<PAGE>
 
================================================================================

                      SECURITIES AND EXCHANGE COMMISSION

                             WASHINGTON, DC 20549
                                        

                                   FORM 10-K

[X]  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
     ACT OF 1934 FOR THE FISCAL YEAR ENDED January 3, 1998.

                                      OR

[_]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
     EXCHANGE ACT OF 1934 [NO FEE REQUIRED] FOR THE TRANSITION PERIOD FROM
     _________ TO __________
                        COMMISSION FILE NUMBER 1-13430
                                        
                                 CONVERSE INC.
            (Exact name of registrant as specified in its charter)


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

                               ONE FORDHAM ROAD
                       NORTH READING MASSACHUSETTS 01864
              (Address of principal executive offices) (Zip Code)
      Registrant's telephone number, including area code:  (978) 664-1100

                          ---------------------------

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


TITLE OF EACH CLASS                                        NAME OF EACH EXCHANGE
                                                           ON WHICH REGISTERED

Common stock, without par value                               New York Stock
Exchange
7% Convertible Subordinated Notes                             New York Stock
due 2004


         Securities registered pursuant to Section 12 (g) of the Act:
                                     None.

                          ---------------------------

     Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (D) of the Securities Exchange Act of
1934 during the preceding 12 months (or such shorter period that registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days:  YES [X] NO [_]

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

     As of March 10, 1998, the aggregate market value of the registrant's voting
stock held by non-affiliates of the registrant was approximately $39,199,167,
based on the closing sales price of the registrant's Common Stock as reported on
the New York Stock Exchange as of such date ($ 6 7/16).

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

     As of March 10, 1998, 17,319,556 shares of the registrant's Common Stock
were outstanding.

                      DOCUMENTS INCORPORATED BY REFERENCE
                                        
     Portions of the Registrant's definitive Proxy Statement to be filed with
the Securities and Exchange Commission on or before April 30, 1998 for the
Annual Meeting of Stockholders to be held on May 11, 1998 are incorporated by
reference into Part III of this Report, as indicated herein.

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


<TABLE> 
<CAPTION> 

                                                                           Page
                                                                           ----
                                    PART  I.
<S>                                                                        <C>
Item 1.   Business.......................................................    1
               Products..................................................    1
               Marketing and Product Development.........................    2
               Sales and Distribution....................................    3
               Licensing Agreements......................................    3
               Sourcing and Manufacturing................................    4
               Research and Development..................................    5
               Backlog...................................................    5
               Competition...............................................    5
               Trademarks and Patents....................................    6
               Environmental Matters.....................................    6
               Employees.................................................    6
               Risk Factors..............................................    6
 
Item 2.   Properties.....................................................    9
Item 3.   Legal Proceedings..............................................    9
Item 4.   Submission of Matters to a Vote of Security Holders............    9

                                   PART II.
 
Item 5.   Market for Registrant's Common Equity and Related
          Stockholder Matters............................................    10
Item 6.   Selected Financial Data........................................    10
Item 7.   Management's Discussion and Analysis of Financial
          Condition and Results of Operations............................    12
Item 7A.  Quantitative and Qualitative Disclosure About Market Risk......    21
Item 8.   Financial Statements and Supplemental Data.....................    21
Item 9.   Changes in and Disagreements with Accountants on
          Accounting and Financial Disclosure............................    21

                                   PART  III.

Item 10.  Directors and Executive Officers of the Registrant.............    22
Item 11.  Executive Compensation.........................................    23
Item 12.  Security Ownership of Certain Beneficial Owners and Management.    23
Item 13.  Certain Relationships and Related Transactions.................    23 

                                   PART  IV.

Item 14.  Exhibits, Financial Statement Schedules, and Reports
          on Form 8-K....................................................    24

                                   SIGNATURES

          Signatures.....................................................    28
</TABLE> 
<PAGE>
 
Information contained or incorporated by reference in this Report contains
"forward-looking statements" which can be identified by the use of forward-
looking terminology such as "believes," "expects," "may," "will," "should," or
"anticipates" or the negative thereof or other variations thereon or comparable
terminology, or by discussions of strategy. See, e.g., "Management's Discussion
and Analysis of Financial Condition and Results of Operations." No assurance can
be given that the future results covered by the forward-looking statements will
be achieved. The Risk Factors contained in "Business--Risk Factors" of this
Report constitute cautionary statements identifying important factors with
respect to such forward-looking statements, including certain risks and
uncertainties, that could cause actual results to vary materially from the
future results covered in such forward-looking statements. Other factors could
also cause actual results to vary materially from the future results covered in
such forward-looking statements. Converse Inc. (hereinafter the "Company" or
"Converse") undertakes no obligation to publicly release any revisions to these
forward-looking statements to reflect any future events or occurrences.

                                    PART I
                                    ------

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

  Converse is a leading global designer, manufacturer and marketer of high
quality athletic footwear for men, women and children. The Company is also a
global licensor of sports apparel, accessories and selected footwear. The
Company, founded in 1908, began establishing its authentic footwear heritage
with the introduction of its original canvas Chuck Taylor(R) basketball shoe in
1923. Throughout its 90-year history, Converse has achieved a high level of
brand name recognition due to its reputation for high performance products,
quality, value and style. Through its well-known Converse(R) All Star(R) brand,
the Company has consistently maintained its position as the American performance
brand with authentic sports heritage.

  In 1997, the Company's marketing strategy focused on four core footwear
categories: basketball; athletic originals; children's and cross training. The
basketball category is comprised of high performance footwear for athletes and
typically features Converse's proprietary REACT(R) shock absorption technology.
Converse's athletic originals footwear offerings are centered on the Converse
Chuck Taylor All Star canvas athletic shoe, which management believes is the
world's all time best-selling athletic shoe with over 560 million pairs sold
since its introduction.  The children's category consists of children's-sized
models of the Company's basketball, athletic originals and cross training shoes,
as well as certain styles designed exclusively for children. The cross training
category consists of high performance athletic shoes used for sports training
and fitness.

  The Company's products are distributed in over 90 countries to approximately
9,000 customers, which include specialty athletic, sporting goods, department
and shoe stores, as well as to 31 Company-operated retail outlet stores. In 1997
the Company reported record net sales of $450.2 million or a 28.9% increase from
1996. However, this figure understates the total worldwide presence of Converse-
branded products since a large amount is sold through licensees, and Converse
recognizes only a percentage of these licensees' sales which it records as
royalty income. Global wholesale sales of Converse-branded products, which
include direct sales by the Company to retailers, sales by Converse distributors
and sales of licensed products by Converse licensees, were approximately $900
million in 1997, of which over $540 million, or approximately 60%, were
international sales or an increase of approximately 10.6% compared to 1996.
 
PRODUCTS

  In 1997, the Company concentrated its marketing, product development and sales
efforts on its four core categories: basketball; athletic originals; children's
and cross training.

                                       1
<PAGE>
 
BASKETBALL

  Converse's basketball footwear offerings are comprised of high performance
footwear for athletes and typically feature Converse's proprietary REACT shock
absorption technology. The Company's basketball footwear is worn by a number of
NBA players, including endorsers such as Dennis Rodman of the Chicago Bulls and
NBA rookies Bobby Jackson of the Denver Nuggets, Jacque Vaughn of the Utah Jazz
and Brevin Knight of the Cleveland Cavaliers in addition to several major NCAA
basketball teams.

  The Company's basketball footwear sells in the U.S. at suggested retail prices
ranging from $45.00 to $91.00 through an extensive network of athletic
specialty, sporting goods, department and shoe stores. While the target
consumers for Converse basketball shoes are males and females ages 12 to 24, the
Company's basketball shoes appeal to a broad group of consumers.

ATHLETIC ORIGINALS

  Converse athletic originals footwear offerings are centered on the Chuck
Taylor All Star canvas athletic shoe, which management believes is the world's
all time best-selling athletic shoe with over 560 million pairs sold since its
introduction in 1923 as the world's first basketball shoe. Converse's athletic
originals footwear encompasses both classic, time-tested athletic shoes and
styles targeted at alternative sports enthusiasts.  Because these shoes have
authentic sports heritage, many have remained unchanged since their inception
and have become true American sports icons.  The Company's athletic originals
products, which come in a wide variety of colors, sell in the U.S. at suggested
retail prices ranging from $20.00 to $65.00 in athletic specialty, sporting
goods, department and shoe stores, as well as specialty apparel retailers.

CHILDREN'S

  Converse's children's category consists of children's-sized versions of the
Company's basketball, athletic originals and cross training shoes, as well as
certain styles designed exclusively for children. The children's category is
rooted in sports, offering all the features and benefits of the adult models and
the same unique styling that attracts adults to the Company's basketball,
athletic originals and cross training products.  The Company's children's
footwear is generally sold in the U.S. at suggested retail prices ranging from
$22 to $60 through athletic specialty, children's bootery, sporting goods and
department stores.

CROSS TRAINING

  The Company's cross training category consists of high performance athletic
shoes used for multiple sports activities. The Company believes this category
represents a growth opportunity since Converse's cross training and basketball
products have similar target purchasers.  The Company's cross training footwear
sells in the U.S. at suggested retail prices ranging from $50.00 to $75.00
through an extensive network of athletic specialty, sporting goods, department
and shoe stores.

MARKETING AND PRODUCT DEVELOPMENT

  The Company's marketing strategy is centered on the Converse All Star brand,
which is positioned as the American performance brand with authentic sports
heritage. The Company believes that there are significant opportunities to
continue to build the brand, which commands high consumer awareness generated by
its 90-year history.  The Company's consumer research has become an integral
part of its product development, advertising campaigns and in-store point of
purchase materials. Each of the Company's products is now fully supported by a
consistent, integrated marketing program, responsive to the demands of the
Company's target customers.

                                       2
<PAGE>
 
  The Company recently adopted "Stay True" as its new brand positioning
statement and tag line.  "Stay True" is intended to convey the concept, through
the products, that athletes should stay true to themselves and be proud of who
they are and where they came from and to communicate a feeling of continuing
respect for people and institutions that enabled the athlete to succeed.

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

SALES AND DISTRIBUTION

  The Company's products are distributed in over 90 countries to approximately
9,000 customers, which include athletic specialty, sporting goods, department
and shoe stores, as well as to 31 Company-operated retail outlet stores.

UNITED STATES MARKET

  The Company's 38 member U.S. sales force markets Converse footwear through
approximately 4,200 active retail accounts.  In 1997, domestic sales represented
63% of the Company's net sales. The Company has refined its distribution
strategy to increase its focus on key growth accounts such as specialty athletic
retailers. National and large regional accounts are serviced by 13 account
executives who are paid on a salary and bonus basis, and who focus on the
product and merchandising needs of these retailers. Certain of the Company's
domestic sales are served by an electronic data interface ("EDI") ordering
system where electronic customer orders are received directly into Converse's
order processing system. In addition, a quick response system has been
implemented with a number of the Company's highest volume accounts. The quick
response system provides for the rapid replenishment of customer inventory
through an electronic management process which produces constant "on-hand"
customer inventory quantities.

INTERNATIONAL MARKET

  The Company currently markets its products in approximately 90 countries
outside of the United States through subsidiaries, branch offices, independent
distributors and licensees.  Non-U.S. net sales accounted for 36.7% of total
revenues in 1997 compared to 44.4% in 1996.  Moonstar Chemical Corp., Converse's
distributor and licensee of footwear in Japan, accounted for approximately 14%
of 1997 total net sales worldwide for Converse.  The Pacific Region contributes
the largest percentage of international licensing income.  See "Business-
Licensing Agreements."

LICENSING AGREEMENTS

  Converse utilizes licensees who manufacture or purchase and distribute sports
apparel, accessories and selected footwear to provide consumers head-to-toe
Converse-branded products globally. Converse has entered into 69 separate
licensing agreements permitting the licensees to design and market selected
products under the Converse brand name in specific markets. Under the terms of
Converse's licensee arrangements, all products designed by licensees, as well as
the related advertising, must be approved in advance by Converse. In addition,
Converse monitors the quality of the licensed products on an ongoing basis.

                                       3
<PAGE>
 
  The following table details sales by Converse's licensees and the related
royalty income to Converse:
 
<TABLE>
<CAPTION>
                                                                       FISCAL YEAR ENDED
                                          DECEMBER 30, 1995            DECEMBER 28, 1996             JANUARY 3, 1998
                                          -----------------            -----------------             ---------------
<S>                                       <C>                          <C>                           <C> 
                                                                    (DOLLARS IN THOUSANDS)
Total sales by licensees:
    Footwear.......................            $ 84,231                     $101,117                      $141,344         
    Apparel and accessories........             178,185                      307,011                       208,866         
                                               --------                     --------                      -------- 
Total..............................            $262,416                     $408,128                      $350,210         
                                               ========                     ========                      ======== 
                                                                                                                           
Total royalty income:                                                                                                      
    Footwear.......................            $  7,046                     $  7,944                      $ 10,013         
    Apparel and accessories........              10,211                       19,694                        12,556         
                                               --------                     --------                      -------- 
Total..............................            $ 17,257                     $ 27,638                      $ 22,569         
                                               ========                     ========                      ======== 
</TABLE>
                                                                                
  In Japan, Converse has agreements with 12 licensees to produce Converse-
branded apparel, accessories and selected footwear for the Japanese market.
These Japanese licensees accounted for approximately 35.8% of Converse's total
worldwide royalty income in 1997.  Royalty income in the Japanese market was
substantially lower in 1997 than it was in the prior year due to the Company's
strategic decision to eliminate certain lower quality distribution channels in
Japan.  Royalty income in the Pacific Region contributed 59.1% of total
worldwide royalty income.  Royalty income generated in the U.S. represented
approximately 16.9% of total worldwide royalty income in 1997.

SOURCING AND MANUFACTURING

  The majority of the Company's footwear is sourced from various Far East
factories. However, most of the Company's athletic originals products are
manufactured domestically.

SOURCING
 
  In 1997, approximately 64% of all Converse footwear was sourced from a variety
of Far East manufacturers on a per order basis. These manufacturers produce the
Company's footwear according to the Company's own design specifications and
quality standards. Sourcing is managed by the Company's corporate headquarters
in the United States. In selecting subcontractors, Converse attempts to use
manufacturers that specialize in the type of footwear being produced and to
avoid over reliance on any particular supplier by having a sufficient diversity
of manufacturing resources. The Company utilizes one sourcing agent in Taiwan
who assists the Company in selecting and overseeing third party contractors,
ensuring quality, sourcing fabrics and monitoring quotas and other trade
regulations. The Company's production staff and independent sourcing agent
together oversee all aspects of manufacturing and production. Many of the
manufacturers utilized by Converse are also used by the Company's competitors.

  In 1997, the Company purchased over 13.3 million pairs of shoes from 16
manufacturers located in China, Taiwan, Macau, Vietnam and the Philippines.
While one manufacturer produces approximately 30% of the Company's products, the
Company believes any manufacturer can be replaced, if necessary, subject to
short-term supply disruptions.

MANUFACTURING

  Converse is the largest manufacturer of athletic footwear in the United
States, producing over 7.5 million pairs in 1997. Converse operates
manufacturing facilities in Lumberton, North Carolina, Mission, Texas and
Reynosa, Mexico.  The Company manufactures and assembles most of its athletic
originals footwear at the Company's 350,000 square foot Lumberton facility. The
Lumberton factory also produces components for its other manufacturing
facilities.  The Mission facility performs certain cutting operations and
limited production of canvas All Star footwear.  All stitching is done at the
Reynosa facility to capitalize on lower labor costs.

                                       4
<PAGE>
 
  The domestic manufacturing of Converse's athletic originals products has
enabled the Company to actively pursue EDI/Quick response programs with some of
its major customers. Converse's ability to produce its best-selling athletic
originals models with significantly shorter lead-times than foreign-sourced
products is a competitive advantage.

  The principal materials used in Converse's athletic originals footwear
products are canvas, linen and rubber. The Company purchases its raw materials
from diverse suppliers. While one supplier accounts for approximately 15% of raw
materials purchases, the Company believes such supplier can be replaced, if
necessary, subject to short-term supply disruptions.

