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  **UNITED STATES SECURITIES AND EXCHANGE COMMISSION****WASHINGTON, D.C. 20549****FORM 10-Q****(Mark one)**   þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**For the quarterly period ended July 29, 2006**OR   o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the transition period from                                        to                                         Commission file number 000-21543**WILSONS THE LEATHER EXPERTS INC.**(Exact name of registrant as specified in its charter)   **MINNESOTA** **41-1839933**(State or other jurisdiction of (I.R.S. Employerincorporation or organization) Identification No.)   **7401 BOONE AVE. N.**  **BROOKLYN PARK, MN** **55428**(Address of principal executive offices) (Zip Code)**(763) 391-4000**(Registrant’s telephone number, including area code)Indicate by check mark whether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or forsuch shorter period that the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.Yes þ No oIndicate by check mark whether the registrant is a large accelerated filer, an accelerated filer,or a non-accelerated filer (as defined in Rule 12b-2 of the Act).Large accelerated filer o      Accelerated filer þ      Non-accelerated filer oIndicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).Yes o No þAs of September 1, 2006, there were 39,168,526 shares of the Registrant’s common stock, $0.01 parvalue per share, outstanding.  
 

 
**WILSONS THE LEATHER EXPERTS INC.****INDEX**       **Page** **PART I — FINANCIAL INFORMATION**  3      Item 1. Consolidated Financial Statements (Unaudited)  3      Consolidated Balance Sheets as of July 29, 2006 and January 28, 2006  3      Consolidated Statements of Operations for the three months ended July 29, 2006 and July 30, 2005  4      Consolidated Statements of Operations for the year-to-date periods ended July 29, 2006 and July 30, 2005  5      Consolidated Statements of Cash Flows for the year-to-date periods ended July 29, 2006 and July 30, 2005  6      Notes to Consolidated Financial Statements  7      Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations  14      Item 3. Quantitative and Qualitative Disclosures About Market Risk  22      Item 4. Controls and Procedures  23      **PART II — OTHER INFORMATION**  23      Item 1. Legal Proceedings  23      Item 1A. Risk Factors  23      Item 2. Unregistered Sales of Equity Securities and Use of Proceeds  23      Item 4. Submission of Matters to a Vote of Security Holders  23      Item 6. Exhibits  23      Signature  24  Limited Waiver and Tenth Amendment to Fourth Amended and Restated Credit Agreement Rule 13a-14(a)/15d-14(a) Certification of CEO Rule 13a-14(a)/15d-14(a) Certification of CFO Certification of CEO Pursuant to Section 906 Certification of CFO Pursuant to Section 906
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**PART I — FINANCIAL INFORMATION****ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)****WILSONS THE LEATHER EXPERTS INC. AND SUBSIDIARIES****CONSOLIDATED BALANCE SHEETS****(In thousands, except share and per share amounts)**           **July 29,**  **January 28,**   **2006**  **2006****(1)**  **ASSETS**        CURRENT ASSETS:        Cash and cash equivalents   $33,559    $45,552 Accounts receivable, net  3,577   4,063 Inventories  64,110   85,645 Prepaid expenses  3,503   1,987        TOTAL CURRENT ASSETS  104,749   137,247 Property and equipment, net  39,998   41,045 Other assets, net  1,262   1,576        TOTAL ASSETS   $146,009    $179,868                 **LIABILITIES AND SHAREHOLDERS’ EQUITY**        CURRENT LIABILITIES:        Accounts payable   $13,682    $12,036 Accrued expenses  14,916   16,595 Income taxes payable  1,523   5,685 Deferred income taxes  70   53        TOTAL CURRENT LIABILITIES  30,191   34,369 Long-term debt  20,000   20,000 Other long-term liabilities  17,359   17,445        TOTAL LIABILITIES  67,550   71,814                 COMMITMENTS AND CONTINGENCIES                 SHAREHOLDERS’ EQUITY:                 Common stock, $.01 par value; 150,000,000shares authorized; 39,168,526 and 39,087,652shares issued and outstanding on July 29, 2006and January 28, 2006, respectively  392   391 Additional paid-in capital  135,259   133,853 Accumulated deficit  (57,203)  (26,201)Accumulated other comprehensive income  11   11        TOTAL SHAREHOLDERS’ EQUITY  78,459   108,054        TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY   $146,009    $179,868        The accompanying notes are an integral part of these consolidated financial statements.(1) Derived from audited consolidated financial statements.
