
    
    
    
    
    
    8.0Buildings and leasehold improvements
    
    
    
    
    
    
    597.1
    
    
    
    76.2
    
    
    
    
    
    
    
    673.3Furniture, fixtures and equipment
    
    
    
    
    
    
    450.4
    
    
    
    59.4
    
    
    
    
    
    
    
    509.8Property under capital leases
    
    
    
    
    
    
    3.8
    
    
    
    
    
    
    
    
    
    
    
    3.8Total property and equipment
    
    
    
    
    
    
    1,059.3
    
    
    
    135.6
    
    
    
    
    
    
    
    1,194.9Accumulated depreciation and amortization
    
    
    
    
    
    
    (705.7
    )
    
    
    (66.9
    )
    
    
    
    
    
    
    (772.6
    )Property and equipment, net
    
    
    
    
    
    
    353.6
    
    
    
    68.7
    
    
    
    
    
    
    
    422.3Favorable leases, net
    
    
    
    
    
    
    21.7
    
    
    
    
    
    
    
    
    
    
    
    21.7Deferred income taxes
    
    
    
    
    
    
    25.1
    
    
    
    11.3
    
    
    
    
    
    
    
    36.4Goodwill, net
    
    
    
    
    
    
    5.9
    
    
    
    
    
    
    
    
    
    
    
    5.9Other assets
    
    
    1,067.1
    
    
    
    448.5
    
    
    
    1.9
    
    
    
    (1,494.0
    )
    
    
    23.5Non-current assets of discontinued operations
    
    
    
    
    
    
    0.1
    
    
    
    
    
    
    
    
    
    
    
    0.1Total assets
    
    $
    1,083.9
    
    
    $
    1,428.8
    
    
    $
    284.8
    
    
    $
    (1,557.7
    )
    
    $
    1,239.8LIABILITIES AND SHAREOWNERS EQUITYCurrent Liabilities:Current maturities of long-term debt
    
    $
    
    
    
    $
    0.3
    
    
    $
    
    
    
    $
    
    
    
    $
    0.3Notes payable
    
    
    
    
    
    
    
    
    
    
    3.0
    
    
    
    
    
    
    
    3.0Accounts payable
    
    
    
    
    
    
    130.6
    
    
    
    68.8
    
    
    
    (39.1
    )
    
    
    160.3Accrued expenses
    
    
    7.2
    
    
    
    156.9
    
    
    
    20.2
    
    
    
    (24.6
    )
    
    
    159.7Current liabilities of discontinued operations
    
    
    
    
    
    
    15.0
    
    
    
    
    
    
    
    
    
    
    
    15.0Total current liabilities
    
    
    7.2
    
    
    
    302.8
    
    
    
    92.0
    
    
    
    (63.7
    )
    
    
    338.3Long-term debt
    
    
    480.2
    
    
    
    0.9
    
    
    
    6.4
    
    
    
    (283.2
    )
    
    
    204.3Other liabilities
    
    
    1.5
    
    
    
    82.8
    
    
    
    13.7
    
    
    
    (4.4
    )
    
    
    93.6Minority interest
    
    
    
    
    
    
    
    
    
    
    8.6
    
    
    
    
    
    
    
    8.6Commitments and contingencies
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total shareowners equity
    
    
    595.0
    
    
    
    1,042.3
    
    
    
    164.1
    
    
    
    (1,206.4
    )
    
    
    595.0Total liabilities and shareowners equity
    
    $
    1,083.9
    
    
    $
    1,428.8
    
    
    $
    284.8
    
    
    $
    (1,557.7
    )
    
    $
    1,239.8
 15




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##### Table of Contents



CONDENSED CONSOLIDATING STATEMENT OF EARNINGS (LOSS)
(UNAUDITED)
For the Thirteen Weeks Ended April 30, 2005 (dollars in millions) Parent
    
    
    Guarantor
    
    
    Non-guarantorCompany
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    ConsolidatedNet sales
    
    $
    
    
    
    $
    643.0
    
    
    $
    164.6
    
    
    $
    (112.4
    )
    
    $
    695.2Cost of sales
    
    
    
    
    
    
    427.3
    
    
    
    133.4
    
    
    
    (109.9
    )
    
    
    450.8Gross Margin
    
    
    
    
    
    
    215.7
    
    
    
    31.2
    
    
    
    (2.5
    )
    
    
    244.4Selling, general and administrative expense
    
    
    0.6
    
    
    
    173.4
    
    
    
    25.2
    
    
    
    (2.5
    )
    
    
    196.7Restructuring charges
    
    
    
    
    
    
    0.7
    
    
    
    
    
    
    
    
    
    
    
    0.7Operating (loss) profit from continuing operations
    
    
    (0.6
    )
    
    
    41.6
    
    
    
    6.0
    
    
    
    
    
    
    
    47.0Interest expense
    
    
    7.3
    
    
    
    0.3
    
    
    
    0.5
    
    
    
    (3.2
    )
    
    
    4.9Interest income
    
    
    
    
    
    
    (4.4
    )
    
    
    (0.5
    )
    
    
    3.2
    
    
    
    (1.7
    )Equity in (earnings) loss of subsidiaries
    
    
    (35.3
    )
    
    
    (6.1
    )
    
    
    
    
    
    
    41.4
    
    
    
    Earnings (loss) from continuing operations before
income taxes and minority interest
    
    
    27.4
    
    
    
    51.8
    
    
    
    6.0
    
    
    
    (41.4
    )
    