RESEARCH AND DEVELOPMENT

  Converse is a leading innovator of new footwear technologies.  The Company
spent $8.6 million, $6.5 million and $8.8 million on research and development in
1995, 1996 and 1997, respectively.  Converse's state of the art biomechanics
laboratory, located in a leased facility near the Company's headquarters,
continually conducts research on new performance-enhancing technologies. The
Company's biomechanical engineers are also involved in the design stages of
athletic footwear to help develop new technologies and attributes to improve the
function of shoes for specific sports. The Company maintains a full set of
production equipment at its biomechanics laboratory to develop prototypes, and
to ensure that new products can be manufactured efficiently to Converse's
specifications. In addition, Converse maintains a chemistry laboratory that
develops and tests midsole and outsole compounds, adhesives and fabrics for use
in its products.

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

BACKLOG

  At the end of 1997, the Company's global backlog was $129.5 million, compared
to $183.3 million at the end of 1996. The amount of backlog at a particular time
is affected by a number of factors, including the scheduling of the introduction
of new products and the timing of the manufacturing and shipping of the
Company's products. Accordingly, a comparison of backlog as of two different
dates is not necessarily meaningful.

COMPETITION

  The athletic footwear market is highly competitive. Industry participants
compete with respect to fashion, price, quality, performance and durability.
During the second half of 1997, there was an overall weakening of the athletic
footwear and apparel market which has resulted in an oversupply of inventory in
the marketplace.  The athletic footwear industry in the United States can be
broken down into several groups. Nike Inc. ("Nike"), with 1997 estimated U.S.
footwear revenues exceeding $3.8 billion, controls over 47% of the U.S. athletic
footwear market. Reebok International, Inc. ("Reebok"), with 1997 estimated U.S.
footwear revenues exceeding $1.2 billion, controls approximately 15% of the U.S.
athletic footwear market. Each of these companies has full lines of product
offerings, competes with Converse in the Far East for manufacturing sources,
distributes to more than 10,000 outlets worldwide and spends substantially more
on advertising and promotion than Converse. Fila USA, Inc. and adidas AG
("adidas") have estimated U.S. footwear sales of approximately $500 million in
1997, while New Balance Athletic Shoe, Inc. and Stride Rite Corporation each
have 1997 U.S. branded athletic footwear revenues of between $200 million and
$300 million. All of these companies also compete with Converse for access to
foreign manufacturing facilities. In addition to these competitors, there are
companies with U.S. revenues of under $200 million, including Airwalk, ASICS
Tiger Corporation, Vans, Inc., Etonic, Inc., Hyde Athletic Industries, Inc. and
K-Swiss, Inc. among others. Some of these companies emphasize footwear in
categories such as running, tennis or team sports that are not currently being
produced by the Company. Worldwide footwear industry data is unavailable, but
the largest companies worldwide are believed to be Nike, Reebok and adidas.

                                       5
<PAGE>
 
TRADEMARKS AND PATENTS

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

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

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

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

ENVIRONMENTAL MATTERS

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

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

EMPLOYEES

  As of January 3, 1998, Converse employed 2,956 individuals, of which 1,766
were in manufacturing, and 1,190 were in sales, administration, development and
distribution. Management believes its relationship with its employees to be
good. Converse has not experienced any material work stoppages or strikes in
recent years. The Reynosa, Mexico manufacturing workforce, representing
approximately 24% of Converse's work force, is represented by a union.

RISK FACTORS

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

                                       6
<PAGE>
 
RECENT OPERATING RESULTS

  The Company sustained an operating loss of $29.7 million in 1995, and
operating gains of $0.2 million in 1996 and $14.7 million in 1997. The Company
had an accumulated stockholders' deficit of $48.0 million at January 3, 1998.
Although recent improvements in operating earnings are encouraging, there can be
no assurance that any profitability that is achieved will be maintained.

COMPETITION; CHANGES IN CONSUMER PREFERENCES

  As described above under "Business--Competition," the branded athletic
footwear industry is highly competitive. Furthermore, the Company's success
depends in part on its ability to anticipate and respond to changing merchandise
trends and consumer preferences and demands in a timely manner. Accordingly, any
failure by the Company to anticipate and respond to changing merchandise trends
and consumer preferences and demands could materially adversely affect consumer
acceptance of the Company's brand name and product lines, which in turn could
materially adversely affect the Company's business, financial condition or
results of operations.

FOREIGN PRODUCTION

  Approximately 64% of the Company's footwear is manufactured to its
specifications by independent producers located in the Far East, particularly
China, Taiwan, Macau, Vietnam and the Philippines. The Company also operates a
facility in Mexico for the stitching of canvas uppers for certain athletic
originals category footwear. As a result of the Company's continuing use of
foreign manufacturing facilities, the Company's operations are subject to the
customary risks of doing business abroad, including fluctuations in the value of
currencies, import and export duties and trade barriers (including quotas),
restrictions on the transfer of funds, work stoppage and, in certain parts of
the world, political instability. To date, these factors have not had an adverse
impact on the Company's operations. See "Business--Sourcing and Manufacturing."

ECONOMIC CONDITIONS AND SEASONALITY

  Converse and the footwear industry in general are dependent on the economic
environment and levels of consumer spending which affect not only the ultimate
consumer, but also retailers, Converse's primary direct customers. As a result,
Converse's results may be adversely affected by downward trends in the economy
or the occurrence of events that adversely affect the economy in general. There
can be no assurance that any prolonged economic downturn would not have a
material adverse effect on Converse. Sales of Converse's footwear products are
somewhat seasonal in nature with the strongest sales generally occurring in the
first and third quarters. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."

INTERNATIONAL SALES AND CURRENCY EXCHANGE

  International sales accounted for approximately 49%, 44% and 37% of Converse's
net sales in 1995, 1996 and 1997, respectively.  Because a significant portion
of Converse's international sales, particularly those in the Pacific region, are
made through international distributors, Converse's future operating results
will depend, in part, on the relationships with these companies.  Additionally,
Converse's international sales may be affected by changes in demand resulting
from fluctuations in currency exchange rates.  All foreign distributor
agreements are denominated in U.S. dollars.  All international sales are
denominated in U.S. dollars and an increase in the value of the U.S. dollar
relative to foreign currencies could make Converse products less competitive in
those markets.  During 1997, the Company used foreign exchange forward contracts
and put options to protect the Company from the effected changes in foreign
exchange rates on the statement of operations.  International sales and
operations may also be subject to risks such as the imposition of governmental
controls, export license requirements, political instability, trade
restrictions, changes in tariffs and difficulties in staffing and managing
international operations and managing accounts receivable.  In addition, the
laws of certain countries do not protect Converse's products and intellectual
property rights to the same extent as the laws of the United States.  There can
be no assurance that these factors will not have an adverse effect on Converse's
future 

                                       7
<PAGE>
 
international sales and, consequently, on Converse's operating results. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Business - Sales and Distribution - International."

NATURE OF ENDORSEMENT CONTRACTS

  A key element of Converse's marketing strategy has been to obtain endorsements
from prominent athletes, and management believes that this has proven to be an
effective way to gain global brand exposure. See "Business-- Marketing and
Product Development." These endorsement contracts generally have three to five-
year terms, and there can be no assurance that they will be renewed or that
endorsers signed by the Company will continue to be effective promoters of the
Company's products. If Converse were unable in the future to secure suitable
athletes to endorse its products on terms it deemed reasonable, it would be
required to modify its marketing plans and could have to rely more heavily on
other forms of advertising and promotion, which might not prove to be as
effective as endorsements.

RISKS ASSOCIATED WITH THE YEAR 2000

  The Year 2000 issue is the result of computer programs being written using two
digits rather than four to define the applicable year.  In other words, date-
sensitive software may recognize a date using "00" as the year 1900 rather than
the year 2000.  This could result in system failures or miscalculations causing
disruptions of operations, including, among others, a temporary inability to
process transactions, send invoices, or engage in similar normal business
activities.  The Company is completing an evaluation of the Year 2000 issue on
its business.  The Company does not believe that it has material exposure to the
Year 2000 issue with respect to its own information systems.  The Company is
conducting an analysis to determine the extent to which its major suppliers and
customers' systems (insofar as they relate to the Company's business) are
subject to the Year 2000 issue.  The Company is currently unable to predict the
extent to which the Year 2000 issue will affect its suppliers and customers, or
the extent to which it would be vulnerable to its suppliers and customers'
failure to remediate any Year 2000 issue on a timely basis.  The failure of a
major supplier or customer subject to the Year 2000 issue to convert its systems
on a timely basis or a conversion that is incompatible with the Company's
systems could have a material adverse effect on the Company.

CONTROLLING STOCKHOLDERS

  Apollo Investment Fund, L.P. ("Apollo") and its affiliate Lion Advisors, L.P.,
on behalf of an investment account under management ("Lion"; Apollo and Lion
together being referred to herein as the "Apollo Stockholders"), together
beneficially owned approximately 65% of the outstanding Common Stock of the
Company at January 3, 1998. By reason of their ownership of shares of Common
Stock, the Apollo Stockholders have the power effectively to control or
influence control of the Company, including in elections of the Board of
Directors and other matters submitted to a vote of the Company's stockholders,
including extraordinary corporate transactions such as mergers. The Apollo
Stockholders may exercise such control from time to time. A majority of the
Board of Directors consists of individuals associated with affiliates of Apollo
and Lion.

SHARES ELIGIBLE FOR FUTURE SALE

  The Apollo Stockholders have the right to cause Converse to register the
shares of Common Stock that they own pursuant to a registration rights
agreement. Future sales of shares, or the availability of shares for future
sale, could adversely affect the prevailing market prices for the Common Stock.

ANTI-TAKEOVER PROVISIONS

  The Company's Restated Certificate of Incorporation contains certain
provisions, including authorization to issue "blank check" preferred stock
("Preferred Stock"), prohibition of stockholder action by written consent and
the requirement of 75% ("supermajority") stockholder vote to alter, amend,
repeal or adopt certain provisions of the Restated Certificate of Incorporation.
In addition, the Company's Restated Certificate of Incorporation contains
provisions limiting the ability of any person who is the beneficial owner of
more than 10% of the outstanding voting stock to effect certain transactions
involving the Company unless approved by a majority of the Disinterested
Directors (as defined in the 

                                       8
<PAGE>
 
Restated Certificate of Incorporation of the Company). Such provisions could
impede any merger, consolidation, takeover or other business combination
involving the Company or discourage a potential acquirer from making a tender
offer or otherwise attempting to obtain control of the Company.

ITEM 2.  PROPERTIES.
--------------------

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

<TABLE>
<CAPTION>
                                                                          FLOOR SPACE 
LOCATION                                TYPE OF FACILITY                 (SQUARE FEET)                 OWNED/LEASED
--------                                ----------------                  -----------                  ------------
<S>                             <C>                                       <C>                          <C> 
North Reading, MA.............. Headquarters                                 106,800                      Owned
Wilmington, MA................. Research and Development Facility             23,192                      Leased
Lumberton, NC.................. Plant                                        386,761                      Owned 
Charlotte, NC.................. Distribution Center                          431,665                      Leased
Reynosa, Mexico................ Plant                                         50,188                      Owned
Mission, TX.................... Plant                                         55,552                      Leased
Exeter, NH..................... Research and Development Facility              2,050                      Leased
</TABLE>

  In addition to the above properties, the Company leases space for 29 retail
stores in the U.S. and 2 retail stores in the United Kingdom. The Company also
leases several sales and customer service offices and distribution centers
throughout the world. The Wilmington, Massachusetts lease expires in 2003, the
Charlotte, North Carolina lease expires in 2001, the Exeter, New Hampshire lease
expires in 1999 and the Mission, Texas facility lease expires in 1998, with
renewal terms through 2003.  For further information regarding the Lumberton and
Mission facilities see "Business--Sourcing and Manufacturing".

ITEM 3.  LEGAL PROCEEDINGS.
---------------------------

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

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

 Not applicable.

                                       9
<PAGE>
 
                                    PART II


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

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

<TABLE>
<CAPTION>
                                                                                                High                    Low   
                                                                                                ----                    ---    
               <S>                                                                            <C>                    <C> 
               1995                                                                                                              
               ----                                                                                                              
               First Quarter...................................................               $11  3/4               $ 9  3/8    
               Second Quarter..................................................                 9  7/8                 6  5/8    
               Third Quarter...................................................                 8  5/8                 5  3/8    
               Fourth Quarter..................................................                 5  3/4                 3  1/2     
                                                                                                                                  
               1996                                                                                                               
               ----                                                                                                               
               First Quarter...................................................                 7  1/8                 4  1/8     
               Second Quarter..................................................                 5  1/2                 3  7/8     
               Third Quarter...................................................                 6  7/8                 4  1/8     
               Fourth Quarter..................................................                15  3/4                      6     
                                                                                                                                  
               1997                                                                                                               
               ----                                                                                                               
               First Quarter...................................................                 27 3/8                 14 1/4     
               Second Quarter..................................................                     22                 13 1/4     
               Third Quarter...................................................                 22 1/8                10 5/16     
               Fourth Quarter..................................................                 10 1/4                  5 5/8     
</TABLE>

  As of March 10, 1998 there were 17,319,556 shares of Common Stock issued and
outstanding, which shares were held by approximately 2,200 holders of record of
the Company's Common Stock.

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

ITEM 6.  SELECTED FINANCIAL DATA
--------------------------------

  The following selected consolidated financial data of Converse should be read
in conjunction with Converse's historical consolidated financial statements and
the notes thereto contained herein. The following selected historical
consolidated financial data has been derived from the historical consolidated
financial statements of Converse. Prior to the Distribution effected on November
17, 1994, Converse was a wholly-owned subsidiary of Furniture Brands
International, Inc. ("Furniture Brands"). Furniture Brands and its principal
domestic subsidiaries, including Converse, emerged from Chapter 11
reorganization on August 3, 1992. In accordance with AICPA Statement of Position
90-7, "Financial Reporting by Entities in Reorganization under the Bankruptcy
Code," Furniture Brands was required to adopt "fresh-start" reporting, and such
principles have been applied to the consolidated financial statements of
Converse and the tables presented below.  The historical consolidated financial
statements of Converse for 1994 and prior periods may not reflect the results of
operations or financial position that would have been obtained had Converse been
a separate, independent company during such periods.

                                       10
<PAGE>
 
<TABLE>
<CAPTION>
                                                                                        FISCAL YEAR ENDED
                                                         --------------------------------------------------------------------------
(DOLLARS IN THOUSANDS, 
EXCEPT PER SHARE AMOUNTS)                                JAN. 1, 1994  DEC. 31, 1994  DEC. 30, 1995   DEC. 28, 1996   JAN. 3, 1998
                                                         ------------  -------------  --------------  --------------  -------------
<S>                                                      <C>           <C>            <C>             <C>             <C>         
STATEMENT OF OPERATIONS DATA:                                                                                                     
Net sales ...............................................   $ 380,427      $ 437,307     $ 407,483      $ 349,335        $ 450,199
Cost of sales............................................     254,338        286,555       293,948        263,098          329,258
                                                            ---------      ---------     ---------      ---------        ---------
Gross profit.............................................     126,089        150,752       113,535         86,237          120,941
                                                                                                                        
Selling, general and administrative expenses.............     108,059        128,876       146,332        114,888          127,261
Royalty income...........................................      10,808         14,212        17,257         27,638           22,569
Restructuring expense (credit)...........................         ---            ---        14,182         (1,177)           1,537
                                                            ---------      ---------     ---------      ---------        ---------
Earnings (loss) from operations..........................      28,838         36,088       (29,722)           164           14,712
Loss (credit) on investment in unconsolidated subsidiary.         ---            ---        52,160         (1,362)         (12,537)
Interest expense, net....................................       7,501          7,423        14,043         17,776           15,374
Other expense, net.......................................       1,904            504         3,966          6,319            3,026
                                                            ---------      ---------     ---------      ---------        ---------
Earnings (loss) from continuing operations                                                                              
  before income taxes....................................      19,433         28,161       (99,891)       (22,569)           8,849
                                                                                                                        
Income tax expense (benefit).............................       7,329         10,565       (28,144)        (4,134)          13,154
                                                            ---------      ---------     ---------      ---------        ---------
Earnings (loss) from continuing operations...............      12,104         17,596       (71,747)       (18,435)          (4,305)
Extraordinary loss, net of income tax benefit of $576....         ---            ---           ---            ---              744
                                                            ---------      ---------     ---------      ---------        ---------
Net earnings (loss)......................................   $  12,104      $  17,596     $ (71,747)     $ (18,435)       $  (5,049)
                                                            =========      =========     =========      =========        =========
Net basic and diluted earnings (loss) per share:                                                                        
 Continuing operations...................................                  $    1.05     $   (4.30)     $   (1.10)       $   (0.25)
 Extraordinary loss......................................                         --            --             --            (0.04)
                                                                           ---------     ---------      ---------        ---------
 Net earnings (loss).....................................                  $    1.05     $   (4.30)     $   (1.10)       $   (0.29)
                                                                                                                        
BALANCE  SHEET DATA (AT PERIOD END):                                                                                    
 Working capital.........................................   $ 111,080      $ 131,122     $  89,680      $ (32,648)       $  20,260
 Total assets............................................     179,954        223,726       224,507        222,603          234,694
 Long-term debt, less current maturities.................      69,262         77,087       112,824          9,644           80,000
 Total stockholders' equity (deficiency).................      10,270         44,987       (22,685)       (38,868)         (47,982)
</TABLE> 

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

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

GENERAL

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

  Converse is a leading global designer, manufacturer and marketer of high
quality athletic footwear for men, women and children. The Company is also a
global licensor of sports apparel, accessories and selected footwear. The
Company's products are distributed in over 90 countries to approximately 9,000
customers, which include athletic specialty, sporting goods, department and shoe
stores, as well as to 31 Company-operated retail outlet stores. The primary
costs and expenses of the Company result from the following: athletic products
sourced from various Far East manufacturers, employee salaries and fringe
benefits, advertising and promotion expenses and the purchase of raw materials
used in the Company's manufacturing process.