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**WILSONS THE LEATHER EXPERTS INC. AND SUBSIDIARIES****CONSOLIDATED STATEMENTS OF OPERATIONS****(In thousands, except per share amounts)****(Unaudited)**           **For the three months ended**   **July 29,**  **July 30,**   **2006**  **2005**  **NET SALES** $49,158  $58,417 COST OF GOODS SOLD, BUYING AND OCCUPANCY COSTS  47,280   44,989        Gross margin  1,878   13,428          SELLING, GENERAL AND ADMINISTRATIVE EXPENSES  24,092   24,568 DEPRECIATION AND AMORTIZATION  3,109   3,581        Operating loss  (25,323)  (14,721)INTEREST EXPENSE, net  322   683        Loss before income taxes  (25,645)  (15,404)INCOME TAX BENEFIT  (1,143)  (1,411)       Net loss $(24,502) $(13,993)                **BASIC AND DILUTED LOSS PER SHARE:**        Basic and diluted loss per share $(0.63) $(0.36)                Weighted average shares outstanding — basic and diluted  39,146   38,996        The accompanying notes are an integral part of these consolidated financial statements.
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**WILSONS THE LEATHER EXPERTS INC. AND SUBSIDIARIES****CONSOLIDATED STATEMENTS OF OPERATIONS****(In thousands, except per share amounts)****(Unaudited)**           **For the year-to-date period ended**   **July 29,**  **July 30,**   **2006**  **2005**  **NET SALES** $123,838  $142,746 COST OF GOODS SOLD, BUYING AND OCCUPANCY COSTS  102,230   103,933        Gross margin  21,608   38,813          SELLING, GENERAL AND ADMINISTRATIVE EXPENSES  49,672   49,372 DEPRECIATION AND AMORTIZATION  6,281   7,292        Operating loss  (34,345)  (17,851)INTEREST EXPENSE, net  564   1,346        Loss before income taxes  (34,909)  (19,197)INCOME TAX BENEFIT  (3,907)  (1,411)       Net loss $(31,002) $(17,786)                **BASIC AND DILUTED LOSS PER SHARE:**        Basic and diluted loss per share $(0.79) $(0.46)                Weighted average shares outstanding — basic and diluted  39,125   38,949        The accompanying notes are an integral part of these consolidated financial statements.
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**WILSONS THE LEATHER EXPERTS INC. AND SUBSIDIARIES****CONSOLIDATED STATEMENTS OF CASH FLOWS****(In thousands)****(Unaudited)**           **For the year-to-date period ended**   **July 29,**  **July 30,**   **2006**  **2005**  **OPERATING ACTIVITIES:**        Net loss $(31,002) $(17,786)Adjustments to reconcile loss from operations to net cash used inoperating activities:        Depreciation  6,281   7,292 Amortization of deferred financing costs  314   314 Gain on disposal of assets  (5)  (161)Stock-compensation expense  1,154   — Deferred income taxes  17   — Changes in operating assets and liabilities:        Accounts receivable, net  486   814 Inventories  21,535   6,193 Prepaid expenses  (1,516)  (2,860)Accounts payable and accrued expenses  (33)  (3,411)Income taxes payable and other liabilities  (4,248)  (1,686)       Net cash used in operating activities  (7,017)  (11,291)       **INVESTING ACTIVITIES:**        Additions to property and equipment  (5,232)  (4,926)Proceeds from the disposition of property and equipment  3   165        Net cash used in investing activities  (5,229)  (4,761)       **FINANCING ACTIVITIES:**        Proceeds from issuance of common stock, net  253   482 Repayments of long-term debt  —   (5,000)Other financing  —   12        Net cash provided by (used in) financing activities  253   (4,506)       **NET DECREASE IN CASH AND CASH EQUIVALENTS**  (11,993)  (20,558)**CASH AND CASH EQUIVALENTS, beginning of period**  45,552   48,821        **CASH AND CASH EQUIVALENTS, end of period** $33,559  $28,263        The accompanying notes are an integral part of these consolidated financial statements.