    
    43.8(Benefit) provision for income taxes
    
    
    (2.8
    )
    
    
    15.0
    
    
    
    0.3
    
    
    
    
    
    
    
    12.5Earnings (loss) from continuing operations before
minority interest
    
    
    30.2
    
    
    
    36.8
    
    
    
    5.7
    
    
    
    (41.4
    )
    
    
    31.3Minority interest, net of income tax
    
    
    
    
    
    
    
    
    
    
    0.4
    
    
    
    
    
    
    
    0.4Net earnings (loss) from continuing operations
    
    
    30.2
    
    
    
    36.8
    
    
    
    6.1
    
    
    
    (41.4
    )
    
    
    31.7Loss from discontinued operations, net of income
taxes and minority interest
    
    
    
    
    
    
    (1.5
    )
    
    
    
    
    
    
    
    
    
    
    (1.5
    )Net earnings (loss)
    
    $
    30.2
    
    
    $
    35.3
    
    
    $
    6.1
    
    
    $
    (41.4
    )
    
    $
    30.2
 16




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##### Table of Contents



CONDENSED CONSOLIDATING STATEMENT OF EARNINGS (LOSS)
(UNAUDITED)
For the Thirteen Weeks Ended May 1, 2004 (dollars in millions) Parent
    
    
    Guarantor
    
    
    Non-guarantorCompany
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    ConsolidatedNet sales
    
    $
    
    
    
    $
    651.4
    
    
    $
    161.5
    
    
    $
    (120.6
    )
    
    $
    692.3Cost of sales
    
    
    
    
    
    
    457.1
    
    
    
    136.8
    
    
    
    (118.4
    )
    
    
    475.5Gross margin
    
    
    
    
    
    
    194.3
    
    
    
    24.7
    
    
    
    (2.2
    )
    
    
    216.8Selling, general and administrative expense
    
    
    0.5
    
    
    
    167.9
    
    
    
    22.2
    
    
    
    (2.2
    )
    
    
    188.4Restructuring charges
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Operating (loss) profit from continuing operations
    
    
    (0.5
    )
    
    
    26.4
    
    
    
    2.5
    
    
    
    
    
    
    
    28.4Interest expense
    
    
    6.2
    
    
    
    0.3
    
    
    
    1.1
    
    
    
    (2.2
    )
    
    
    5.4Interest income
    
    
    
    
    
    
    (2.3
    )
    
    
    (0.9
    )
    
    
    2.2
    
    
    
    (1.0
    )Equity in (earnings) loss of subsidiaries
    
    
    (18.4
    )
    
    
    (3.2
    )
    
    
    
    
    
    
    21.6
    
    
    
    Earnings (loss) from continuing operations before
income taxes and minority interest
    
    
    11.7
    
    
    
    31.6
    
    
    
    2.3
    
    
    
    (21.6
    )
    
    
    24.0(Benefit) provision for income taxes
    
    
    (2.4
    )
    
    
    10.6
    
    
    
    (0.2
    )
    
    
    
    
    
    
    8.0Earnings (loss) from continuing operations before
minority interest
    
    
    14.1
    
    
    
    21.0
    
    
    
    2.5
    
    
    
    (21.6
    )
    
    
    16.0Minority interest, net of income tax
    
    
    
    
    
    
    
    
    
    
    1.9
    
    
    
    
    
    
    
    1.9Net earnings (loss) from continuing operations
    
    
    14.1
    
    
    
    21.0
    
    
    
    4.4
    
    
    
    (21.6
    )
    
    
    17.9Loss from discontinued operations, net of income
taxes and minority interest
    
    
    
    
    
    
    (2.6
    )
    
    
    (1.2
    )
    
    
    
    
    
    
    (3.8
    )Net earnings (loss)
    
    $
    14.1
    
    
    $
    18.4
    
    
    $
    3.2
    
    
    $
    (21.6
    )
    
    $
    14.1
 17




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##### Table of Contents



CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
(UNAUDITED)
For the Thirteen Weeks Ended April 30, 2005 (dollars in millions) Parent
    
    
    Guarantor
    
    
    Non-guarantorCompany
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    ConsolidatedOperating Activities:Net earnings
    
    $
    30.2
    
    
    $
    35.3
    
    
    $
    6.1
    
    
    $
    (41.4
    )
    
    $
    30.2Loss from discontinued operations, net of
income taxes and minority interest
    
    
    
    
    
    
    (1.5
    )
    
    
    
    
    
    
    
    
    
    
    (1.5
    )Net earnings from continuing operations
    
    
    30.2
    
    
    
    36.8
    
    
    
    6.1
    
    
    
    (41.4
    )
    
    
    31.7Adjustments for non-cash items included in
earnings from continuing operations:Loss on impairment of and disposal of assets
    
    
    
    
    
    
    2.3
    
    
    
    0.1
    
    
    
    
    
    
    
    2.4Depreciation and amortization
    
    
    
    
    
    
    21.7
    
    
    
    1.3
    
    
    
    
    
    
    
    23.0Amortization of deferred financing costs
    
    
    
    
    
    
    0.3
    
    
    
    
    
    
    
    
    
    
    
    0.3Amortization of unearned restricted stock
    
    
    0.2
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    0.2Deferred income taxes
    
    
    
    
    
    
    1.7
    
    
    
    
    
    
    
    
    
    
    
    1.7Minority interest, net of tax
    
    
    
    
    
    
    
    
    
    
    (0.4
    )
    