  The Company's Fiscal 1997 (as defined below) financial results have been
affected by several significant factors  including:  (i) record sales revenues
of $450.2 million, a 28.9% increase over the previous year; (ii) increased
demand for the Company's athletic originals products resulting in the expansion
of the Company's manufacturing capabilities and significant improvements in the
factories' quality, productivity and economic performance; (iii) successful
resolution of litigation resulting from the 1995 purchase of Apex One, Inc.
("Apex"); (iv) completion of an $80.0 million convertible bond offering
resulting in reduced interest expense; (v) execution of a new five-year term
Credit Facility; (vi) overall weakening of the athletic footwear and apparel
market which negatively impacted second half financial results; (vii)
significant strengthening of the U.S. dollar in the European and Asian markets
resulting in weaker sales, gross profit and licensing income; and (viii)
Company-wide restructuring charges as a result of the uncertainty caused by the
recent industry downturn and the oversupply of inventory in the marketplace.

  These factors have had, and may continue to have, an impact on the Company's
future financial results.

RESULTS OF OPERATIONS

  The Company's fiscal year end is the Saturday closest to December 31 in each
year. The results of operations will periodically include a 53-week fiscal year.
For purposes of the Company's financial statements, Fiscal 1997 refers to the
53-week period ended January 3, 1998 ("Fiscal 1997"), Fiscal 1996 refers to the
52-week period ended December 28, 1996 ("Fiscal 1996"), and Fiscal 1995 refers
to the 52-week period ended December 30, 1995 ("Fiscal 1995").

                                       12
<PAGE>
 
COMPARISON OF FISCAL 1997 AND FISCAL 1996

  The following table sets forth certain items related to operations and such
items as a percentage of net sales for Fiscal 1997 and Fiscal 1996:
 
<TABLE> 
<CAPTION>
                                                                                        FISCAL YEAR ENDED  
                                                                      -----------------------------------------------------
                                                                        JANUARY 3, 1998    %      DECEMBER 28, 1996   %
                                                                        ----------------          -----------------                
                                                                         (Dollars in Thousands, except per share amounts)
<S>                                                                     <C>               <C>     <C>               <C>   
Net sales.................................................................   $450,199     100.0     $349,335        100.0
Gross profit..............................................................    120,941      26.9       86,237         24.7
Selling, general and administrative expenses..............................    127,261      28.3      114,888         32.9
Royalty income............................................................     22,569       5.0       27,638          7.9
Restructuring expenses (credit)...........................................      1,537       0.3       (1,177)        (0.3)
Earnings from operations..................................................     14,712       3.3          164          0.0
Loss (credit) on investment in unconsolidated subsidiary..................    (12,537)     (2.8)      (1,362)        (0.4)
Interest expense..........................................................     15,374       3.4       17,776          5.1
Income tax expense (benefit)..............................................     13,154       2.9       (4,134)        (1.2)
Loss from continuing operations...........................................     (4,305)     (1.0)     (18,435)        (5.3)
Extraordinary loss........................................................        744      (0.1)        ----         ----
Net loss..................................................................   $ (5,049)     (1.1)    $(18,435)        (5.3)

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

Net Sales

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

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

Gross Profit

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

Selling, General and Administrative Expenses

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

                                       13
<PAGE>
 
growth in the United States and the Pacific region. As a percentage of net
sales, selling, general and administrative expenses decreased to 28.3% for
Fiscal 1997 from 32.9% for the prior year.

Royalty Income

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

Restructuring Expenses (Credit)

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

Earnings from Operations

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

Loss (Credit) on Investment in Unconsolidated Subsidiary

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

Interest Expense

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

Income Tax Expense (Benefit)

  Income tax expense for Fiscal 1997 was $13.2 million, compared to an income
tax benefit of $4.1 million for Fiscal 1996.  As of January 3, 1998, the
Company's gross deferred tax assets were $44.2 million, which is the result of
net operating loss carryforwards and other future tax deductible items totaling
$117.2 million.  Although the period to use these deferred tax assets is 12 to
15 years for tax purposes, the accounting guidance requires that a shorter time
frame be used to assess the certainty of their realization.  As a result of the
uncertainty caused by the recent industry downturn and 

                                       14
<PAGE>
 
related oversupply of inventory in the marketplace during the fourth quarter of
Fiscal 1997, the Company increased its deferred tax valuation by $9.3 million to
a total of $20.9 million.

Loss from Continuing Operations

  The net loss from continuing operations for Fiscal 1997 was $4.3 million or
$0.25 per share, compared to a loss of $18.4 million or $1.10 per share in
Fiscal 1996. The net loss from continuing operations for Fiscal 1997, excluding
non-recurring items, was $1.2 million, or $0.07 per share, compared to a net
loss from continuing operations in the prior year, excluding non-recurring
items, of $15.6 million, or $0.93 per share. The Company incurred the following
non-recurring items net of tax in Fiscal 1997: a restructuring charge of $0.9
million, a gain of $7.1 million on its investment in Apex, and an increase to
the deferred tax asset valuation allowance of $9.3 million.

Extraordinary Loss

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

Net Loss

  Due to the factors described above, the Company recorded a net loss of $5.0
million in Fiscal 1997 compared to an $18.4 million net loss in Fiscal 1996. The
Fiscal 1997 net loss of $5.0 million included the following net of tax non-
recurring items: (i) restructuring charge of $0.9 million relating to a
workforce reduction and the closing of certain retail stores; (ii) gain on
investment in unconsolidated subsidiary of $7.1 million resulting from the
settlement of outstanding Apex litigation; (iii) a $9.3 million charge to
increase the valuation allowance related to the Company's deferred tax assets;
and (iv) an extraordinary charge of $0.7 million relating to the write-off of
certain deferred bank financing fees.

Net Loss Per Share

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

COMPARISON OF FISCAL 1996 AND FISCAL 1995

  The following table sets forth certain items related to operations and such
items as a percentage of net sales for Fiscal 1996 and Fiscal 1995:

<TABLE> 
<CAPTION>
                                                                                          FISCAL YEAR ENDED
                                                                      ---------------------------------------------------------
                                                                        DECEMBER 28, 1996     %        DECEMBER 30, 1995   %
                                                                        -----------------    --        -----------------   --
                                                                          (Dollars in Thousands, except per share amounts)
<S>                                                                   <C>                  <C>         <C>               <C>
Net sales..........................................................          $349,335      100.0            $407,483     100.0
Gross profit.......................................................            86,237       24.7             113,535      27.9
Selling, general and administrative expenses.......................           114,888       32.9             146,332      35.9
Royalty income.....................................................            27,638        7.9              17,257       4.2
Restructuring expenses (credit)....................................            (1,177)      (0.3)             14,182       3.5
Earnings (loss) from operations....................................               164        0.0             (29,722)     (7.3)
Loss (credit) on investment in unconsolidated subsidiary...........            (1,362)      (0.4)             52,160      12.8
Interest expense...................................................            17,776        5.1              14,043       3.4
Income tax expense (benefit).......................................            (4,134)      (1.2)            (28,144)     (6.9)
Net loss...........................................................          $(18,435)      (5.3)           $(71,747)    (17.6)

Net loss per share.................................................          $  (1.10)                      $  (4.30)
</TABLE>

                                       15
<PAGE>
 
Net Sales

  Net sales for Fiscal 1996 decreased to $349.3 million from $407.5 million for
Fiscal 1995, a decrease of 14.3%. The $58.2 million decrease in net sales was
attributable to declines in the athletic originals (31%), cross training (22%)
and basketball (3%) categories. These declines were slightly offset by a 20%
improvement in the children's category. Fiscal 1996 net sales for the Company's
four core product categories decreased 12.5% from Fiscal 1995. This decline was
primarily attributable to decreased net sales in the core categories in the
first half of Fiscal 1996 and partially offset by increased net sales in the
second half of Fiscal 1996.

  During Fiscal 1996 net sales in the United States decreased to $194.1 million
from $208.0 million in Fiscal 1995, a decrease of $13.9 million or 6.7%. The
Company's international net sales decreased from $199.5 million to $155.3
million over the same period, a decrease of $44.2 million or 22.2%. Fiscal 1996
international net sales declines over the prior year period were recorded in the
following geographic regions: Europe, Middle East and Africa (18.4%), Pacific
(Japan) (12.6%), and Latin/South America (47.0%).

Gross Profit

  Gross profit decreased to $86.2 million for Fiscal 1996 from $113.5 million
for Fiscal 1995, a 24.0% decline. The Company's gross profit margin decreased to
24.7% for Fiscal 1996, as compared to 27.9% for the prior year. Weak sell-
throughs of certain products, manufacturing losses relating to production
declines and operating inefficiencies, the sell-off of discontinued categories
and increased air freight costs all contributed to the decline in gross profit.

Selling, General and Administrative Expenses

  Selling, general and administrative expenses, which are primarily comprised of
advertising, promotion and selling expenses in addition to employee salaries and
benefits and other overhead costs, decreased to $114.9 million for Fiscal 1996
from $146.3 million for Fiscal 1995, a 21.5% decline. The decrease in selling,
general and administrative expenses of $31.4 million is a result of the expense
reduction plan announced by the Company in November 1995 and was primarily
attributable to: (i) a reduction in sports marketing spending as a result of
refocused endorsement efforts; (ii) a decrease in worldwide advertising
expenses; and (iii) a reduction in salary and benefit expenses related to a
streamlining of the Company's operations. As a percentage of net sales, selling,
general and administrative expenses decreased to 32.9% for Fiscal 1996 from
35.9% for the prior year.

Royalty Income

  Despite the decrease in the Company's net sales in Fiscal 1996, there was a
substantial increase in royalty income in Fiscal 1996 which management primarily
attributed to the strong consumer demand for Converse-branded apparel in the
Pacific region. Royalty income increased to $27.6 million for Fiscal 1996 from
$17.3 million for Fiscal 1995, an increase of $10.3 million or 59.5%. As a
percentage of net sales, royalty income grew to 7.9% for Fiscal 1996 from 4.2%
for Fiscal 1995. The $10.3 million growth was mainly attributable to a $7.7
million increase in royalty income in Japan and a $1.7 million increase in
royalty income in the United States primarily as a result of growth in licensed
apparel sales in these markets.

Restructuring Expenses (Credit)

  The Company established restructuring reserves during Fiscal 1995 which
included the sale of certain idle assets of the Company. One such asset, a
distribution center in Chester, South Carolina was sold at a gain of $2.2
million in June 1996. The gain on the sale of this asset was partly offset by
additional restructuring charges for severance and additional asset write-offs.
See Note 4 to the Consolidated Financial Statements of the Company included
herein.

                                       16
<PAGE>
 
Earnings (Loss) from Operations

  The Company recorded earnings from operations in Fiscal 1996 of $0.2 million,
compared to a loss of $29.7 million in Fiscal 1995. This change was primarily
due to the factors discussed above.

Loss (Credit) on Investment in Unconsolidated Subsidiary

  In the fourth quarter of Fiscal 1996, Converse reversed certain accruals
totaling $1.9 million relating to the settlement of certain Apex-related
obligations. These reversals were partly offset by other Apex-related expenses.
See Note 3 to the Consolidated Financial Statements of the Company included
herein.

Interest Expense

  Interest expense for Fiscal 1996 increased to $17.8 million from $14.0 million
in Fiscal 1995, a 27.1% increase. The increase is primarily attributable to: (i)
increased borrowing levels under the A Facility to finance normal business
activities; (ii) an increase in the interest rate charged for the B Facility;
(iii) interest paid into escrow on the subordinated notes delivered in
connection with the purchase of Apex; and (iv) fees paid in conjunction with
certain amendments to the Credit Facility. These increases were partly offset by
an interest expense reduction due to decreased borrowing levels on the B
Facility. See Note 8 to the Consolidated Financial Statements of the Company
included herein.

Income Tax Expense (Benefit)

  Income tax benefit recorded for Fiscal 1996 was $4.1 million as compared to an
income tax benefit for Fiscal 1995 of $28.1 million. Deferred income tax assets
have been established for net operating loss carryforwards and net temporary
differences between the book and the tax basis of assets and liabilities. Based
on the review of operating forecasts, historical operating results and the
significant net operating loss carryforwards, the Company has recorded a
valuation allowance of $11.6 million against these tax assets. Approximately
$107.0 million of future taxable income will be necessary to realize the
Company's net deferred tax assets of $35.0 million. See Note 10 to the
Consolidated Financial Statements of the Company included herein.

Net Loss

     Due to the factors described above, the Company recorded a net loss of
$18.4 million for Fiscal 1996, compared to a $71.7 million net loss in the prior
year.

Net Loss Per Share

  The Company recorded a net loss per share of $1.10 in Fiscal 1996 versus a net
loss per share of $4.30 in Fiscal 1995. The weighted average number of shares
outstanding in Fiscal 1996 was 16,760,620 compared to 16,692,156 in Fiscal 1995.

LIQUIDITY AND CAPITAL RESOURCES

Cash Flow

  Net cash required for operating activities was $48.1 million for Fiscal 1997.
Requirements for operating activities were comprised of a net loss of $12.8
million (after giving effect to adjustments for non-cash items), working capital
needs of $32.7 million consisting principally of receivables, inventories and
payables, and other long-term assets and liabilities of $2.6 million. In Fiscal
1996, net cash required for operating activities was $8.0 million. The major
components of cash flow were a requirement for operating cash from a net loss of
$33.8 million (after giving effect to

                                       17
<PAGE>
 
adjustments for non-cash items), offset by cash provided from a decrease in
refundable income taxes of $10.8 million and an increase in accounts payable and
accrued expenses of $16.9 million.

  Net cash used from investing activities was $5.9 million in Fiscal 1997 and
consisted entirely of additions to property, plant and equipment. In Fiscal
1996, net cash used by investing activities was $0.2 million and consisted of
additions to property, plant and equipment of $5.3 million offset by proceeds of
$5.1 million received from the disposal of a distribution facility in Chester,
South Carolina.

  Net cash provided by financing activities was $52.8 million for Fiscal 1997.
Cash was provided from the net proceeds from the sale of 7% Convertible
Subordinated Notes in May 1997 of $76.4 million, net borrowings under the Credit
Facility (see Financing Arrangements below) of $96.9 million and net proceeds
from the exercise of stock options of $0.5 million. This was partially offset by
cash used from the decrease of short-term debt of $3.2 million and the repayment
of the Old Credit Facility (see Financing Arrangements below) of $117.8 million.
In Fiscal 1996, net cash provided by financing activities of $10.9 million is
attributable to net proceeds from debt of $8.5 million and from the exercise of
stock options of $2.4 million.

Working Capital

  The Company's working capital position, net of cash, increased to $14.5
million on January 3, 1998, from a deficit of $38.6 million on December 28,
1996, an improvement of $53.1 million.