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**WILSONS THE LEATHER EXPERTS INC. AND SUBSIDIARIES****NOTES TO CONSOLIDATED FINANCIAL STATEMENTS****(UNAUDITED)****1 Summary of significant accounting policies**     *Nature of organization*     Wilsons The Leather Experts Inc. (“Wilsons Leather”, “Wilsons” or the “Company”), a Minnesotacorporation, is the leading specialty retailer of quality leather outerwear, accessories andapparel in the United States. At July 29, 2006, Wilsons Leather operated 422 permanent retailstores located in 45 states, including 296 mall stores, 112 outlet stores and 14 airport stores.The Company supplemented its permanent mall stores with 118 seasonal stores during its peak sellingseason from October through January during fiscal 2005. Operation of the Company’s temporaryseasonal stores will be suspended in 2006 and for the foreseeable future, but may be reconsideredif circumstances warrant.     *Basis of presentation*     The accompanying consolidated financial statements include those of the Company and all of itssubsidiaries. All material intercompany balances and transactions between the consolidated entitieshave been eliminated in consolidation. At July 29, 2006, Wilsons Leather operated in onereportable segment: selling leather outerwear, accessories and apparel. The Company’s chiefoperating decision-maker evaluates revenue and profitability performance on an enterprise basis tomake operating and strategic decisions.     The accompanying unaudited consolidated financial statements have been prepared by the Companypursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) applicableto interim financial information. Certain information and footnote disclosures, normally includedin consolidated financial statements prepared in accordance with U. S. generally acceptedaccounting principles (“GAAP”), have been condensed or omitted in these interim statements pursuantto such rules and regulations. Although management believes that the accompanying disclosures areadequate so as not to make the information presented misleading, it is recommended that theseinterim consolidated financial statements be read in conjunction with the Company’s most recentaudited consolidated financial statements and related notes included in its 2005 Annual Report onForm 10-K. In the opinion of management, all adjustments (which include normal recurringadjustments) necessary for a fair presentation of the financial position, results of operations andcash flows for the interim periods presented have been made. The Company’s business is highlyseasonal, and accordingly, interim operating results are not indicative of the results that may beexpected for the fiscal year ending February 3, 2007.     *Fiscal year*     The Company’s fiscal year ends on the Saturday closest to January 31. The periods that willend or have ended February 3, 2007, and January 28, 2006 are referred to herein as 2006, and 2005,respectively. The year ending February 3, 2007, consists of 53 weeks as compared to 52 weeks forall other years presented in this Form 10-Q.     *Use of estimates*     The preparation of financial statements in conformity with GAAP requires management to makeestimates and assumptions that affect the reported amounts of assets and liabilities and disclosureof contingent assets and liabilities at the date of the financial statements and the reportedamounts of revenues and expenses during the reporting period. Matters of significance in whichmanagement relies on these estimates relate primarily to the realizability of assets such asaccounts receivable, property and equipment, and inventories, and the adequacy of certain accruedliabilities and reserves. Ultimate results could differ from those estimates.     *Cash and cash equivalents*     Cash equivalents consist principally of short-term investments with original maturities ofthree months or less and are recorded at cost, which approximates fair value. The short-terminvestments consist solely of money market funds. Interest income of $0.5 million and $0.3 millionin the second quarter of 2006 and 2005, respectively, and $1.1 million and $0.6 million in thecomparable year-to-date periods, is included in interest expense, net in the accompanyingstatements of operations.