    
    
    
    
    
    (0.4
    )Changes in working capital:Inventories
    
    
    
    
    
    
    (27.7
    )
    
    
    (13.2
    )
    
    
    2.2
    
    
    
    (38.7
    )Other current assets
    
    
    (9.5
    )
    
    
    (1.2
    )
    
    
    (1.5
    )
    
    
    11.0
    
    
    
    (1.2
    )Accounts payable
    
    
    
    
    
    
    21.0
    
    
    
    (8.2
    )
    
    
    (4.5
    )
    
    
    8.3Accrued expenses
    
    
    3.6
    
    
    
    3.0
    
    
    
    0.6
    
    
    
    (8.7
    )
    
    
    (1.5
    )Other assets and liabilities, net
    
    
    (23.1
    )
    
    
    (22.3
    )
    
    
    6.4
    
    
    
    41.4
    
    
    
    2.4Net cash provided by (used in) discontinued
operations
    
    
    
    
    
    
    (7.7
    )
    
    
    
    
    
    
    
    
    
    
    (7.7
    )Cash flow provided by (used in) operating
activities
    
    
    1.4
    
    
    
    27.9
    
    
    
    (8.8
    )
    
    
    
    
    
    
    20.5Investing Activities:Capital expenditures
    
    
    
    
    
    
    (13.5
    )
    
    
    (0.3
    )
    
    
    
    
    
    
    (13.8
    )Sales of marketable securities
    
    
    
    
    
    
    5.0
    
    
    
    
    
    
    
    
    
    
    
    5.0Investment in subsidiaries
    
    
    
    
    
    
    (0.3
    )
    
    
    
    
    
    
    0.3
    
    
    
    Cash flow used in investing activities from
continuing operations
    
    
    
    
    
    
    (8.8
    )
    
    
    (0.3
    )
    
    
    0.3
    
    
    
    (8.8
    )Financing Activities:Repayment on notes payable
    
    
    
    
    
    
    
    
    
    
    (1.0
    )
    
    
    
    
    
    
    (1.0
    )Restricted cash
    
    
    
    
    
    
    
    
    
    
    1.0
    
    
    
    
    
    
    
    1.0Issuance of debt
    
    
    
    
    
    
    
    
    
    
    1.2
    
    
    
    
    
    
    
    1.2Issuances of common stock
    
    
    0.7
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    0.7Purchases of common stock
    
    
    (2.1
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2.1
    )Contributions by parents
    
    
    
    
    
    
    
    
    
    
    0.3
    
    
    
    (0.3
    )
    
    
    Contributions by minority owners
    
    
    
    
    
    
    
    
    
    
    0.2
    
    
    
    
    
    
    
    0.2Cash flow (used in) provided by financing
activities from continuing operations
    
    
    (1.4
    )
    
    
    
    
    
    
    1.7
    
    
    
    (0.3
    )
    
    
    Effect of exchange rate changes on cash
    
    
    
    
    
    
    
    
    
    
    2.0
    
    
    
    
    
    
    
    2.0Increase (decrease) in cash and cash equivalents
    
    
    
    
    
    
    19.1
    
    
    
    (5.4
    )
    
    
    
    
    
    
    13.7Cash and cash equivalents, beginning of period
    
    
    
    
    
    
    210.8
    
    
    
    78.8
    
    
    
    
    
    
    
    289.6Cash and cash equivalents, end of period
    
    $
    
    
    
    $
    229.9
    
    
    $
    73.4
    
    
    $
    
    
    
    $
    303.3
 18




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##### Table of Contents



CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
(UNAUDITED)
For the Thirteen Weeks Ended May 1, 2004 (dollars in millions) Parent
    
    
    Guarantor
    
    
    Non-guarantorCompany
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    ConsolidatedOperating Activities:Net earnings
    
    $
    14.1
    
    
    $
    18.4
    
    
    $
    3.2
    
    
    $
    (21.6
    )
    
    $
    14.1Loss from discontinued operations, net of
income taxes and minority interest
    
    
    
    
    
    
    (2.6
    )
    
    
    (1.2
    )
    
    
    
    
    
    
    (3.8
    )Net earnings from continuing operations
    
    
    14.1
    
    
    
    21.0
    
    
    
    4.4
    
    
    
    (21.6
    )
    
    
    17.9Adjustments for non-cash items included in
earnings from continuing operations:Loss on impairment of and disposal of assets
    
    
    
    
    
    
    2.6
    
    
    
    0.2
    
    
    
    
    
    
    
    2.8Depreciation and amortization
    
    
    
    
    
    
    21.8
    
    
    
    2.8
    
    
    
    
    
    
    
    24.6Amortization of deferred financing costs
    
    
    
    
    
    
    0.2
    
    
    
    
    
    
    
    
    
    
    
    0.2Amortization of unearned restricted stock
    
    
    0.2
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    0.2Deferred income taxes
    
    
    
    
    
    
    1.4
    
    
    
    (2.2
    )
    
    
    
    
    
    
    (0.8
    )Minority interest, net of tax
    
    
    
    
    
    
    
    
    
    
    (1.9
    )
    
    
    
    
    
    
    (1.9
    )Changes in working capital:Inventories
    
    
    
    
    
    
    (39.4
    )
    
    
    (10.3
    )
    
    
    1.7
    
    
    
    (48.0
    )Other current assets
    
    
    (2.4
    )
    
    
    16.8
    
    
    
    (1.2
    )
    
    
    (17.3
    )
    