  As of January 3, 1998, total current assets, net of cash, increased $5.8
million from the prior year to $176.5 million. Receivables and inventories
increased $10.5 million and $7.9 million, respectively. The increase in
receivables is primarily due to the increased sales activity in the fourth
quarter of Fiscal 1997 (up $19.4 million, or 28.0%, versus prior year fourth
quarter). The increase in inventories is primarily attributable to timing, as
the Company had several spring launch dates scheduled in January 1998 (versus
February-March in prior year) which necessitated the purchasing of inventory in
the fourth quarter of Fiscal 1997. These increases were partially offset by a
decrease in restricted cash, prepaid expenses and other current assets of $12.6
million due principally to an increase in the valuation allowance related to the
Company's deferred tax assets.

  Total current liabilities decreased from $209.2 million on December 28, 1996
to $162.0 million on January 3, 1998, a decrease of $47.2 million. This decrease
is due to reductions in short-term debt of $4.4 million, credit facility
borrowing of $20.9 million, and payables and accrued expenses of $21.9 million.

Financing Arrangements

  In May 1997, the Company issued $80.0 million of 7% Convertible Subordinated
Notes due June 1, 2004 (the "Convertible Notes"). The Convertible Notes are
subordinated to all existing and future Senior Indebtedness (as defined
therein). The Convertible Notes are convertible at any time prior to maturity,
unless previously redeemed into common stock of the Company, at the option of
the holder, at a conversion price of $21.83 per share, subject to adjustment in
certain events. In addition, the Convertible Notes may be redeemed, in whole or
in part, at the option of the Company, at any time on or after June 5, 2000, at
redemption prices set forth therein plus accrued interest to the date of
redemption. Interest is payable semi-annually on June 1 and December 1,
commencing on December 1, 1997. Proceeds from the Convertible Notes were used to
repay indebtedness under the Company's then existing credit agreement (the "Old
Credit Facility").

  Simultaneously with the issuance of the Convertible Notes in May 1997, the
Company entered into a new $150.0 million secured credit agreement (the "Credit
Facility") with BT Commercial Corporation ("BTCC") for revolving loans, letters
of credit, foreign exchange contracts and banker acceptances and repaid the Old
Credit Facility. In connection with the repayment of the Old Credit Facility,
the Company wrote-off deferred financing fees of $1.3 million in the second
quarter. This write-off is presented as an extraordinary item on the statement
of operations. In July 1997, BTCC, 

                                       18
<PAGE>
 
as agent, syndicated the Credit Facility to a group of participating lenders
(the "Banks"). The amount of credit available to the Company at any time is
limited by a borrowing base formula, as defined in the Credit Facility,
consisting primarily of U.S. and Canadian accounts receivable and inventory (the
"Borrowing Base"). The aggregate of letters of credit, foreign exchange
contracts and banker acceptances may not exceed $80.0 million at any time;
revolving loans are limited only by the Credit Facility's maximum availability
less any amounts outstanding for letters of credit, foreign exchange contracts
or banker acceptances.

  The Credit Facility is for a five-year term and, accordingly, has an
expiration date of May 21, 2002. However, the total revolving loans and banker
acceptances outstanding under the Credit Facility of $96.8 million are
classified as current due to the Company's lockbox arrangement (whereby payments
by the Company's customers are deposited in a lockbox controlled by the Banks)
and certain clauses contained in the Credit Facility regarding mandatory
repayment that involve subjective judgments by the Banks. This classification is
required by Emerging Issues Task Force 95-22, "Balance Sheet Classification of
Borrowings Outstanding under a Revolving Credit Agreement that Includes both a
Subjective Acceleration Clause and a Lockbox Arrangement".

  As of January 3, 1998, the Borrowing Base was $111.2 million.  Utilization
under the Credit Facility at year end amounted to $102.0 million consisting of
revolving loans of $74.3 million, banker acceptances of $22.5 million and
outstanding letters of credit of $5.2 million.  Accordingly, $9.2 million of the
maximum available Borrowing Base remained unutilized as of January 3, 1998.

  Revolving loans under the Credit Facility bear interest either at the Prime
Lending Rate (as defined therein) plus one percent (1.00%) per annum or at the
Adjusted LIBOR Rate (as defined therein) plus a margin of two and one-half
percent (2.50%) per annum.  The foregoing LIBOR margin is subject to a reduction
based upon the Company achieving certain interest coverage ratios specified in
the Credit Facility.  At January 3, 1998, revolving loans outstanding under the
Credit Facility bore interest of 8.45% based upon the weighted average of the
Prime Lending Rate and Adjusted LIBOR Rate.  Obligations outstanding under the
Credit Facility are secured by first priority liens on substantially all of the
Company's U.S. and Canadian assets.

  The Credit Facility, as amended, requires compliance with customary
affirmative and negative covenants, including certain financial covenants.  In
November 1997, the Credit Facility was amended for one financial covenant with
respect to the fourth quarter 1997 requirement of the Interest Coverage Ratio
(as defined therein).  The Company was in compliance with the amended financial
covenant as of January 3, 1998.  In January 1998, the Credit Facility was
amended for the Interest Coverage Ratio requirements for the four quarterly
periods in fiscal 1998.  The Company believes that it will be in compliance with
this amended financial covenant during 1998.

  Subsidiaries of the Company maintain asset based financing arrangements in
certain European countries with various lenders.  In general, these financing
arrangements allow for borrowings based upon eligible accounts receivable and
inventory at varying advance rates and varying interest rates.  Total short-term
borrowings outstanding under these financing arrangements were $9.0 million as
of January 3, 1998.  Interest is payable at the respective lender's base rate
plus 1.5% (6.0% to 8.5% at year end).  Additionally, letters of credit
outstanding under these financing arrangements totaled $3.9 million at year end.
The obligations are secured by first priority liens on the respective European
assets being financed.  In addition, Converse Inc. provided guarantees with
respect to the outstanding borrowings for certain of the financing arrangements.

Capital Expenditures

  Capital expenditures were $5.9 million, $5.3 million and $5.8 million in
Fiscal 1997, Fiscal 1996 and Fiscal 1995, respectively.  Fiscal 1997 investments
included $0.5 million on building improvements primarily to upgrade the heating
system at the corporate office, $0.5 million on leasehold improvements primarily
to open or remodel the Company's retail stores, $1.6 million to maintain and
upgrade the Company's manufacturing facilities in Lumberton, North Carolina,
Mission, Texas and Reynosa, Mexico, $0.7 million to maintain and upgrade the
Company's distribution 

                                       19
<PAGE>
 
facility in Charlotte, North Carolina, $1.2 million in information technology to
support improvements in networking and international operations and $1.4 million
on various smaller projects and improvements.

  In Fiscal 1996, the Company spent $1.4 million on leasehold improvements
primarily to open or remodel the Company's retail stores, $1.0 million to
maintain and upgrade the Company's manufacturing facility in Lumberton, North
Carolina, $0.9 million in information technology to support improvements in
networking, retail store operations and international operations, $0.9 million
to upgrade the Company's trade show booth and $1.1 million on various smaller
projects and improvements.  Fiscal 1995 investments included $2.3 million in new
equipment and improvements to upgrade the Company's manufacturing facility in
Lumberton, North Carolina, $0.8 million in computer equipment, $0.7 million to
move the research and development offices to its present location, $0.7 million
to support international expansion, $0.4 million to open four new retail stores,
and the remaining $0.9 million was invested in various smaller projects.

YEAR 2000 SOFTWARE CHANGES

  A Company-wide task force has been established to review the possible effects
of the Year 2000 issue on its business and to implement potential solutions.
The Company is also in communication with its suppliers, customers and others
with which it does business to coordinate conversion efforts.  All Year 2000
compliance related costs will be expensed as incurred.  The Company does not
believe that it has material exposure to the Year 2000 issue with respect to its
own information system.  See "Business-Risk Factor - Risks Associated with the
Year 2000 Issue."

BACKLOG

  At the end of Fiscal 1997, the Company's global backlog was $129.5 million,
compared to $183.3 million at the end of Fiscal 1996. The amount of backlog at a
particular time is affected by a number of factors, including the scheduling of
the introduction of new products and the timing of the manufacturing and
shipping of the Company's products. Accordingly, a comparison of backlog as of
two different dates is not necessarily meaningful.

IMPACT OF RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

  The Financial Accounting Standards Board issued Statement No. 130, "Reporting
Comprehensive Income".  This Statement established standards for reporting and
display of comprehensive income and its components in a full set of general-
purpose financial statements.  This Statement is required to be adopted in the
Company's fiscal year-end 1998.  This Statement is not expected to have a
material impact on the Company's consolidated financial position or results of
operations.

  The Financial Accounting Standards Board issued Statement No. 131, "Disclosure
about Segments of an Enterprise and Related Information".  This Statement
requires an enterprise to report financial and descriptive information about its
reportable operating income.  Operating segments are components that are
evaluated regularly by chief operating decision makers in deciding how to
allocate resources and in assessing performance.  This Statement requires a
business enterprise to report a measure of segment profit or loss, certain
specific revenue and expense items (including interest, depreciation, and income
taxes), and segment assets.  It also establishes standards for related
disclosures about products and services, geographic areas, and major customers.
This Statement is required to be adopted in the Company's fiscal year-end 1998.
Management has not yet completed its assessment of how this Statement will
impact existing segment disclosures.

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

                                       20
<PAGE>
 
ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
-------------------------------------------------------------------

  Not applicable.

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

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

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

  Not applicable.

                                       21
<PAGE>
 
                                   PART III
                                   --------

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

EXECUTIVE OFFICERS OF THE COMPANY

  The information required by this item with respect to the Company's directors
is incorporated herein by reference to the Company's definitive proxy statement
for the Annual Meeting of Stockholders to be held on May 11, 1998, which will be
filed with the Securities and Exchange Commission on or before April 30, 1998
(the "1998 Proxy Statement").  Information required by this Item with respect to
the Company's executive officers is set forth below.

<TABLE>
<CAPTION>
NAME                                                                 AGE    POSITION
----                                                                 ---    --------
<S>                                                                  <C>    <C>
Glenn N. Rupp...................................................      53    Chairman of the Board and
                                                                            Chief Executive Officer
Donald J. Camacho...............................................      47    Senior Vice President and
                                                                            Chief Financial Officer
Edward C. Fredrick..............................................      51    Senior Vice President,
                                                                            Research and Development
Jack A. Green...................................................      52    Senior Vice President,
                                                                            General Counsel and Secretary
Thomas L. Nelson................................................      43    Senior Vice President,
                                                                            Sales/North America
Herbert R. Rothstein............................................      56    Senior Vice President, Production
James E. Solomon................................................      42    Senior Vice President, Marketing
Alistair M. Thorburn............................................      40    Senior Vice President, International
James E. Lawlor.................................................      44    Vice President, Finance and Treasurer
</TABLE>

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

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

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

  MR. GREEN has served as Senior Vice President, General Counsel and Secretary
since August 1985, having joined the Company as Vice President, Legal in 1983.

                                       22
<PAGE>
 
  MR. NELSON joined Converse as Senior Vice President, Sales/North America on
March 13, 1995. Before joining Converse, Mr. Nelson worked for The Rockport
Company, a subsidiary of Reebok International Ltd., where he served as Senior
Vice President of Sales/Operations from 1992 to 1995. Prior to that, Mr. Nelson
worked for G.H. Bass & Company from 1983 to 1992 where he held several sales-
related positions before being promoted to Senior Vice President of Sales in
1990.

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

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

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

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

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

  The information required by this Item is incorporated by reference from the
1998 Proxy Statement.

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

  The information required by this Item is incorporated by reference from the
1998 Proxy Statement.

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

  The information required by this Item is incorporated by reference from the
1998 Proxy Statement.

                                       23
<PAGE>
 
                                    PART IV

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

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

     1.   Financial statements:

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

<TABLE>
<CAPTION>
                                                                                 Page
                                                                                 ---
<S>                                                                              <C>
 
          Report of Independent Accountants                                      F-2
 
          Consolidated Balance Sheet at
          December 28, 1996 and January 3, 1998                                  F-3
 
          For each of the fiscal years ended December 30, 1995,
          December 28, 1996 and January 3, 1998:
 
               Consolidated Statement of Operations                              F-4
               Consolidated Statement of Cash Flows                              F-5
               Consolidated Statement of Stockholders' Equity (Deficiency)       F-6
 
          Notes to Consolidated Financial Statements                             F-7
 
     2.   Financial Statement Schedule:
 
               Schedule II - Valuation and Qualifying Accounts                   F-26
</TABLE>

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

          3.1  Restated Certificate of Incorporation (3)

          3.2  By-laws (3)

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

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

          10.2 Amendment Number One to Credit Agreement (12)

          10.3 Amendment Number Two to Credit Agreement*

                                       24
<PAGE>
 
          10.4  Amendment Number Three Credit Agreement*

          10.5  Converse Inc. 1994 Stock Option Plan, as Amended and Restated as
                of July 30, 1997 (13)

          10.6  Converse Inc. 1995 Non-Employee Director Stock Option Plan, as
                amended and restated as of July 30, 1997 (13)

          10.7  Amendment and Reaffirmation of Lease dated June 29, 1988,
                between Godley Construction Company Inc. ("Godley") and Converse
                Inc. and Lease Agreement dated as of March 26, 1974, between
                Godley and Charlotte Footwear, Inc. (1)

          10.8  Sublease Agreement dated as of September 28, 1993, between Kmart
                Corporation and Converse Inc. (1)

          10.9  Registration Rights Agreement dated as of November 17, 1994,
                between Apollo Interco Partners, L.P. and Converse Inc. (3)

          10.10 Consulting Agreement dated as of November 17, 1994, between
                Apollo Advisors, L.P. and Converse Inc. (3)

          10.11 Converse Inc. Executive Incentive Plan (1)

          10.12 Converse Inc. Team Incentive Plan (1)

          10.13 Converse Inc. Supplemental Executive Retirement Plan (6)

          10.14 Agreement among Julius W. Erving, the Erving Group and Converse
                Inc., dated October 1, 1984 as amended by an Amendment dated
                September 16, 1988, a Second Amendment dated July 18, 1989, a
                Third Amendment dated October 17, 1991, and a Fourth Amendment
                dated February 7, 1994 (2)

          10.15 Fifth Amendment to Agreement among Julius W. Erving, The Erving
                Group, Inc. and Converse Inc. (5)

          10.16 Sixth Amendment to Agreement among Julius W. Erving, the Erving
                Group, Inc. and Converse Inc.(8)

          10.17 Seventh Amendment to Agreement among Julius W. Erving, the
                Erving Group, Inc. and Converse Inc.(7)

          10.18 Lease Agreement dated as of January 3, 1995 between Talbot
                Operations Inc. and Converse Inc. (4)

          10.19 Employment Agreement between Converse and Glenn N. Rupp (8)

          10.20 Employment Agreement between Converse and James Solomon (9)
     
          10.21 Employment Agreement between Converse and Donald J. Camacho (6)

          10.22 Form of Employment Agreement dated as of October 25, 1995,
                between Converse and each of the following: Jack A. Green,
                Herbert R. Rothstein, Alistair Thorburn, Thomas L. Nelson and
                James E. Lawlor (6)

          10.23 Employment Agreement between Converse and Edward C. Frederick
                (11)

                                       25
<PAGE>
 
          10.24 Amended and Restated Accommodation Letter (10)

          10.25 Consultant's Agreement between Converse and Exeter Research,
                Inc. (11)

          10.26 Letter regarding joint basketball promotion between Converse,
                Footlocker and Julius Erving (11)

          10.27 Purchase Agreement dated June 1, 1997 between Converse and
                Exeter Research, Inc. (12)

          21.   List of subsidiaries*

          23.   Consent of Price Waterhouse LLP*

          27    Financial Data Schedule*

                *   Filed herewith

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

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

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

(4)  Filed as an Exhibit to Converse Inc. Form 10-K dated March 17, 1995, and
     incorporated by reference herein.

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

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

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

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

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

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

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

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

                                       26
<PAGE>
 
  (13) Filed as an Exhibit by Converse Inc. Quarterly Report on Form 10-Q for
       the quarter ended September 29, 1997, and incorporated by reference
       herein.

       (b)  No reports on Form 8-K were filed by the Company during the last
            quarter of Fiscal 1995.
  