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     *Inventories*     The Company values its inventories, which consist primarily of finished goods held for salethat have been purchased from domestic and foreign vendors, at the lower of cost or market value,determined by the retail inventory method on the last-in, first-out (“LIFO”) basis. As of July 29,2006, and January 28, 2006, the LIFO cost of inventories approximated the first-in, first-out costof inventories. The inventory cost includes the cost of merchandise, freight, duty, sourcingoverhead, and other merchandise-specific charges. A periodic review of inventory quantities on handis performed to determine if inventory is properly stated at the lower of cost or market. Factorsrelated to current inventories such as future consumer demand, fashion trends, current aging,current and anticipated retail markdowns, and class or type of inventory are analyzed to determineestimated net realizable values. A provision is recorded to reduce the cost of inventories to theestimated net realizable values, if required. Any significant unanticipated changes in the factorsnoted above could have a significant impact on the value of the Company’s inventories and itsreported operating results.     *Property and equipment*     The Company’s property and equipment consist principally of store leasehold improvements andstore fixtures and are included in the “Property and equipment” line item in its consolidatedbalance sheets included in this report. Leasehold improvements include the cost of improvementsfunded by landlord incentives and lease costs during the pre-opening period of construction,renovation, fixturing and merchandise placement (the “build-out” period). Prior to the thirdquarter of 2005, the Company capitalized rental costs incurred during the build-out period.Beginning with the third quarter of 2005, the Company has expensed all such build-out period rentalcosts pursuant to Financial Accounting Standards Board (“FASB”) Staff Position No. FAS 13-1 (“FSPFAS 13-1”). Leasehold improvements are recorded at cost and are amortized using the straight-linemethod over the lesser of the applicable store lease term or the estimated useful life. The typicalinitial lease term for the Company’s stores is 10 years and the estimated useful lives of theassets range from five to 10 years. Capital additions required for lease extensions subsequent toinitial lease term are amortized over the term of the lease extension. Computer hardware andsoftware and distribution center equipment are amortized over three to five years and 10 years,respectively. Property and equipment retired or disposed of are removed from cost and relatedaccumulated depreciation accounts. Maintenance and repairs are charged directly to expense asincurred. Major renewals or replacements are capitalized after making the necessary adjustment tothe asset and accumulated depreciation accounts for the items renewed or replaced.     *Store closing and impairment of long-lived assets*     The Company continually reviews its stores’ operating performance and assesses plans for storeclosures. In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144,*Accounting for the Impairment or Disposal of Long-Lived Assets,*(“SFAS No. 144”) losses related tothe impairment of long-lived assets are recognized when expected future cash flows are less thanthe asset’s carrying value. When a store is closed or when a change in circumstances indicates thecarrying value of an asset may not be recoverable, the Company evaluates the carrying value of theasset in relation to its expected future cash flows. If the carrying value is greater than theexpected future cash flows, a provision is made for the impairment of the asset to write the assetcost down to its estimated fair value. Fair value is determined by estimating net future cashflows, discounted using a risk-adjusted rate of return. These impairment charges are recorded as acomponent of selling, general and administrative expenses when incurred.     When a store under a long-term lease is to be closed, the Company records a liability for anylease termination or broker fees at the time an agreement related to such closing is executed. AtJuly 29, 2006, and January 28, 2006, the Company had no amounts accrued for store leaseterminations.     *Debt issuance costs*     Debt issuance costs are amortized on a straight-line basis over the life of the related debt.Amortization expense is included in interest expense in the accompanying consolidated statements ofoperations.     *Operating leases*     The Company has approximately 424 noncancelable operating leases, primarily for retail stores,which expire at various times through 2017. These leases generally require the Company to paycosts, such as real estate taxes, common area maintenance costs and contingent rentals based onsales. In addition, these leases generally include scheduled rent increases and may include rentholidays. The Company accounts for these scheduled rent increases and rent holidays on astraight-line basis over the initial terms of the leases, including any rent holiday periods,commencing on the date the Company can take possession of the leased facility. Resulting