    
    (4.1
    )Accounts payable
    
    
    
    
    
    
    9.1
    
    
    
    (36.0
    )
    
    
    23.9
    
    
    
    (3.0
    )Accrued expenses
    
    
    (4.6
    )
    
    
    26.7
    
    
    
    2.5
    
    
    
    (8.3
    )
    
    
    16.3Other assets and liabilities, net
    
    
    (6.8
    )
    
    
    (15.6
    )
    
    
    7.7
    
    
    
    21.6
    
    
    
    6.9Net cash provided by (used in) discontinued
operations
    
    
    
    
    
    
    (5.7
    )
    
    
    0.2
    
    
    
    
    
    
    
    (5.5
    )Cash flow provided by operating activities
    
    
    0.5
    
    
    
    38.9
    
    
    
    (33.8
    )
    
    
    
    
    
    
    5.6Investing Activities:Capital expenditures
    
    
    
    
    
    
    (23.8
    )
    
    
    (2.4
    )
    
    
    
    
    
    
    (26.2
    )Purchase of marketable securities
    
    
    
    
    
    
    (4.0
    )
    
    
    
    
    
    
    
    
    
    
    (4.0
    )Sales of marketable securities
    
    
    
    
    
    
    10.0
    
    
    
    
    
    
    
    
    
    
    
    10.0Investment in subsidiaries
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Cash flow used in investing activities
    
    
    
    
    
    
    (17.8
    )
    
    
    (2.4
    )
    
    
    
    
    
    
    (20.2
    )Financing Activities:Repayment on notes payable
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Restricted cash
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Issuance of debt
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Payment of deferred financing costs
    
    
    (0.1
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (0.1
    )Repayment of debt
    
    
    
    
    
    
    (0.3
    )
    
    
    
    
    
    
    
    
    
    
    (0.3
    )Issuances of common stock
    
    
    0.3
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    0.3Purchases of common stock
    
    
    (0.7
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (0.7
    )Contributions by parents
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Contributions by minority owners
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Cash flow used in financing activities
    
    
    (0.5
    )
    
    
    (0.3
    )
    
    
    
    
    
    
    
    
    
    
    (0.8
    )Effect of exchange rate changes on cash
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Decrease in cash and cash equivalents
    
    
    
    
    
    
    20.8
    
    
    
    (36.2
    )
    
    
    
    
    
    
    (15.4
    )Cash and cash equivalents, beginning of period
    
    
    
    
    
    
    67.4
    
    
    
    69.3
    
    
    
    
    
    
    
    136.7Cash and cash equivalents, end of period
    
    $
    
    
    
    $
    88.2
    
    
    $
    33.1
    
    
    $
    
    
    
    $
    121.3
 19




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##### Table of Contents



ITEM 2  MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This discussion and analysis should be read in conjunction with the Condensed Consolidated
Financial Statements and Notes to the Condensed Consolidated Financial Statements included in this
Form 10-Q. FORWARD-LOOKING STATEMENTS This report contains forward-looking statements relating to such matters as anticipated financial
performance, international expansion opportunities, consumer spending patterns, capital expenditure
plans, business prospects, products, future store openings and closings, possible strategic
initiatives and similar matters. Forward looking statements are identified by words such as
expects, anticipates, intends, plans, believes, seeks, or variations of such words. A
variety of known and unknown risks and uncertainties and other factors could cause actual results
and expectations to differ materially from the anticipated results or expectations which include,
but are not limited to: changes in consumer spending patterns; changes in consumer preferences and
overall economic conditions; the impact of competition and pricing; changes in weather patterns;
the financial condition of the Companys suppliers and manufacturers; changes in existing or
potential duties, tariffs or quotas; changes in relationships between the United States and foreign
countries, changes in relationships between Canada and foreign countries; economic and political
instability in foreign countries, or restrictive actions by the governments of foreign countries in
which suppliers and manufacturers from whom the Company sources are located or in which the Company
has retail locations or otherwise does business; changes in trade, customs and/or tax laws;
fluctuations in currency exchange rates; availability of suitable store locations on acceptable
terms; the ability to terminate leases on acceptable terms; the ability to hire and retain
associates; performance of other parties in strategic alliances; general economic, business and
social conditions in the countries from which we source products, supplies or have or intend to
open stores; performance of partners in joint ventures; the ability to comply with local laws in
foreign countries; threats or acts of terrorism; strikes, work stoppages and/or slowdowns by unions
that play a significant role in the manufacture, distribution or sale of product; congestion at
major ocean ports; changes in the value of the dollar relative to the Chinese yuan and other
currencies. Please refer to the Companys 2004 Annual Report on Form 10-K for the fiscal year
ended January 29, 2005 for more information on these and other risk factors that could cause actual
results to differ. The Company does not undertake any obligation to release publicly any revisions
to such forward-looking statements to reflect events or circumstances after the date hereof or to
reflect the occurrence of unanticipated events. OVERVIEW We are the largest specialty family footwear retailer in the Western Hemisphere with retail stores
in the United States, Canada, the Caribbean, and the Central American and South American Regions.
The Central American Region is composed of operations in Costa Rica, the Dominican Republic, El
Salvador, Guatemala, Honduras, Nicaragua, Panama and Trinidad & Tobago. The South American Region
is composed of operations in Ecuador. Our stores offer fashionable, quality, private label and
branded footwear and accessories for women, men and children at affordable prices in a
self-selection shopping format. During 2004, we substantially completed a series of strategic initiatives as part of a
restructuring plan designed to sharpen our focus on our core business strategy, reduce expenses,
accelerate decision-making, increase profitability, improve our operating margin and build value
for shareowners over the long-term. The strategic initiatives included 1) closing all Parade
stores and related operations, 2) the sale of Chile and Peru entities, 3) closing of approximately
260 Payless ShoeSource stores, 4) ceasing wholesale businesses with no significant growth
opportunity and 5) eliminating approximately 200 management and administrative positions. As a
result of the restructuring, we have reflected the financial information of the Parade, Peru and
Chile stores and 26 of the Payless closed stores as discontinued operations in the Condensed
Consolidated Financial Statements. Unless otherwise noted, the amounts and discussions included in
this Managements Discussion and Analysis of Financial Condition and Results of Operations relate
to continuing operations. For the first quarter of 2005, total sales increased 0.4 percent, or $2.9 million, to $695.2
million as compared to the first quarter of the prior year. Same-store sales, one of the key
indicators we consider as a measure of performance, increased 2.7 percent. Gross margin was 35.1
percent of sales in the current years first quarter, versus 31.3 percent in the prior years first
quarter. The improvement in gross margin resulted primarily from more favorable initial mark-on
relative to last year and the positive leverage on occupancy costs due to increased sales.
Inventory condition also continued to improve in the first quarter. We believe that inventory is
currently in excellent condition, with a low level of aged merchandise. In total, Cost of Sales
decreased by $24.7 million in the first quarter of 2005. The improvements in inventory condition
in addition to other items relating to the costing of inventory represented approximately $12
million of the reduction in Cost of Sales in the first quarter and are unlikely to occur in this
magnitude during future quarters. 20