       UPON WRITTEN REQUEST TO THE COMPANY'S SECRETARY, THE COMPANY WILL FURNISH
       SHAREHOLDERS WITH A COPY OF ANY OR ALL SUCH EXHIBITS REQUESTED AT A
       CHARGE OF TEN CENTS PER PAGE, WHICH REPRESENTS THE COMPANY'S REASONABLE
       EXPENSES IN FURNISHING SUCH EXHIBITS.




                                  SIGNATURES
                                        
  Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized, in North Reading,
Massachusetts on March 31, 1998.

                                             CONVERSE INC.

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

                                       27
<PAGE>
 
  Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrants and in the capacities and on the date indicated.


<TABLE>
<CAPTION>
SIGNATURE                                        TITLE                                        DATE
---------                                        -----                                        ----
<S>                               <C>                                                         <C>
/s/ Glenn N. Rupp                 Chairman of the Board, Chief Executive Officer              March 31, 1998
-------------------------------- 
Glenn N. Rupp                     and Director (Principal Executive Officer)
 
/s/ Donald J. Camacho             Senior Vice President and Chief Financial Officer           March 31, 1998
-------------------------------- 
Donald J. Camacho                 (Principal financial and Accounting Officer)
 
/s/ Donald J. Barr                Director                                                    March 31, 1998
--------------------------------
Donald J. Barr
 
/s/ Leon D. Black                 Director                                                    March 31, 1998
--------------------------------
Leon D. Black
 
/s/ Julius W. Erving              Director                                                    March 31, 1998
--------------------------------
Julius W. Erving
 
/s/ Robert H. Falk                Director                                                    March 31, 1998
--------------------------------
Robert H. Falk
 
/s/ Gilbert Ford                  Director                                                    March 31, 1998
--------------------------------
Gilbert Ford
 
/s/ Michael S. Gross              Director                                                    March 31, 1998
--------------------------------
Michael S. Gross
 
/s/ John J. Hannan                Director                                                    March 31, 1998
--------------------------------
John J. Hannan
 
/s/ Joshua J. Harris              Director                                                    March 31, 1998
--------------------------------
Joshua J. Harris
 
/s/ John H. Kissick               Director                                                    March 31, 1998
--------------------------------
John H. Kissick
 
/s/ Richard B. Loynd              Director                                                    March 31, 1998
--------------------------------
Richard B. Loynd
 
/s/ Michael D. Weiner             Director                                                    March 31, 1998
--------------------------------
Michael D. Weiner
</TABLE>

                                       28
<PAGE>
 
                        CONVERSE INC. AND SUBSIDIARIES

                  INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
                                                                                                           PAGE
                                                                                                         --------
<S>                                                                                                      <C>
Report of Independent Accountants                                                                          F-2
 
Consolidated Balance Sheet.............................................................................    F-3
 
Consolidated Statement of Operations...................................................................    F-4
 
Consolidated Statement of Cash Flows...................................................................    F-5
 
Consolidated Statement of Stockholders' Equity.........................................................    F-6
 
Notes to Consolidated Financial Statements.............................................................    F-7
</TABLE>
                                        
<PAGE>
 
                       REPORT OF INDEPENDENT ACCOUNTANTS


To the Board of Directors and
Stockholders of Converse Inc.

  In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of operations, cash flows and stockholders' equity
present fairly, in all material respects, the financial position of Converse
Inc. and its subsidiaries at December 28, 1996 and January 3, 1998, and the
results of their operations and their cash flows for each of the three years in
the period ended January 3, 1998, in conformity with generally accepted
accounting principles.  These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits.  We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement.  An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation.  We believe that our audits provide a
reasonable basis for the opinion expressed above.


PRICE WATERHOUSE LLP

Boston, Massachusetts
February 18, 1998

                                      F-2
<PAGE>
 
                        CONVERSE INC. AND SUBSIDIARIES

                          CONSOLIDATED BALANCE SHEET

               (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)



<TABLE>
<CAPTION>
                                                                                              DECEMBER 28, 1996   JANUARY 3, 1998 
                                                                                              ------------------  ----------------
<S>                                                                                           <C>                 <C> 
ASSETS
Current assets:
 Cash and cash equivalents..................................................................       $  5,908            $  5,738    
 Restricted cash............................................................................          1,354                 ---    
 Receivables, less allowances of $1,994 and $2,066, respectively............................         61,546              72,083    
 Inventories (Note 5).......................................................................         86,799              94,681    
 Prepaid expenses and other current assets (Note 10)........................................         20,965               9,713    
                                                                                                   --------            --------    
     Total current assets...................................................................        176,572             182,215    
Net property, plant and equipment (Note 6)..................................................         17,849              20,086    
Other assets (Note 10)......................................................................         28,182              32,393    
                                                                                                   --------            --------    
                                                                                                   $222,603            $234,694    
                                                                                                   ========            ========    
                                                                                                                                   
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY)                                                                                  
Current liabilities:                                                                                                               
 Short-term debt (Note 8)...................................................................       $ 13,421            $  9,036    
 Credit facility (Note 8)...................................................................        117,765              96,844    
 Accounts payable...........................................................................         49,503              41,318    
 Accrued expenses (Note 7)..................................................................         25,124              14,279    
 Income taxes payable (Note 10).............................................................          3,407                 478    
                                                                                                   --------            --------   
     Total current liabilities..............................................................        209,220             161,955    
Long-term debt (Note 8).....................................................................          9,644              80,000    
Current assets in excess of reorganization value (Note 2)...................................         32,376              30,299    
Accrued postretirement benefits other than pensions (Note 11)...............................         10,231              10,422    
Commitments and contingencies (Note 14)                                                                                            
Stockholders' equity (deficiency):                                                                                                 
 Common stock, $1.00 stated value, 50,000,000 shares authorized, 17,213,156 and                                                    
     17,317,956 shares issued and outstanding at December 28, 1996 and                                                             
     January 3, 1998, respectively..........................................................         17,213              17,318    
 Preferred stock, no par value, 10,000,000 shares authorized, none issued and                                                       
     outstanding............................................................................            ---                 ---    
 Additional paid-in capital.................................................................          5,392               2,271    
 Retained deficit...........................................................................        (60,265)            (65,314)    
 Foreign currency translation adjustment....................................................         (1,208)             (2,257)    
                                                                                                   --------            --------    
     Total stockholders' equity (deficiency)................................................        (38,868)            (47,982)    
                                                                                                   --------            --------    
                                                                                                   $222,603            $234,694    
                                                                                                   ========            ========    
</TABLE>

See accompanying notes to consolidated financial statements.

                                      F-3
<PAGE>
 
                        CONVERSE INC. AND SUBSIDIARIES

                     CONSOLIDATED STATEMENT OF OPERATIONS

               (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

<TABLE>
<CAPTION>
                                                                                          FISCAL YEAR ENDED
                                                                      -------------------------------------------------------
                                                                      DECEMBER 30, 1995   DECEMBER 28, 1996   JANUARY 3, 1998
                                                                      -----------------   -----------------   ---------------
<S>                                                                   <C>                 <C>                 <C>
Net sales..............................................................        $407,483            $349,335          $450,199
Cost of sales..........................................................         293,948             263,098           329,258
                                                                               --------            --------          --------
Gross profit...........................................................         113,535              86,237           120,941

Selling, general and administrative expenses...........................         146,332             114,888           127,261
Royalty income.........................................................          17,257              27,638            22,569
Restructuring expense (credit) (Note 4)................................          14,182              (1,177)            1,537
                                                                               --------            --------          --------
Earnings (loss) from operations........................................         (29,722)                164            14,712

Loss (credit) on investment in unconsolidated subsidiary
     (Note 3)..........................................................          52,160              (1,362)          (12,537)
Interest expense.......................................................          14,043              17,776            15,374
Other expense, net (Note 15)...........................................           3,966               6,319             3,026
                                                                               --------            --------          --------
Earnings (loss) from continuing operations before income taxes.........         (99,891)            (22,569)            8,849

Income tax expense (benefit) (Note 10).................................         (28,144)             (4,134)           13,154
                                                                               --------            --------          --------
Loss from continuing operations........................................         (71,747)            (18,435)         (  4,305)

Extraordinary loss, net of income tax benefit of $576 (Note 9).........             ---                 ---               744

Net loss...............................................................        $(71,747)           $(18,435)         $ (5,049)
                                                                               ========            ========          ========
Net basic and diluted loss per share (Note 2):
     Continuing operations.............................................          $(4.30)             $(1.10)         $  (0.25)
     Extraordinary loss................................................             ---                 ---             (0.04)
                                                                               --------            --------          --------
     Net loss..........................................................          $(4.30)             $(1.10)         $  (0.29)
                                                                               ========            ========          ========
Weighted average common shares outstanding (Note 2)....................          16,692              16,761            17,272
                                                                               ========            ========          ========
</TABLE>


See accompanying notes to consolidated financial statements.

                                      F-4
<PAGE>
 
                         CONVERSE INC. AND SUBSIDIARIES

                      CONSOLIDATED STATEMENT OF CASH FLOWS
                (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

<TABLE>
<CAPTION>
                                                                                                 FISCAL YEAR ENDED
                                                                             ------------------------------------------------------
                                                                             DECEMBER 30, 1995   DECEMBER 28, 1996  JANUARY 3, 1998
                                                                             -----------------   -----------------  ---------------
<S>                                                                           <C>                 <C>                <C>
Cash flows from operating activities:
 Net loss.....................................................................      $(71,747)          $(18,435)       $  (5,049)
 Adjustments to reconcile net loss to net cash provided by (required for)
  operating activities:                                                  
 Loss (credit) on investment in unconsolidated subsidiary, less cash payments
  of $28,763, $3,439 and $8,064, respectively.................................        23,397             (4,801)         (20,601)
 Provision for restructuring actions, less cash payments of $1,230, $5,316         
  and $3,763, respectively....................................................        12,952             (6,493)          (2,226)
 Extraordinary loss on write-off of deferred financing fees...................          ----               ----            1,320
 Depreciation of property, plant and equipment................................         2,744              3,100            3,589
 Amortization of intangible assets............................................           471                539              548
 Amortization of current assets in excess of reorganization value.............        (2,078)            (2,078)          (2,077)
 Deferred income taxes........................................................       (18,551)            (5,614)          11,709
Changes in assets and liabilities:                                                
 Receivables..................................................................         7,940               (759)         (12,359)
 Inventories..................................................................        18,546             (5,844)          (8,775)
 Prepaid expenses and other current assets....................................        (9,750)            10,859              114
 Accounts payable and accrued expenses........................................           912             16,889           (8,751)
 Income taxes payable.........................................................           223              1,612           (2,929)
 Other long-term assets and liabilities.......................................          (966)             3,009           (2,620)
                                                                                    --------           --------        ---------
  Net cash required for operating activities..................................       (35,907)            (8,016)         (48,107)
                                                                                    --------           --------        ---------
Cash flows from investing activities:                                             
 Proceeds from disposal of assets.............................................           ---              5,101              ---
 Additions to property, plant and equipment...................................        (5,760)            (5,305)          (5,909)
                                                                                    --------           --------        ---------
  Net cash used by investing activities.......................................        (5,760)              (204)          (5,909)
                                                                                    --------           --------        ---------
Cash flows from financing activities:                                             
 Net proceeds from exercise of stock options..................................           ---              2,385              512
 Net proceeds from (payment of) short-term debt...............................         8,093                231           (3,236)
 Net proceeds from (repayment of) old credit facility.........................        32,185              8,261         (117,765)
 Net borrowings under  new credit facility....................................           ---                ---           96,844
 Net proceeds from bond issue.................................................           ---                ---           76,400
                                                                                    --------           --------        ---------
  Net cash provided by financing activities...................................        40,278             10,877           52,755
                                                                                    --------           --------        ---------
Effect of foreign currency rate fluctuations on cash and cash equivalents.....          (865)               513            1,091
                                                                                    --------           --------        ---------
Net increase (decrease) in cash and cash equivalents..........................        (2,254)             3,170             (170)
Cash and cash equivalents at beginning of period..............................         4,992              2,738            5,908
                                                                                    --------           --------        ---------
Cash and cash equivalents at end of period....................................      $  2,738           $  5,908        $   5,738
                                                                                    ========           ========        =========
Supplemental Disclosures:                                                         
 Cash payments for (refunds of) income taxes, net.............................      $  5,081           $(10,150)       $   3,719
                                                                                    ========           ========        =========
 Cash payments for interest...................................................      $ 12,276           $ 13,283        $  16,663    
                                                                                    ========           ========        =========
</TABLE>


See accompanying notes to consolidated financial statements.

                                      F-5
<PAGE>
 
                        CONVERSE INC. AND SUBSIDIARIES

                CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
               (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)


<TABLE>
<CAPTION>
                                                                                                     FOREIGN             TOTAL
                                                                                  RETAINED           CURRENCY        STOCKHOLDERS'
                                                  COMMON      ADDITIONAL          EARNINGS          TRANSLATION         EQUITY
                                                  STOCK    PAID-IN CAPITAL        (DEFICIT)         ADJUSTMENT       (DEFICIENCY)
                                                 --------  ---------------        ---------         -----------      ------------ 
<S>                                              <C>       <C>                    <C>               <C>              <C>
Balance, December 31, 1994                        $16,692          $  ----        $ 29,917            $(1,622)          $ 44,987
Net loss                                                                           (71,747)                              (71,747)
Foreign currency translation                                                                              547                547
Issuance of common stock warrants (Note 3)                           3,528                                                 3,528
                                                 --------       ----------        --------            -------         ---------- 
Balance, December 30, 1995                         16,692            3,528         (41,830)            (1,075)           (22,685)
Net loss                                                                           (18,435)                              (18,435)
Foreign currency translation                                                                             (133)              (133)
Exercise of common stock options                      521            1,864                                                 2,385
                                                 --------       ----------        --------            -------         ---------- 
Balance, December 28, 1996                         17,213            5,392         (60,265)            (1,208)           (38,868)
Net loss                                                                            (5,049)                               (5,049)
Foreign currency translation                                                                           (1,049)            (1,049)
Exercise of common stock options                      105              407                                                   512
Cancellation of common stock warrants (Note 3)                      (3,528)                                               (3,528)
                                                 --------       ----------        --------            -------         ---------- 
Balance, January 3, 1998                          $17,318          $ 2,271        $(65,314)           $(2,257)          $(47,982)
                                                 ========       ==========        ========            =======         ========== 
</TABLE>
                                                                                
 
See accompanying notes to consolidated financial statements.

                                      F-6
<PAGE>
 
                         CONVERSE INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

1.   SUMMARY OF BUSINESS OPERATIONS

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

Distribution

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

2.   SIGNIFICANT ACCOUNTING POLICIES

     The major accounting policies of Converse are set forth below.

Fiscal year

     Converse's fiscal year end is the Saturday closest to December 31 in each
year.  For 1997, Converse's fiscal year ended on January 3, 1998 ("Fiscal
1997"); for 1996, Converse's fiscal year ended on December 28, 1996 ("Fiscal
1996"); and for 1995, Converse's fiscal year ended December 30, 1995 ("Fiscal
1995").  Fiscal year 1997 includes 53-weeks whereas Fiscal years 1996 and 1995
include 52-weeks.

Basis of consolidation

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

     As more fully described in Note 3, effective May 18, 1995, Converse
acquired 100% of the outstanding common stock of Apex One, Inc. ("Apex"). On
August 11, 1995, Converse stopped funding the operations of Apex. As a result of
this decision, Apex was unable to meet its obligations, ceased operations and on
September 14, 1995 filed for Chapter 11 bankruptcy protection. Because
Converse's control of Apex was temporary in nature, its investment in Apex has
been recorded as an unconsolidated equity investment. Accordingly, the
accompanying consolidated financial statements do not include the accounts of
Apex.

Management estimates

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

Cash and cash equivalents

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

                                      F-7
<PAGE>
 
Fair value of financial instruments

     The carrying amount of cash, cash equivalents, trade receivables and trade
payables approximates their fair value because of the short maturity of these
financial instruments. The fair value of Converse's long-term instruments is
estimated based on market values for similar instruments and approximates their
carrying value at December 28, 1996 and January 3, 1998. As described in Note 3,
at December 28, 1996, the Apex subordinated notes and common stock warrants were
carried within the accompanying consolidated balance sheet at their originally
recorded amounts of $9,644 and $3,528, respectively. In the first quarter of
1997, Converse settled substantially all of the remaining material claims
between the Company and the former owners of Apex. See Note 3.

Inventories

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

Property, plant and equipment

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

Current assets in excess of reorganization value

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

Foreign currency transactions

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

     During Fiscal 1997, the Company used foreign exchange forward contracts and
put options to protect the Company from the effects of changes in foreign
exchange rates on the statement of operations. These instruments do not qualify
for hedge accounting. At January 3, 1998, the Company had open "out of the
money" put options totaling $15.1 million with a maximum remaining term to
maturity of less than one year and no open foreign exchange forward contracts.
Net realized losses of $214 related to these transactions have been reflected in
the statement of operations for the year ended January 3, 1998.

Revenue recognition

     Revenue from the sale of product is recognized at the time of shipment.
Royalty income is recognized by Converse upon the shipment of product by the
licensees to the ultimate customer.

                                      F-8
<PAGE>
 
Advertising

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

Endorsement contracts

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

Earnings per share

     In February 1997, Statement of Financial Accounting Standards No. 128,
"Earnings per Share" (SFAS No. 128) was issued which supersedes the old
methodology for calculation of earnings per share, as promulgated under APB
Opinion No. 15. SFAS No. 128 requires presentation of "basic" earnings per share
(which excludes dilution as a result of unexercised stock options and
convertible subordinated debentures) and "diluted" earnings per share. The
Statement was adopted in Fiscal 1997, and all prior periods were retroactively
restated. For the fiscal years ended December 30, 1995, December 28, 1996 and
January 3, 1998, basic and diluted earnings per share are the same.

Concentration of risk

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

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

Reclassifications

     Certain amounts in the prior year financial statements and related notes
have been reclassified to conform with the Fiscal 1997 presentation.

3.   LOSS ON INVESTMENT IN UNCONSOLIDATED SUBSIDIARY

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

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

                                      F-9
<PAGE>
 
     As a result of this decision, Apex ceased operations and was unable to meet
its obligations and on September 14, 1995 filed for Chapter 11 bankruptcy
protection. Because Converse's control of Apex was temporary in nature, its
investment in Apex was recorded as an unconsolidated equity investment. During
1995, Converse recorded a loss on this unconsolidated subsidiary, comprised
primarily of: (i) the Company's initial investment in Apex; (ii) additional
funding advances; (iii) contractual obligations, bank guarantees, professional
fees and other closing costs; and (iv) loss on the sale of Apex inventory
purchased by Converse for sale to independent third parties.

     As a result of the significant operations and financial difficulties
discovered subsequent to the acquisition of Apex, Converse performed an
investigation of potential breaches of representations and warranties by Apex
and its former owners in connection with Converse's purchase of Apex. In
November 1995, Converse paid into escrow, as opposed to paying the former owners
directly, the first interest payment of $443 pertaining to the subordinated
notes issued as part of the Apex purchase price. Converse also paid the May 1996
and November 1996 interest payments into escrow. In January 1996, certain former
owners of Apex filed suit against Converse seeking a declaratory judgment that
they were entitled to payment of this interest. In March 1996, Converse filed a
counter claim against these former Apex owners for breach of warranty and other
claims relating to the Apex purchase (together the "State Court Action"). In
January 1997, a jury ruled unanimously in favor of Converse and against each of
the four former owners of Apex who were parties to the State Court Action. In
connection with the favorable jury verdict, the Company was awarded damages
against each of the four former Apex owners. Subsequently, the Company entered
into settlement agreements with three of these parties, whereby subordinated
notes, common stock warrants and other contractual obligations issued to such
parties by Converse in connection with the acquisition of Apex were delivered to
the Company, together with a cash payment of $2,000 by one of the former owners,
in satisfaction of Converse's indemnification claims. Separately, during the
first quarter of 1997, the Company entered into settlement agreements with
substantially all of the remaining former owners of Apex who were not parties to
the State Court Action, whereby these former owners acknowledged their
obligations to Converse for indemnification claims under the Securities Purchase
Agreement. As part of these settlements, the former owners delivered to Converse
in full satisfaction of Converse's indemnification claims their subordinated
notes, common stock warrants and other contractual obligations issued by
Converse to these parties in connection with the acquisition of Apex.

     As a result of the Chapter 11 bankruptcy filing, various lawsuits were
filed against Converse alleging that the Company was liable for the debts of
Apex. Claims in connection with these lawsuits totaled approximately $6,500.
Despite Converse's belief that it had valid defenses to the claims made, the
Company entered into settlement discussions with the Apex estate in order to
avoid defending these lawsuits and incurring the associated legal fees. In
February 1997, the United States Bankruptcy Court confirmed the Apex plan of
liquidation pursuant to which Converse made a $4,400 payment to the Apex estate
and a $500 payment to certain creditors of Apex during the first quarter of
1997. In addition, Converse withdrew its claims against Apex. The confirmed plan
also included injunction and release provisions which preclude Apex or its
creditors from bringing or continuing any Apex-related claims against Converse.

                                      F-10
<PAGE>
 
     The following table summarizes the Fiscal 1995, 1996 and 1997 activity
     relating to Apex:

<TABLE>
<CAPTION>                                                                             CONTRACTUAL 
                                                                                      OBLIGATIONS, 
                                                                                          BANK             
                                                                   FUNDING            GUARANTEES,
                                                   INITIAL         PROVIDED          PROFESSIONAL      
                                                  INVESTMENT        MAY 18 -        FEES  AND OTHER      LOSS ON SALE OF
                                                    IN APEX     AUGUST 11, 1995      CLOSING COSTS       APEX INVENTORY     TOTAL  
                                                  ---------     ---------------     ---------------      ---------------    -----  
<S>                                               <C>           <C>                 <C>                  <C>                <C>    
Loss as of July 1, 1995......................      $ 13,172        $ 10,422             $ 18,005            $   ---       $ 41,599  

Changes in estimates.........................          ----            ----                2,680              7,881         10,561 
Charges/write-offs...........................       (13,172)        (10,422)             (10,460)            (7,881)       (41,935)
                                                    -------         -------              -------             ------        ------- 
December 30, 1995 Balance....................          ----            ----               10,225               ----         10,225 
Changes in estimates.........................          ----            ----               (1,877)               515         (1,362)
Charges/write-offs...........................          ----            ----               (2,924)              (515)        (3,439)
                                                    -------         -------              -------             ------        ------- 
December 28, 1996 Balance....................          ----            ----                5,424               ----          5,424 
Changes in estimates.........................       (13,172)           ----                  635               ----        (12,537)
Charges/write-offs...........................        13,172            ----               (6,059)              ----          7,113 
                                                    -------         -------              -------             ------        ------- 
January 3, 1998 Balance......................      $   ----        $   ----             $   ----            $  ----       $   ---- 
                                                    =======         =======              =======             ======        ======= 


 
</TABLE>

     During 1995, Converse recorded a $41,599 loss on its unconsolidated equity
investment in Apex, as described above. During the fourth quarter of 1995,
Converse recorded an additional $10,561 loss on its unconsolidated equity
investment in Apex, resulting in a total loss of $52,160. This additional loss
was comprised of unanticipated losses of $7,881 on the fourth quarter sale of
Apex inventory purchased by Converse for sale to independent third parties and
additional contractual obligations, professional fees and other closing costs of
$2,680. This additional amount was a result of changes in estimates made during
the fourth quarter of 1995 due to previously unanticipated events and
circumstances.

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

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

4.   RESTRUCTURING CHARGES

     During 1995, Converse recorded restructuring charges of $14,182 relating
primarily to initiatives aimed at reducing future operating costs, including
domestic manufacturing, global distribution, marketing, and general and
administrative costs.

     The Company recorded a restructuring charge of $2,100 in the fourth quarter
of 1997, in order to bring the Company's expenses more in line with projected
revenues as a result of the uncertainty caused by the recent industry downturn
and the related oversupply of inventory in the marketplace. This restructuring
charge related to a workforce reduction and elimination of certain unprofitable
retail stores.

                                      F-11
<PAGE>
 
   The following table summarizes the Fiscal 1995, 1996 and 1997 activity
relating to these initiatives:

<TABLE>
<CAPTION>
                                                                                                                     
                                                
                                                  LOSS       EMPLOYEE                                 REDUCTION IN                  
                                   CONTRACT     (CREDIT)     SEVERANCE       LEASE        RETAIL     LIABILITY FOR     
                                 TERMINATION    ON ASSET     & RELATED    TERMINATION     STORE      POSTRETIREMENT    
                                    COSTS       DISPOSALS      COSTS         COSTS        CLOSINGS      BENEFITS        TOTAL
                                ------------   ----------   ----------    -----------     --------   --------------     -----    
<S>                             <C>            <C>          <C>           <C>             <C>        <C>                <C>       
1995 restructuring accrual...        $ 6,150    $ 4,807       $ 2,502         $1,453          ----          $ ( 730)    $14,182  
Charges/write-offs...........           (415)    (4,807)         (815)          ----          ----              730      (5,307) 
                                ------------   ----------    ---------    -----------     --------    --------------    -------  
December 30, 1995 Balance....          5,735       ----         1,687          1,453          ----             ----       8,875  
Changes in estimates  .......         (1,000)    (1,533)        1,356           ----          ----             ----      (1,177) 
Charges/write-offs...........         (3,233)     1,533          (587)          (889)         ----             ----      (3,176) 
                                ------------   ----------   ----------    -----------     --------    --------------    -------  
December 28, 1996 Balance....          1,502       ----         2,456            564          ----             ----       4,522  
Changes in estimates  .......           ----       ----          ----         $ (564)         ----             ----        (564) 
1997 restructuring...........            444       ----         1,192           ----           464             ----       2,100  
Charges/write-offs...........         (1,633)      ----        (1,987)          ----          ----             ----      (3,620) 
                                ------------   ----------   ----------    -----------     --------    --------------    -------  
January 3, 1998 Balance......        $   313    $  ----       $ 1,661         $ ----          $464         $   ----     $ 2,438  
                                ============   ==========   ==========    ===========     ========    ==============    =======   
</TABLE>

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

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

   During the first quarter of 1997, the Company re-opened the manufacturing
facility located in Mission, Texas for cutting and limited production due to an
unexpected increase in demand for athletic originals products.  Accordingly, the
remaining lease termination restructuring reserve of $564 was reversed into
income.  During the fourth quarter of 1997, the Company recorded a restructuring
charge of $2,100.  The costs included in the charge were primarily: (i) employee
severance and related benefits for the termination of 35 employees;  (ii) costs
related to the closing of three unprofitable retail stores; and (iii)
termination costs related to marketing endorser contracts.  All remaining
restructuring liabilities represent fixed amounts to be paid out over the next
two years.

5. INVENTORIES

   Inventories are summarized as follows:

<TABLE>
<CAPTION>
                                           DECEMBER 28, 1996   JANUARY 3, 1998
                                           -----------------   ---------------
<S>                                        <C>                 <C> 
   Retail merchandise...............             $ 6,298             $ 5,245  
   Finished products................              73,887              81,311  
   Work-in-process..................               3,320               4,560  
   Raw materials....................               3,294               3,565  
                                                --------           ---------
                                                 $86,799             $94,681  
                                                ========           =========
</TABLE>                                                            

                                      F-12
<PAGE>
 
6. PROPERTY, PLANT AND EQUIPMENT

   Property, plant and equipment consisted of the following:

<TABLE>
<CAPTION>
                                                    ESTIMATED
                                                     USEFUL
                                                  LIFE (YEARS)        DECEMBER 28, 1996        JANUARY 3, 1998
                                                  ------------        -----------------        ---------------
<S>                                               <C>                 <C>                      <C> 
Building and leasehold improvements                    5 - 10                  $ 5,734                $ 7,832        
Machinery and equipment......................          3 - 11                    9,890                 12,012        
Furniture and fixtures.......................           5 - 8                    2,448                  2,944        
Office and computer equipment................               7                    7,272                  8,381        
                                                                           -----------              ---------        
                                                                                25,344                 31,169        
Less accumulated depreciation................                                    7,495                 11,083        
                                                                           -----------              ---------        
                                                                               $17,849                $20,086        
                                                                           ===========              =========        
</TABLE>
                                                                               
7. ACCRUED EXPENSES

   Accrued expenses consisted of the following:

<TABLE> 
<CAPTION> 
                                                            DECEMBER 28, 1996              JANUARY 3, 1998
                                                            -----------------              ---------------
<S>                                                         <C>                             <C> 
   Employee compensation..........................              $ 3,543                         $ 3,325
   Advertising and promotion......................                3,432                           2,520
   Customer deposits..............................                2,943                              61
   Accrued interest...............................                2,160                           1,155
   Restructuring charges..........................                4,522                           2,438
   Loss on investment in unconsolidated
       subsidiary.................................                5,424                            ----
   Other..........................................                3,100                           4,780          
                                                               --------                        --------
                                                                $25,124                         $14,279
                                                               ========                        ========          
</TABLE>
                                                                                
8. DEBT

   Debt consisted of the following:

<TABLE>
<CAPTION>
                                                            DECEMBER 28, 1996              JANUARY 3, 1998
                                                            -----------------              ---------------
<S>                                                         <C>                            <C> 
Current:
   Short-term debt...................................             $ 13,421                       $ 9,036          
   Credit facility...................................                 ----                       $96,844          
   Old credit facility...............................             $117,765                          ----          
 Long-Term:                                                                                                       
   Convertible subordinated notes....................                 ----                       $80,000          
   Subordinated notes (Apex).........................             $  9,644                          ----          
</TABLE>

Short-term debt

   Converse maintains asset based financing arrangements in certain European
countries with various lenders. In general, these financing arrangements allow
the Company to borrow against varying percentages of eligible customer
receivable balances based on pre-established credit lines, along with varying
percentages of inventory, as defined.  Interest is payable at the respective
lender's base rate plus 1.5% (6.0% to 8.5% at January 3, 1998). The obligations
are 

                                      F-13
<PAGE>
 
secured by a first priority lien on the respective European assets being
financed. In addition, Converse has provided guarantees of these borrowings in
certain of the European countries.

Credit facility

   Simultaneously with the issuance of the $80,000 principal amount of
Convertible Subordinated Notes (the "Convertible Notes") in May 1997 (see
below), the Company entered into a new $150,000 secured credit agreement (the
"Credit Facility") with BT Commercial Corporation ("BTCC") for revolving loans,
letters of credit, foreign exchange contracts and banker acceptances and repaid
the indebtedness under the Company's then existing credit agreement (the "Old
Credit Facility").  In connection with the repayment of the Old Credit Facility,
the Company wrote-off deferred financing fees of $1,320 in the second quarter.
This write-off is presented as an extraordinary item on the statement of
operations.  In July 1997, BTCC, as agent, syndicated the Credit Facility to a
group of participating lenders (the "Banks").  The amount of credit available to
the Company at any time is limited by a borrowing base formula, as defined in
the Credit Facility, consisting primarily of U.S. and Canadian accounts
receivable and inventory (the "Borrowing Base").  The aggregate of letters of
credit, foreign exchange contracts and banker acceptances may not exceed $80,000
at any time; revolving loans are limited only by the Credit Facility's maximum
availability less any amounts outstanding for letters of credit, foreign
exchange contracts or banker acceptances.

   The Credit Facility is for a five-year term and, accordingly, has an
expiration date of May 21, 2002.  However, the total revolving loans and banker
acceptances outstanding under the Credit Facility of $96,844 are classified as
current due to the Company's lockbox arrangement (whereby payments by the
Company's customers are deposited in a lockbox controlled by the Banks) and
certain clauses contained in the Credit Facility regarding mandatory repayment
that involve subjective judgments by the Banks.  This classification is required
by Emerging Issues Task Force 95-22, "Balance Sheet Classification of Borrowings
Outstanding under a Revolving Credit Agreement that Includes both a Subjective
Acceleration Clause and a Lockbox Arrangement".

   As of January 3, 1998, the Borrowing Base was $111,197. Utilization under the
Credit Facility at year end amounted to $101,964 consisting of revolving loans
of $74,256, banker acceptances of $22,588 and outstanding letters of credit of
$5,120. Accordingly, $9,233 of the maximum available Borrowing Base remained
unutilized as of January 3, 1998.