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##### Table of Contents



Our cash and cash equivalents balance at the end of the 2005 first quarter was $303.3 million, an
increase of $13.7 million from the end of 2004 and $182.0 million over the 2004 first quarter.
Total inventories at the end of the 2005 first quarter were $383.9 million, a reduction of $38.3
million from the 2004 first quarter. Inventory per store declined by 5.6 percent on a cost basis
and 6.3 percent on a footwear unit basis over the same period. We are committed to serving the interest of our shareowners by building long-term value through
consistent execution of our core business strategy: to be the Merchandise Authority in value-priced
footwear and accessories. We will strive for continued improvements in operating results by:  
    Maintaining a singular focus on our core business, the Payless ShoeSource chain of
family footwear stores;
    Accelerating customer acceptance of the Merchandise Authority positioning in
value-priced footwear and accessories, differentiating our product offering from other
retailers;
    Continuing our efforts to build select athletic and casual lifestyle brands that
provide styling and quality to a broader audience of customers;
    Refocusing our marketing efforts to build more customer traffic in the Payless stores
and communicate our Merchandise Authority position more clearly;
    Continuing to improve our information technology to manage inventory, pricing and store operations;
    Continuing to pursue gross margin improvement relative to 2004;
    Maintaining disciplined control of expenses; and,
    Improving the in-store shopping experience. REVIEW OF OPERATIONS The following discussion summarizes the significant factors affecting operating results for the
first quarter ended April 30, 2005 (2005) compared to May 1, 2004 (2004). NET EARNINGS We posted net earnings of $30.2 million in the first quarter of 2005 compared with net earnings of
$14.1 million in the first quarter of 2004. The following table presents the components of costs and expenses, as a percent of revenues, for
the first quarter of 2005 and 2004. 21




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##### Table of Contents



First Quarter2005
    
    
    2004Cost of sales
    
    
    64.9
    %
    
    
    68.7
    %Selling, general and administrative expense
    
    
    28.3
    
    
    
    27.2Restructuring charges
    
    
    0.1
    
    
    
    Operating profit from continuing operations
    
    
    6.7
    
    
    
    4.1Interest expense, net
    
    
    0.4
    
    
    
    0.6Earnings from continuing operations before income
taxes and minority interest
    
    
    6.3
    
    
    
    3.5Effective income tax rate*
    
    
    28.6
    %
    
    
    33.3
    %Earnings from continuing operations before minority
interest
    
    
    4.5
    
    
    
    2.3Minority interest
    
    
    0.1
    
    
    
    0.3Earnings from continuing operations
    
    
    4.6
    
    
    
    2.6Loss from discontinued operations, net of income taxes
and minority interest
    
    
    (0.3
    )
    
    
    (0.6
    )Net Earnings
    
    
    4.3
    %
    
    
    2.0
    %
   * Percent of pre-tax earnings NET SALES Net sales are recognized at the time the sale is made to the customer, are net of estimated returns
and current promotional discounts and exclude sales tax. Same-store sales are calculated on a
weekly basis. If a store is open the entire week in each of the two years being compared, its GAAP
sales are included in the same-store sales calculation for that week. Relocated and remodeled
stores are also included in the same-store sales calculation if they were open during the entire
week in each of the two years being compared. Same-store sales for the first quarter of 2005 and
2004 exclude all stores in the South American and Central American Regions. Sales percent increases (decreases) are as follows: First Quarter2005
    
    
    2004Net Sales
    
    
    0.4
    %
    
    
    3.7
    %Same-store Sales
    
    
    2.7
    
    
    
    2.9Average selling price per unit
    
    
    5.4
    
    
    
    7.5Unit volume
    
    
    (4.9
    )
    
    
    (3.7
    )Footwear average selling price per unit
    
    
    2.8
    
    
    
    0.4Footwear unit volume
    
    
    (1.4
    )%
    
    
    2.5
    %
 Net sales for the 2005 first quarter totaled $695.2 million compared with $692.3 million in
the 2004 first quarter. Net sales increased, despite a reduction in 178 stores classified as
continuing operations, and same-store sales increased in the first quarter of 2005 from 2004
primarily due to positive performance in branded athletics, particularly womens, and womens
casual footwear. Our mens and accessories businesses performed below expectations. COST OF SALES Cost of sales includes cost of merchandise sold and our buying and occupancy costs. Cost of sales
was $450.8 million in the 2005 first quarter, down 5.2 percent from $475.5 million in the 2004
first quarter. 22




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##### Table of Contents



As a percentage of net sales, cost of sales was 64.9 percent in the first quarter of 2005, compared
with 68.7 percent in the first quarter of 2004. The decrease in cost of sales as a percentage of
net sales was due primarily to more favorable initial mark-on relative to last year and the
positive leverage on occupancy costs due to increased sales. Inventory condition also continued to
improve in the first quarter. We believe that inventory is currently in excellent condition, with
a low level of aged merchandise. In total, Cost of Sales decreased by $24.7 million in the first
quarter of 2005. The improvements in inventory condition in addition to other items relating to
the costing of inventory represented approximately $12 million of the reduction in Cost of Sales in
the first quarter and are unlikely to occur in this magnitude during future quarters. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES Selling, general and administrative expenses were $196.7 million in the first quarter of 2005, an
increase of 4.4 percent from $188.4 million in the first quarter of 2004. As a percentage of net sales, selling, general and administrative expenses were 28.3 percent during
the first quarter of 2005 compared with 27.2 percent in the first quarter of 2004. The 2005
increase is the result of an additional $6.1 million in costs for employee incentive programs and
$2.7 million in advertising expenses. These increases were partially offset by payroll costs that
were $2.7 million below last year, reflecting reduced headcount. On May 26, 2005, we announced a CEO succession plan and entered into a letter agreement with our
Chief Executive Officer, Steven J. Douglass, confirming certain matters with respect to Mr.
Douglass separation from the Company when his successor commences employment. The letter
agreement serves as Mr. Douglass notice of resignation upon his separation from all director,
officer and employee positions that he holds with the Company, its subsidiaries and its affiliates.
We expect to record a second quarter pre-tax charge that is currently estimated to be
approximately $7 million in connection with our obligations under a previous employment agreement with the company.
This charge will be reflected in selling, general and administrative expenses in the second quarter
of 2005. RESTRUCTURING CHARGES The Company recorded $2.9 million in restructuring charges during the quarter ($0.7 million related
to continuing operations) primarily due to contract termination costs in excess of original
estimates. INTEREST EXPENSE, NET Interest expense decreased from $5.4 million in the first quarter of 2004 to $4.9 million in the
first quarter of 2005 due primarily to a reduction in demand notes payable. Interest income
increased from $1.0 million in the first quarter of 2004 to $1.7 million in the first quarter of
2005 due primarily to an increase in cash and cash equivalents. EFFECTIVE INCOME TAX RATE The Companys effective income tax rate on continuing operations was 28.6 percent during the first
quarter of 2005, including the benefit of released tax reserves relating to favorable income tax
audit settlements of $2.7 million. In total for fiscal 2005, the effective income tax rate is
expected to be approximately 35 percent, exclusive of the reserve release which was discreet to the
first quarter. The Companys effective income tax rate on continuing operations was 33.3 percent in
the first quarter of 2004. MINORITY INTEREST, NET OF TAX Minority interest represents our joint venture partners share of net earnings or losses on
applicable international operations. LIQUIDITY AND CAPITAL RESOURCES We ended the first quarter of 2005 with a cash and cash equivalents balance of $303.3 million, an
increase of $182.0 million over the 2004 first quarter. Internally generated cash flow from
operations is expected to continue to be the most important component of our capital resources. 23




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##### Table of Contents



Cash Flow Provided by Operating Activities Cash flow provided by operations was $20.5 million in the 2005 first quarter, compared with $5.6
million in the 2004 first quarter. As a percentage of net sales, cash flow from operations was 2.9
percent in the 2005 first quarter, compared with 0.8 percent in the same period in 2004. The
significant changes in cash flow during the 2005 first quarter as compared with the 2004 period are
due to higher net earnings and changes in inventory and accrued expenses. Cash Flow Used in Investing Activities In the 2005 first quarter, our capital expenditures totaled $13.8 million, compared with $26.2
million for the same period in 2004. We estimate that capital expenditures for the remainder of the
year will be approximately $56.2 million. Total capital expenditures for 2005 are expected to be
approximately $70 million, compared to approximately $105 million in 2004. This reduction in
capital expenditures compared with recent years is consistent with our focus on execution of
merchandise authority in our core business. We anticipate that internal cash flow and available
financing from our $200 million revolving credit agreement will be sufficient to finance all of
these expenditures. Cash Flow Provided by Financing Activities In January 2004, we replaced our $150 million senior secured revolving credit facility (the Old
Facility) with a new $200 million senior secured revolving credit facility (the New Facility).
Funds borrowed under the New Facility are secured by domestic merchandise inventory and
receivables. We may borrow up to $200 million through the New Facility, subject to a sufficient
borrowing base. The New Facility bears interest at the LIBOR rate, plus a variable margin of 1.25
percent to 2.0 percent, or the base rate defined in the agreement governing the New Facility. The
margin on the New Facility varies based upon certain borrowing levels specified in the agreement
governing the New Facility. The variable interest rate at April 30, 2005, was 4.5 percent. A
monthly commitment fee of 0.30 percent per annum is payable on the unborrowed balance. The New
Facility is scheduled to expire in January 2008, with a one-year extension to January 2009 at our
option. No amounts were drawn on the New Facility as of April 30, 2005. Based on our borrowing
base, we may borrow up to $200.0 million under the New Facility, less $19.7 million in outstanding
letters of credit as of April 30, 2005. In July 2003, we sold $200.0 million of 8.25% Senior Subordinated Notes (the Notes) for $196.7
million, due 2013. As of April 30, 2005, the fair value of the Notes was $206.0 million based on
recent trading activity of the Notes. On or after August 1, 2008, we may, on any one or more
occasions, redeem all or a part of the Notes at the redemption prices set forth below, plus accrued
and unpaid interest, if any, on the Notes redeemed, to the applicable redemption date: Year
    