   Revolving loans under the Credit Facility bear interest either at the Prime
Lending Rate (as defined therein) plus one percent (1.00%) per annum or at the
Adjusted LIBOR Rate (as defined therein) plus a margin of two and one-half
percent (2.50%) per annum.  The foregoing LIBOR margin is subject to reduction
based upon the Company achieving certain interest coverage ratios specified in
the Credit Facility.  At January 3, 1998, revolving loans outstanding under the
Credit Facility bore interest of 8.45% based upon the weighted average of the
Prime Lending Rate and Adjusted LIBOR Rate.  Obligations outstanding under the
Credit Facility are secured by first priority liens on substantially all of the
Company's U.S. and Canadian assets.  The Credit Facility requires compliance
with customary affirmative and negative covenants, including certain financial
covenants.  In November 1997, the Credit Facility was amended to adjust one
financial covenant pertaining to the fourth quarter 1997 Interest Coverage
Ratio, as defined therein.  The Company was in compliance with this amended
financial covenant as of January 3, 1998.  In January 1998, the Credit Facility
was amended to adjust the Interest Coverage Ratio requirements for the four
quarterly periods in fiscal 1998.  The Company believes that it will be in
compliance with this amended financial covenant during 1998.

   The Credit Facility provides for customary ongoing fees including an unused
line fee of .50% per annum on the unutilized portion of the credit commitment
and fees with respect to documentary or stand-by letters of credit varying from
1.25% to 2.25% per annum on the outstanding face amount of the respective
credit.  The Company is obligated to pay BTCC, as agent for the Credit Facility,
an annual collateral management fee of $100.

                                      F-14
<PAGE>
 
   In May 1997, the Company paid a funding fee with respect to the Credit
Facility of 2% of the total commitment, or $3,000, to BTCC.  In November 1997, a
fee of $150 was paid to the Banks with respect to the above-referenced amendment
executed on November 21, 1997.  The Company has capitalized these fees and is
amortizing these costs over the term of the Credit Facility.  Accordingly,
unamortized financing fees relating to the Credit Facility, recorded in other
assets on the consolidated balance sheet of the Company, were $2,780 at January
3, 1998.  Unamortized financing fees of $2,014 with respect to the Old Credit
Facility were included in other assets on the consolidated balance sheet of the
Company at December 28, 1996.

Convertible subordinated notes

   On May 21, 1997, the Company completed the sale of the Convertible Notes due
June 1, 2004.  The Convertible Notes are subordinated to all existing and future
Senior Indebtedness (as defined therein).  The Convertible Notes are convertible
at any time prior to maturity, unless previously redeemed into common stock of
the Company, at the option of the holder, at a conversion price of $21.83 per
share, subject to adjustment in certain events.  In addition, the Convertible
Notes may be redeemed, in whole or in part, at the option of the Company, at any
time on or after June 5, 2000 at the redemption prices set forth therein plus
accrued interest to the date of redemption.  Interest is payable semi-annually
on June 1 and December 1, commencing on December 1, 1997.  The Company
capitalized deferred note issuance costs of $3,673 in conjunction with the
issuance of the Convertible Notes.  These deferred costs are being amortized
over the seven year life of the Convertible Notes.  Proceeds from the
Convertible Notes were used to repay indebtedness under the Old Credit Facility.

Subordinated notes (Apex)

   On May 18, 1995, in conjunction with Converse's acquisition of 100% of the
outstanding common stock of Apex (see Note 3), Converse issued subordinated
notes in the face amount of $11,000, discounted at a rate of 12%, to $9,644.
The notes bore interest at the rate of 8% per annum for the first three years
and were to bear interest at the rate of 10% and 12% in 1998 and 1999,
respectively.  The notes had an original maturity of May 18, 2003.

   As described in Note 3, during 1997, substantially all of these notes were
returned to Converse in connection with the settlement of the Apex litigation.
The Company had accrued $1,354 of interest expense related to these notes which
was included as restricted cash on the December 28, 1996 balance sheet.  In
connection with the settlement of the subordinated notes, this interest expense
was reversed in Fiscal 1997.

Total interest expense consisted of the following:

<TABLE>
<CAPTION>
                                                                 FISCAL YEAR ENDED
                                      ----------------------------------------------------------------------
                                        DECEMBER 30, 1995        DECEMBER 28, 1996         JANUARY 3, 1998
                                        -----------------        -----------------         ---------------
<S>                                   <C>                        <C>                       <C> 
Interest on short-term debt, Credit
  Facility and Old Credit Facility....        $ 9,220                  $11,368                 $ 9,777
Interest on Convertible Notes.........           ----                     ----                   3,508
Interest on subordinated notes........            474                      880                  (1,354)
Amortization of Convertible Notes
  Issuance costs......................           ----                     ----                     320
Credit line fees......................          2,030                    1,518                   1,819
Amortization of Old
  Credit Facility financing fees......          1,767                    1,767                     694
Old Credit Facility amendment
  and other fees......................            552                    2,243                     240
Amortization of Credit Facility
  Financing fees......................           ----                     ----                     370
                                            ---------                ---------               --------- 
                                              $14,043                  $17,776                 $15,374        
                                            =========                =========               ========= 
</TABLE>

                                      F-15
<PAGE>
 
9.   EXTRAORDINARY LOSS

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

10.  INCOME TAXES

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

<TABLE>
<CAPTION>
                                                                        FISCAL YEAR ENDED
                                           ----------------------------------------------------------------------------
                                              DECEMBER 30, 1995         DECEMBER 28, 1996          JANUARY 3, 1998
                                           -----------------------  -------------------------  ------------------------
<S>                                        <C>                      <C>                        <C>
     Domestic.......................                   $(84,482)                 $(17,967)                $ 29,730
     Foreign........................                    (15,409)                   (4,602)                 (20,881)
                                                  -------------             -------------            ------------- 
                                                       $(99,891)                 $(22,569)                $  8,849
                                                  =============             =============            =============
</TABLE>

     Income tax expense (benefit) related to continuing operations was comprised
of the following:

<TABLE>
<CAPTION>
                                                                      FISCAL YEAR ENDED
                                      ---------------------------------------------------------------------------------
                                          DECEMBER 30, 1995           DECEMBER 28, 1996            JANUARY 3, 1998
                                      --------------------------  --------------------------  -------------------------
<S>                                   <C>                         <C>                         <C>
Current:
     Federal........................               $(12,666)                    $(3,617)                   $  ----
     State..........................                    417                         299                        362
     Foreign........................                  2,656                       3,571                      2,336
                                              -------------               -------------              ------------- 
                                                     (9,593)                        253                      2,698
                                              -------------               -------------              ------------- 
Deferred:                                                                                          
     Federal........................                (16,557)                     (3,906)                     8,574
     State..........................                 (1,994)                       (481)                     1,882
                                              -------------               -------------              ------------- 
                                                    (18,551)                     (4,387)                    10,456
                                              -------------               -------------              ------------- 
                                                   $(28,144)                    $(4,134)                   $13,154
                                              =============               =============              ============= 
</TABLE>

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

<TABLE>
<CAPTION>
                                                                            FISCAL YEAR ENDED
                                               --------------------------------------------------------------------------
                                                  DECEMBER 30, 1995         DECEMBER 28, 1996         JANUARY 3, 1998
                                               ------------------------  -----------------------  -----------------------
<S>                                            <C>                       <C>                      <C>
Federal corporate statutory tax rate                                                                              
 (benefit)......................................         (35.0)%                  (35.0)%                   35.0% 
State taxes (benefit), net of Federal tax                                                                        
 effect.........................................          (1.5)                    (2.9)                    13.9 
Foreign income taxes............................           1.7                     10.1                     ----
Valuation allowance.............................           6.7                     12.7                    105.0
Other...........................................          (0.1)                    (3.2)                    (5.3)
                                                    ----------               ----------               ---------- 
Effective income tax (benefit) rate                      (28.2)%                  (18.3)%                  148.6%
                                                    ==========               ==========               ========== 
</TABLE>

     Deferred income taxes reflect the effect of temporary differences between
the tax basis of assets and liabilities and the reported amounts of assets and
liabilities for financial reporting purposes net of any valuation allowance.
Converse's deferred tax assets and liabilities at December 28, 1996 and January
3, 1998, consisted of the following:

                                      F-16
<PAGE>
 
<TABLE>
<CAPTION>
                                                                     DECEMBER 28, 1996           JANUARY 3, 1998
                                                                 -------------------------  -------------------------
<S>                                                              <C>                        <C>
Deferred tax assets:
     Tax benefit of loss carryforwards..........................                 $ 22,263                   $ 36,526
     Loss on investment in unconsolidated subsidiary............                   11,739                       ----
     Restructuring accruals.....................................                    1,524                        978
     Fair value adjustments.....................................                    3,718                      3,234
     Employee postretirement benefits other than pensions.......                    4,061                      4,012
     Expense accruals...........................................                    3,182                        561
     Receivable, inventory and other reserves...................                    3,399                      2,660
     Depreciation...............................................                      341                      1,604
                                                                              -----------                ----------- 
       Gross deferred tax assets................................                   50,227                     49,575
Deferred tax liabilities:
     Employee pension plans.....................................                     (762)                      (627)
     Other......................................................                   (2,840)                    (4,739)
                                                                              -----------                ----------- 
       Net deferred tax assets before valuation allowance.......                   46,625                     44,209
     Valuation allowance........................................                  (11,584)                   (20,877)
                                                                              -----------                ----------- 
       Net deferred tax assets..................................                 $ 35,041                   $ 23,332
                                                                              ===========                ===========
</TABLE>
                                                                                
 The net deferred tax assets are included in the consolidated balance sheet as
follows:

<TABLE>
<CAPTION>
                                                                      DECEMBER 28, 1996          JANUARY 3, 1998
                                                                   ----------------------  --------------------------
<S>                                                                <C>                     <C>
Prepaid expenses and other current assets.....................                    $14,491                    $ 2,063
Other assets..................................................                     20,550                     21,269
                                                                           --------------             --------------  
                                                                                  $35,041                    $23,332
                                                                           ==============             ==============  
</TABLE>

     Statement of Financial Accounting Standards No. 109, "Accounting for Income
Taxes," requires that a valuation allowance be recorded against deferred tax
assets for which there is a greater than fifty percent chance that the tax
assets will not be realized. In assessing the realizability of the deferred tax
assets, Converse has based its judgment primarily on estimated future earnings.
Although the period to use these deferred tax assets is 12 to 15 years for tax
purposes, the accounting guidance requires that a shorter time frame be used to
assess the certainty of their realization. Converse believes it's deferred tax
assets will be realized; however, as a result of the uncertainty caused by the
recent industry downturn and the related oversupply of inventory in the
marketplace during the fourth quarter of Fiscal 1997, the Company increased its
deferred tax valuation by $9,293 to a total of $20,877.

     At January 3, 1998, Converse had operating loss carryforwards of $88,416.
The loss carryforwards expire between the years 2009 and 2012.

11.  EMPLOYEE BENEFITS

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

                                      F-17
<PAGE>
 
Defined benefit pension plan

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

  The table below summarizes the plan's funded status and amounts recognized in
the balance sheet:

<TABLE>
<CAPTION>
                                                               DECEMBER 28, 1996              JANUARY 3, 1998
                                                               -----------------              ---------------
<S>                                                            <C>                            <C>
Actuarial present value of benefit obligations:
 
   Vested benefit obligation............................              $39,048                    $42,444
                                                                     ========                   ======== 
   Accumulated benefit obligation.......................              $39,641                    $48,467
                                                                     ========                   ========  
   Projected benefit obligation.........................              $46,781                    $58,553
Fair value of plan assets...............................               51,122                     59,507
                                                                     --------                   -------- 
Plan assets in excess of projected benefit obligation...                4,341                        954
Unrecognized net loss (gain)............................               (2,166)                       895
Unrecognized prior service cost.........................                  (82)                       (75)
                                                                     --------                   -------- 
Prepaid pension cost included in other assets...........              $ 2,093                    $ 1,774
                                                                     ========                   ========  
</TABLE>

  Net periodic pension cost for Fiscal 1995, 1996 and 1997 included the
following components:

<TABLE>
<CAPTION>
                                                                        FISCAL YEAR ENDED
                                            -------------------------------------------------------------------------
                                               DECEMBER 30, 1995        DECEMBER 28, 1996         JANUARY 3, 1998
                                               -----------------        -----------------         ---------------
<S>                                         <C>                         <C>                       <C>
Service cost-benefits earned during the
 period..................................            $  1,300                 $  1,410                 $  1,751       
                                                                                                                      
Interest cost on the projected benefit                                                                                
 obligation..............................               3,309                    3,375                    3,769       
                                                                                                                      
Actual return on plan assets.............             ( 9,775)                 ( 6,365)                 (10,457)      
Net amortization and deferral............               6,364                    2,110                    5,662       
                                                    ----------               ----------               ----------      
Net periodic pension cost................            $  1,198                 $    530                 $    725       
                                                    ==========               ==========               ==========      
</TABLE>

  Measurement of the projected benefit obligation was based on a weighted
average discount rate of 7.25%, 7.50% and 7.00% in Fiscal 1995, 1996 and 1997,
respectively, and a rate of increase in future compensation levels of 4.5% in
each year.  The expected long-term rate of return on plan assets used in
determining net pension cost was 9.5% in each year.

Defined benefit postretirement plan

  In addition to pension benefits, certain retired employees are currently
provided with specified health care and life insurance benefits.  Eligibility
requirements generally state that benefits are available to employees who retire
after a certain age with specified years of service if they agree to contribute
a portion of the cost.  Converse has reserved the right to modify or terminate
these benefits.  Health care and life insurance benefits are provided to both
retired and active employees through medical benefit trusts, third-party
administrators and insurance companies.

                                     F-18
<PAGE>
 
  The following table sets forth the combined financial status of deferred
postretirement benefits other than pensions:

<TABLE>
<CAPTION>
                                                              DECEMBER 28, 1996              JANUARY 3, 1998
                                                              -----------------              ---------------     
<S>                                                           <C>                            <C>
Accumulated postretirement benefit obligation:
   Retirees..........................................             $ 4,311                         $ 3,514         
   Fully eligible active plan participants...........                 128                              97         
   Other active plan participants....................               1,564                           1,391         
                                                                 ---------                       --------- 
       Total.........................................               6,003                           5,002         
Unrecognized net gain................................               1,735                           3,152         
Unrecognized prior service gain......................               2,493                           2,268         
                                                                 ---------                       ---------  
Accrued postretirement benefit obligation............             $10,231                         $10,422         
                                                                 =========                       =========
</TABLE>

  Net periodic postretirement benefit cost (income) for Fiscal 1995, 1996 and
1997 was $(651), $221, and $216, respectively.

  For measurement purposes, a 15.0%, 15.0% and 9.0% annual rate of increase in
the cost of health care benefits was assumed for Fiscal 1995, 1996 and 1997,
respectively.  The rates are assumed to decrease gradually to 8.0% in the year
2002 for pre-age 65 retirees and to 7.0% in 1999 for post-age 65 retirees for
Fiscal 1995 and 1996, and down to 6.0% by 2000 for both pre- and post-age 65
participants for Fiscal 1997 and remain at those levels thereafter.  The health
care cost trend rate assumption has an effect on amounts reported.  Increasing
the health care cost trend rate by one percentage point in each year would
increase the accumulated postretirement benefit obligation as of January 3, 1998
by approximately $239 and the net periodic cost by $27 for the year.

  Measurement of the accumulated postretirement benefit obligation was based
upon a weighted average discount rate of 7.25%, 7.50% and 7.00% for Fiscal 1995,
1996 and 1997, respectively, and a long-term rate of
  compensation increase of 4.5% for Fiscal 1995 and 1996, and 4.0% for Fiscal
1997.

Other retirement plans and benefits
 
  Converse has a non-contributory defined contribution plan covering all hourly
employees with at least one year of service at its domestic manufacturing and
warehouse facilities.  Contributions under this plan are fixed at $0.39 per hour
of service with a maximum contribution based on 2,000 hours per employee.  The
defined contribution expense was $992, $318 and $625  for Fiscal 1995, 1996 and
1997, respectively.

  Converse also sponsors a savings plan.  The total cost of this plan for Fiscal
1995, 1996, and 1997 was $609, $329 and $333, respectively.

12. STOCK OPTION PLANS
 
Converse 1994 stock option plan
 
  The Board of Directors of Converse adopted the Converse Inc. 1994 Stock Option
Plan (the "1994 Plan") as a means to encourage ownership of Converse common
stock by key employees and enable Converse to attract and retain the services of
outstanding employees in competition with other employers.
 