    Percentage2008
    
    
    104.125
    %2009
    
    
    102.750
    %2010
    
    
    101.375
    %2011 and thereafter
    
    
    100.000
    %
 We have entered into $2.0 million of demand notes payable to efficiently finance our
subsidiaries in the Central American Region. We maintain cash balances of $2.0 million in
certificates of deposit as compensating balances to collateralize these notes payable. The notes
payable accrue interest at a weighted average 6.75 percent. The certificates of deposit earn
interest at a weighted average of 6.00 percent and are reflected as restricted cash in the
accompanying condensed consolidated balance sheet. Financial Commitments For a discussion of our contractual obligations, see a discussion of future commitments under Item
7, Managements Discussion and Analysis of Financial Condition and Results of Operations, in our
Form 10-K for the fiscal year ended January 29, 2005. There have been no significant developments
with respect to our contractual obligations since January 29, 2005. 24




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##### Table of Contents



FINANCIAL CONDITION RATIOS A summary of key financial information for the periods indicated is as follows: April 30, 2005
    
    
    May 1, 2004
    
    
    January 29, 2005Current Ratio
    
    
    2.3
    
    
    
    2.2
    
    
    
    2.2Debt-Capitalization Ratio*
    
    
    25.0
    %
    
    
    27.8
    %
    
    
    25.9
    %
   *
    
    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 66.1%, 68.1% and 67.3%
respectively, for the periods referred to above. STORE ACTIVITY As of April 30, 2005, we operated 4,646 retail shoe stores offering quality footwear and
accessories in all 50 of the United States, the District of Columbia, Puerto Rico, Guam, Saipan,
the U.S. Virgin Islands, Canada, and the Central and South American Regions. The following table
presents the change in store count for the entire company for the first quarter of 2005 and 2004.
We consider a store relocation to be both a store opening and a store closing. First Quarter2005
    
    
    2004Beginning of period
    
    
    4,640
    
    
    
    5,042Stores opened
    
    
    39
    
    
    
    80Stores closed
    
    
    (33
    )
    
    
    (56
    )Ending store count
    
    
    4,646
    
    
    
    5,066
 As of the end of the 2004 first quarter, we operated 4,824 stores classified as continuing
operations. As of April 30, 2005, we operated 147 stores in the Central America Region, 31 stores in the South
America Region and 310 stores in Canada. We have entered into a joint venture agreement to operate
Payless ShoeSource stores in Japan. We own 60 percent of the Japanese joint venture and, therefore,
have consolidated the results of such operations in our financial statements. We opened the first
test store in Japan during the fourth quarter of 2004. We will continue to evaluate the performance
of this test store before considering any additional locations in Japan. We have curtailed any
other expansion into new international markets to focus on our core business. CRITICAL ACCOUNTING POLICIES In preparing the condensed consolidated financial statements included in this Form 10-Q, management
makes estimates and assumptions that affect the amounts reported within the financial statements.
Actual results could differ from these estimates. For more information regarding our critical
accounting policies, estimates and judgments, see the discussion under Managements Discussion and
Analysis of Financial Condition and Results of Operations in our Form 10-K for the year ended
January 29, 2005. 
 ITEM 3  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK INTEREST RATE RISK Interest on our senior secured revolving credit facility, which is entirely comprised of a
revolving line of credit, is based on the London Inter-Bank Offered Rate (LIBOR) plus a variable
margin of 1.25 percent to 2.0 percent, or the base rate, as defined in the credit agreement. There
are no outstanding borrowings on the revolving line of credit; however, if we were to borrow
against our revolving line of credit, borrowing costs may fluctuate depending upon the volatility
of LIBOR and amounts borrowed. 25




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##### Table of Contents



FOREIGN CURRENCY RISK We have retail operations in foreign countries; therefore, our cash flows in U.S. dollars are
impacted by fluctuations in foreign currency exchange rates. We adjust our retail prices, when
possible, to reflect changes in exchange rates to mitigate this risk. To further mitigate this
risk, we may, from time to time, enter into forward contracts to purchase or sell foreign
currencies. For the quarters ended April 30, 2005, and May 1, 2004, fluctuations in foreign
currency exchange rates did not have a material impact on our operations or cash flows and we did
not enter into any forward contracts to purchase or sell foreign currencies. In the first quarter of 2005, approximately 92 percent of our footwear, based on cost, was
sourced from the Peoples Republic of China (the PRC). The national currency of the PRC, the
yuan, is currently not a freely convertible currency. The yuan may be made freely convertible or
be revalued by the PRC government. If this occurs, the products we source from the PRC could
become more expensive in dollar terms. 
 ITEM 4  CONTROLS AND PROCEDURES As of April 30, 2005, we carried out an evaluation, under the supervision and with the
participation of our principal executive officer and principal financial officer, of the
effectiveness of the design and operation of our disclosure controls and procedures. Based on this
evaluation, our principal executive officer and principal financial officer concluded that our
disclosure controls and procedures are effective in alerting them in a timely manner to material
information required to be disclosed in our periodic reports filed with the Securities Exchange
Commission. In addition, there was no change in our internal control over financial reporting that
occurred during our most recently completed fiscal quarter that has materially affected, or is
reasonably likely to materially affect, our internal control over financial reporting. 
 PART II  OTHER INFORMATION 
 ITEM 1  LEGAL PROCEEDINGS Other than as described below, there are no material pending legal proceedings other than ordinary,
routine litigation incidental to the business to which the Company is a party or of which any of
its property is subject. On or about December 20, 2001, a First Amended Complaint was filed against the Company in the U.S.
District Court for the District of Oregon, captioned Adidas America, Inc. and Adidas-Salomon AG v.
Payless ShoeSource, Inc. The First Amended Complaint seeks injunctive relief and unspecified
monetary damages for trademark and trade dress infringement, unfair competition, deceptive trade
practices and breach of contract. The Company believes it has meritorious defenses to claims
asserted in the lawsuit and has filed an answer and a motion for summary judgment which the court
granted in part. An estimate of the possible loss, if any, or the range of loss cannot be made. On or about January 20, 2000, a complaint was filed against the Company in the U.S. District Court
for the District of New Hampshire, captioned Howard J. Dananberg, D.P.M. v. Payless ShoeSource,
Inc. The Complaint seeks injunctive relief, unspecified treble monetary damages, attorneys fees,
interest and costs for patent infringement. The Company believes it has meritorious defenses to
claims asserted in the lawsuit. An estimate of the possible loss, if any, or the range of loss
cannot be made. 26




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ITEM 2  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS The following table provides information about purchases by the Company (and its affiliated
purchasers) during the quarter ended April 30, 2005, of equity securities that are registered by
the Company pursuant to Section 12 of the Exchange Act: ISSUER PURCHASES OF EQUITY SECURITIES Total Number of Shares
    
    
    
    Approximate Dollar Value ofPurchased as Part of
    
    
    
    Shares that May Yet BeTotal Number of
    
    
    
    
    
    
    
    
    Publicly Announced
    
    
    
    Purchased Under the Plans orShares Purchased(1)
    
    
    
    Average Price Paid
    
    
    
    Plans or Programs(2)
    
    
    
    Programs(3)Period
    
    
    (in Thousands)
    
    
    
    per Share
    
    
    
    (in Thousands)
    
    
    
    (in Millions)01/30/05  02/26/05
    
    
    
    4
    
    
    
    $
    12.06
    
    
    
    
    0
    
    
    
    $
    238.102/27/05  04/02/05
    
    
    
    128
    
    
    
    
    15.38
    
    
    
    
    125
    
    
    
    
    236.204/03/05  04/30/05
    
    
    
    3
    
    
    
    
    15.51
    
    
    
    
    0
    
    
    
    
    236.2Total
    
    
    
    135
    
    
    
    $
    15.29
    
    
    
    
    125
    
    
    
    $
    236.2
    (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 the Companys
Credit Agreement and Senior Subordinated Notes. 
 ITEM 4  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS (a) The annual meeting of shareowners of the Registrant was held on May 26, 2005. (b) At the annual meeting of shareowners of the Registrant held on May 26, 2005, action was taken
with respect to the election of three directors of the Registrant: 60,046,607 shares were voted for
Steven J. Douglass while authority was withheld with respect to 1,127,437 shares, 60,465,876 shares
were voted for Howard E. Fricke while authority was withheld with respect to 708,168 shares, and
60,653,277 shares were voted for Judith K. Hofer while authority was withheld with respect to
520,767 shares. Other directors whose term of office continued after the meeting include: Daniel
Boggan Jr., Michael A. George, Mylle H. Mangum , John F. McGovern, Michael E. Murphy, Michael A.
Weiss and Robert C. Wheeler. (c) Shareowners ratified the appointment of Deloitte & Touche LLP as the Companys independent
public accountants: 60,983,770 votes in favor, 130,487 votes against and 59,787 votes abstained. 
 ITEM 6  EXHIBITS (a) Exhibits: Number
    
    Description31.1
    
    Certification Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002 of the Chairman of the Board and Chief Executive
Officer*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 Chairman of the Board and Chief Executive
Officer*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 27




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SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Company has duly caused
this report to be signed on its behalf by the undersigned thereunto duly authorized. PAYLESS SHOESOURCE, INC.Date: June 8, 2005
    By:
    /s/ Steven J. DouglassSteven J. DouglassChairman of the Board andChief Executive Officer(Principal Executive Officer)Date: June 8, 2005
    By:
    /s/ Ullrich E. PorzigUllrich E. PorzigSenior Vice PresidentChief Financial Officer and Treasurer(Principal Financial and Accounting Officer)
 28




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INDEX TO EXHIBITS 31.1
    
    Certification Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002 of the Chairman of the Board and Chief Executive
Officer*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 Chairman of the Board and Chief Executive
Officer*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