  The 1994 Plan authorizes grants to key employees, including executive officers
of Converse and its subsidiaries, and to its consultants, of incentive and non-
qualified options to purchase shares of common stock.  The plan administrator
has discretion to grant non-qualified options at less than 100% of the fair
market value per share of the common stock of Converse on the date of grant.
Converse incentive stock options must be granted with an exercise price of not
less than 100% of the fair market value per share of common stock of Converse on
the date of grant.  Option prices are payable in full and in cash, upon the
exercise of a stock option, and the proceeds are added to the general funds of
Converse.  As of January 3, 1998, the number of shares of common stock which may
be issued under the 1994 Plan is 2,300,000 subject to 

                                     F-19
<PAGE>
 
adjustment upon the occurrence of certain contingencies. The maximum number of
shares with respect to which options may be granted to any individual during any
calendar year and during the term of the 1994 Plan is 500,000 and 750,000,
respectively. Options under the 1994 Plan generally expire nine years from the
grant date.

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

  The following table summarizes option activity under the 1994 Plan:

<TABLE>
<CAPTION>
                                                                                               WEIGHTED AVERAGE
                                                                            EXERCISE            EXERCISE PRICE
                                                  NUMBER OF OPTIONS      PRICE PER SHARE          PER SHARE
                                                  -----------------      ---------------          ---------
<S>                                               <C>                    <C>                   <C>
Outstanding at January 1, 1995..................        920,000            $ 5.27-$11.46            $ 8.66      
Granted.........................................        633,000            $ 5.00-$23.00              9.64      
Canceled........................................       (429,000)           $        7.00              7.00      
                                                     ----------- 
Outstanding at December 30, 1995................      1,124,000            $ 5.00-$23.00              7.71      
Granted.........................................      1,221,000            $ 4.00-$23.00              7.17      
Canceled........................................       (520,200)           $ 5.00-$23.00             11.71      
Exercised.......................................       (246,000)           $  5.00-$7.00              5.57      
                                                     ----------- 
Outstanding at December 28, 1996................      1,578,800            $ 4.00-$23.00              6.31      
Granted.........................................        442,000            $10.94-$26.88             17.30      
Canceled........................................       (127,250)           $ 5.27-$26.88              9.34      
Exercised.......................................       (104,800)           $  4.00-$9.40              5.96      
                                                     ----------- 
Outstanding at January 3, 1998..................      1,788,750            $ 4.00-$26.88              8.85      
                                                     ===========                                   ========
Exercisable at January 3, 1998..................        370,650                                     $ 6.81       
                                                     ===========                                   ========
Available for future grants.....................        160,450                              
                                                     =========== 
</TABLE>

  The following table summarizes information about the 1994 Plan stock options
outstanding at January 3, 1998:

<TABLE>
<CAPTION>
                                        OPTIONS OUTSTANDING                                     OPTIONS EXERCISABLE
                   -----------------------------------------------------------             -------------------------------  
                                       WEIGHTED AVERAGE                                 
                                             REMAINING                                                                       
    RANGE OF       NUMBER OUTSTANDING    CONTRACTUAL LIFE     WEIGHTED AVERAGE         NUMBER EXERCISABLE    WEIGHTED AVERAGE
 EXERCISE PRICES   AT JANUARY 3, 1998         (YEARS)          EXERCISE PRICE          AT JANUARY 3, 1998     EXERCISE PRICE  
 ---------------   ------------------    ----------------      --------------          ------------------     --------------
<S>                <C>                  <C>                   <C>                      <C>                   <C>
$4.00-$5.00              509,800                7                   $ 4.99                   102,000               $ 5.00     
$5.27                     74,750                6                     5.27                    46,000                 5.27     
$5.63-$6.50              468,200                8                     6.27                    88,200                 6.31     
$7.00                    206,000                6                     7.00                    74,000                 7.00     
$7.75-$8.65               22,000                6                     7.99                     5,200                 7.96     
$9.00-$11.46             288,000                8                    10.87                    43,250                10.70     
$13.00-$19.00             20,000                8                    16.00                     8,000                16.00     
$20.63-$26.88            200,000                8                    24.44                     4,000                22.00      
                      -----------                                                           ---------
                       1,788,750                                                             370,650      
                      ===========                                                           =========
</TABLE>

                                     F-20
<PAGE>
 
  On June 2, 1995, Converse repriced certain stock options granted under the
1994 Plan.  Options to purchase 854,000 shares of common stock were repriced at
an exercise price of $7.00 per share, which represented the closing price of
Converse's common stock on June 2, 1995.  The original vesting schedules and
expiration dates associated with these stock options were also amended to
coincide with the stock option repricing date.  None of the foregoing stock
option grants had vested prior to the repricing date and they did not begin to
vest until June 2, 1996.  On September 5, 1996, Converse repriced certain
additional stock options granted under the 1994 Plan.  Options to purchase
105,000 shares of common stock at prices ranging from $5.00 to $23.00 per share
were repriced to an exercise price of $6.375 per share, which represented the
closing price of Converse's common stock on September 5, 1996.  In connection
with this repricing, options to purchase 45,000 shares of common stock were
canceled.  None of the repriced options had vested prior to the repricing date
and they did not begin to vest until September 5, 1997.  The above option
activity table reflects all options at their amended price and vesting terms.

Converse 1995 non-employee director plan

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

  Converse has reserved an aggregate of 45,000 shares for issuance under the
1995 Plan.  Options to purchase 22,500 of these shares were granted during 1995
at the fair market value on the date of grant of $9.88. These stock options
become exercisable in equal one-third increments on the anniversaries of the
grant date beginning on March 22, 1996 and expire ten years from the date of
grant.  No such options were exercised during 1995, 1996 or 1997 and all options
remain outstanding at January 3, 1998.

Other stock option activity

  On October 13, 1995, in addition to the aforementioned option grants, Converse
granted options to purchase an aggregate of 275,000 shares of common stock not
pursuant to any formal plan.  These options were granted in conjunction with a
consulting agreement at the fair market value on the date of grant of $4.88 and
were exercised during Fiscal 1996.

Stock-based compensation
 
  The Company accounts for stock-based compensation using the method prescribed
in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees".  Accordingly, no compensation cost has been recognized for the
Company's stock option plans.  The Company has adopted the disclosure-only
provisions of Statement of Financial Accounting Standards No. 123, "Accounting
for Stock-Based Compensation" ("SFAS 123").  Had compensation cost been
determined based on the fair value at the grant dates for awards in 1995, 1996,
and 1997 consistent with the provisions of SFAS 123, the Company's net loss and
loss per share would have been increased to the pro forma amounts indicated
below:

<TABLE>
<CAPTION>
                                                                       FISCAL YEAR ENDED
                                        -------------------------------------------------------------------------------
                                            DECEMBER 30, 1995          DECEMBER 28, 1996           JANUARY 3, 1998
                                            -----------------          -----------------           ---------------        
<S>                                     <C>                            <C>                         <C>
Net loss - as reported................         $(71,747)                  $(18,435)                   $(5,049)
Net loss - pro forma..................          (73,031)                   (19,559)                    (7,041)
Basic and diluted loss per share               
  as reported.........................            (4.30)                     (1.10)                     (0.29)
Basic and diluted loss per share               
  pro forma...........................            (4.38)                     (1.17)                     (0.41)
</TABLE>

                                      F-21
<PAGE>
 
  The fair value of options granted at date of grant was estimated using the
Black-Scholes model with the following weighted average assumptions:

<TABLE>
<CAPTION>
                                                                       FISCAL YEAR ENDED
                                        -------------------------------------------------------------------------------
                                            DECEMBER 30, 1995          DECEMBER 28, 1996           JANUARY 3, 1998
                                            -----------------          -----------------           ---------------      
<S>                                     <C>                            <C>                         <C>
Expected life (years)..................            5.3                        6.0                        6.0
Interest rate..........................           6.45%                      6.27%                      6.18%
Volatility.............................          75.00%                     65.00%                     67.00%
Dividend yield.........................           ----                       ----                       ----
</TABLE>

  The weighted average grant date fair value of options granted during Fiscal
1995, Fiscal 1996 and Fiscal 1997 was $3.87, $3.37 and $12.20, respectively.

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

13. LEASE COMMITMENTS

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

 Rental expense under operating leases was as follows:

<TABLE>
<CAPTION>  
                                                                       FISCAL YEAR ENDED  
                                        ------------------------------------------------------------------------------- 
                                            DECEMBER 30, 1995          DECEMBER 28, 1996           JANUARY 3, 1998  
                                            -----------------          -----------------           ---------------        
<S>                                     <C>                            <C>                         <C>
Minimum rentals........................            $3,901                        $4,244                  $4,713       
Contingent rentals ....................             1,088                           825                   1,588       
                                                  ---------                     -------                 -------       
                                                   $4,989                        $5,069                  $6,301       
                                                  =========                     =======                 =======        
</TABLE>
                                                                               
  Future minimum lease payments under operating leases are $3,246, $2,735,
$2,146, $1,383 and $688 for 1998 through 2002, respectively.

14.  COMMITMENTS AND CONTINGENCIES

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

15.  RELATED PARTY TRANSACTIONS

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

                                      F-22
<PAGE>
 
1996 to one or more Pre-Distribution tax periods. For the year ended December
30, 1995, the amendment applied to the first $41,000 of tax operating losses
generated, which approximated the taxable income available in the carryback
period. For the year ended December 30, 1995, tax operating losses of
approximately $31,000 were carried back generating a tax refund of $10,832. In
accordance with the Agreement, as amended, Furniture Brands paid Converse $8,000
on February 29, 1996 and in return Furniture Brands was entitled to the full
amount of the tax refund. Furniture Brands is not entitled to any refund of the
$8,000 payment in the event the ultimate tax refund it receives from the
Internal Revenue Service is less than anticipated. In accordance with the
agreement, Furniture Brands was also entitled to tax refunds resulting from the
carryback of approximately $10,000 of the Company's Fiscal 1996 tax operating
losses.

  The $2,832 excess of the Fiscal 1995 tax refund over Furniture Brands' payment
to Converse and the $3,616 tax refund associated with the aforementioned $10,000
of 1996 tax operating losses of Converse being carried back to Furniture Brands
have been recorded by Converse as other expense in Fiscal 1995 and 1996,
respectively.  In addition, Furniture Brands and Converse shared, on an equal
basis, 1994 tax carryback benefits totaling $1,380.  Furniture Brands' share of
this amount, $690, was recorded by Converse as other expense for Fiscal 1995.

  In connection with the Distribution, Converse and Furniture Brands entered
into a Distribution and Services Agreement for Fiscal 1995 relating to the
continued provision of certain of the services described above by Furniture
Brands to Converse as well as additional advisory services, support and
consulting as a result of Converse being a public company.  In November 1995,
this Agreement was amended to decrease the amount of fees payable from Converse
to Furniture Brands.  For the year ended December 30, 1995, Converse paid $210
to Furniture Brands for these services.

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

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

16.  OTHER FINANCIAL DATA

  Items charged to earnings during Fiscal 1995, 1996 and 1997 included the
following:

<TABLE>
<CAPTION>
                                                                        FISCAL YEAR ENDED
                                               ---------------------------------------------------------------------
                                               DECEMBER 30, 1995        DECEMBER 28, 1996            JANUARY 3, 1998
                                               -----------------        -----------------            ---------------
<S>                                            <C>                      <C>                          <C>
Advertising and promotion..................          $49,884                  $28,544                     $34,887
Research and development...................          $ 8,617                  $ 6,503                     $ 8,817
</TABLE>

                                      F-23
<PAGE>
 
17.  BUSINESS SEGMENT INFORMATION

  Converse operates in one industry segment; designing, manufacturing and
marketing of athletic and leisure footwear. Converse has a diversified customer
base with one customer accounting for 12% of the Company's net sales in both
Fiscal 1995 and Fiscal 1996 and 14% in Fiscal 1997. Converse's products are
distributed in the United States and internationally.

<TABLE>
<CAPTION>
                                                                                   FISCAL YEAR ENDED
                                                         --------------------------------------------------------------
                                                         DECEMBER 30, 1995       DECEMBER 28, 1996      JANUARY 3, 1998
                                                         -----------------       -----------------      ---------------
<S>                                                      <C>                     <C>                    <C>
Total Revenues:
    United States......................................         $277,241              $254,255              $325,904
    Europe, Middle East, Africa........................          115,788                96,613                82,926
    Pacific............................................           49,979                43,695                71,327
    Americas (excluding United States).................           36,577                19,374                18,899
    Less:  Inter-Geographic Revenues...................          (72,102)              (64,602)              (48,857)
                                                                --------              --------              --------
                                                                $407,483              $349,335              $450,199
                                                                ========              ========              ========
Operating Income (loss):
    United States......................................         $(38,922)             $(12,367)             $  9,925
    Europe, Middle East, Africa........................          (12,131)              (11,253)              (16,846)
    Pacific............................................           18,276                23,576                20,808
    Americas (excluding United States).................            3,055                   208                   825
                                                                --------              --------              --------
                                                                $(29,722)             $    164              $ 14,712
                                                                ========              ========              ========
Identifiable Assets:
    United States......................................         $ 85,147              $ 99,724              $ 85,577
    Europe, Middle East, Africa........................           83,358                72,293                78,384
    Pacific............................................           33,780                35,611                53,600
    Americas (excluding United States).................           22,222                14,975                17,133
                                                                --------              --------              --------
                                                                $224,507              $222,603              $234,694
                                                                ========              ========              ========
United States Export Sales:
(included in geographic revenues above)
    Europe, Middle East, Africa........................         $ 15,984              $ 12,203              $ 12,599
    Pacific............................................           31,171                23,570                62,335
    Americas (excluding United States).................           20,758                11,415                10,831
                                                                --------              --------              --------
                                                                $ 67,913              $ 47,188              $ 85,765
                                                                ========              ========              ========
</TABLE>
                                                                                
  Inter-Geographic sales are accounted for based on established sales prices
between the related companies and pertain primarily to sales from the United
States to various foreign operations.

                                     F-24
<PAGE>
 
18.  QUARTERLY FINANCIAL INFORMATION (UNAUDITED)

     Following is a summary of unaudited quarterly information:

<TABLE>
<CAPTION>
                                                   FIRST                 SECOND              THIRD                 FOURTH 
                                                  QUARTER               QUARTER             QUARTER               QUARTER 
                                                  -------               -------             -------               -------  
<S>                                               <C>                   <C>                <C>                    <C>     
Year ended December 28, 1996:
Net sales.............................           $ 86,551              $ 79,907            $113,318              $ 69,559 
Gross profit..........................           $ 21,617              $ 22,887            $ 29,930              $ 11,803 
Net earnings (loss)...................           $ (3,260)             $ (3,743)           $ (3,011)             $ (8,421)
                                                 ========              ========            ========              ======== 
Net earnings (loss) per share.........           $  (0.20)             $  (0.22)           $  (0.18)             $  (0.50)
                                                 ========              ========            ========              ======== 

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

                                     F-25
<PAGE>
 
                                  SCHEDULE II

                       VALUATION AND QUALIFYING ACCOUNTS

                         (DOLLAR AMOUNTS IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                          ADDITIONS
                                                                         (REVERSALS)
                                                    BEGINNING         CHARGED TO COSTS                             ENDING
              DESCRIPTION                            BALANCE            AND EXPENSES        DEDUCTIONS            BALANCE
              ------------                          ---------           ------------        ----------            -------
<S>                                                 <C>                <C>                  <C>                   <C>
Year Ended December 30, 1995:
  Allowance for Doubtful Accounts.................   $ 1,553              $1,366               $  682             $ 2,237
  Inventory Reserve...............................     1,473               6,424                  681               7,216
  Deferred Tax Asset Valuation Allowance..........      ----               6,650                 ----               6,650

Year Ended December 28, 1996:
  Allowance for Doubtful Accounts.................   $ 2,237              $  670               $  913             $ 1,994
  Inventory Reserve...............................     7,216                 306                1,951               5,571
  Deferred Tax Asset Valuation Allowance..........     6,650               4,934                 ----              11,584

Year Ended January 3, 1998:
  Allowance for Doubtful Accounts.................   $ 1,994              $1,074               $1,002             $ 2,066
  Inventory Reserve...............................     5,571                (769)               1,840               2,962
  Deferred Tax Asset Valuation Allowance..........    11,584               9,293                 ----              20,877
</TABLE>


                                     F-26