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liabilities are recorded as short-term or long-term deferred rent liabilities as appropriate.Rent expense for lease extensions subsequent to the initial lease terms are also calculated under astraight-line basis to the extent that they include scheduled rent increases or rent holidays. Inaddition, leasehold improvements funded by landlord incentives are recorded as short-term orlong-term deferred rent liabilities as appropriate. These liabilities are then amortized as areduction of rent expense on a straight-line basis over the life of the related lease. Prior to thethird quarter of 2005, the Company capitalized rental costs incurred during the build-out period.Beginning with the third quarter of 2005, the Company has expensed all such build-out period rentalcosts pursuant to FSP FAS 13-1.     *Revenue recognition*     The Company recognizes sales upon customer receipt of the merchandise generally at the pointof sale. Shipping and handling revenues are excluded from net sales as a contra-expense and therelated costs are included in costs of goods sold, buying and occupancy costs. The Companyrecognizes layaway sales in full upon final payment and delivery of the merchandise to thecustomer. All customer payments prior to the final payment are recorded as customer deposits andare included in accrued expenses in the accompanying balance sheet. Revenue for gift card sales andstore credits is recognized at redemption. A reserve is provided at the time of sale for projectedmerchandise returns based upon historical experience. The Company recognizes revenue for on-linesales at the time goods are received by the customer. An allowance for on-line sales is recordedfor shipments in-transit at period end, as product is shipped to these customers Free on Boarddestination. Revenue on sales to wholesale customers is generally recognized upon shipment, as ourstandard terms are Free on Board origin. Generally, there are no return rights other than thosefor merchandise that is defective or in breach of any express warranties. Wholesale revenues maybe recognized post shipment if the contractual shipping or right-of-return terms differ from theCompany’s standard terms.     *Income taxes*     Income taxes are accounted for under the asset and liability method. Deferred tax assets andliabilities are recognized for the future tax consequences attributable to differences between thefinancial statement carrying amounts of existing assets and liabilities and their respective taxbases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities aremeasured using enacted tax rates expected to apply to taxable income in the years in which thosetemporary differences are expected to be recovered or settled. The effect on deferred tax assetsand liabilities of a change in tax rates is recognized in income in the period that includes theenactment date. In light of cumulative losses over the past five fiscal years, the Company believesit is more likely than not that the Company’s net deferred tax asset will not be realized.Accordingly, a full valuation allowance has been recorded against the Company’s net deferred taxassets.     *Foreign currency translation*     The functional currency for the Company’s foreign operations is the applicable foreigncurrency. The translation from the applicable foreign currency to U.S. dollars is performed forbalance sheet accounts using the current exchange rate in effect at the balance sheet date and forrevenue and expense accounts using a weighted average exchange rate during the period. The gains orlosses resulting from such translation are included in shareholders’ equity as other comprehensiveincome (loss) and have been insignificant in all fiscal periods presented. Transaction gains andlosses are reflected in income.     *Loss per share*     Basic and diluted loss per share is computed by dividing the net loss by the weighted averagenumber of common shares outstanding during the applicable period. Pursuant to the treasury stockmethod, potentially dilutive common shares related to stock options and warrants have been excludedfrom the calculation of weighted average shares outstanding for the periods presented because theirinclusion would have an anti-dilutive effect on loss per share. The following table reconciles thenumber of shares utilized in the loss per share calculations (in thousands):                   **For the three months ended**  **For the year-to-date period ended**   **July 29,**  **July 30,**  **July 29,**  **July 30,**   **2006**  **2005**  **2006**  **2005** Weighted average common shares outstanding — basic  39,146   38,996   39,125   38,949 Effect of dilutive securities: stock options  —   —   —   — Effect of dilutive securities: warrants  —   —   —   —              Weighted average common shares outstanding — diluted  39,146   38,996   39,125   38,949                   The total dilutive potential common shares excluded from the above calculations for thefiscal quarters ended July 29, 2006 and July 30, 2005, were 767,703 and 2,237,925, respectively,and 717,434 and 1,824,726 for the year-to-date periods ended July 29, 2006 and July 30, 2005,respectively, as their inclusion would have had an anti-dilutive effect on net loss per share.
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     *New accounting pronouncements*     In July 2006, the FASB issued Financial Interpretation No. (“FIN”) 48, *Accounting forUncertainty in Income Taxes*—an interpretation of FASB Statement No. 109 (“FIN 48”). FIN 48clarifies the accounting for and disclosure of uncertainty in income taxes recognized in accordancewith SFAS No. 109, *“Accounting for Income Taxes.”*FIN 48 prescribes a recognition threshold andmeasurement attribute for financial statement recognition and measurement of a tax position takenor expected to be taken in a tax return. FIN 48 also provides guidance on derecognition,classification, interest and penalties, accounting in interim periods and disclosure. FIN 48 iseffective for fiscal years beginning after December 15, 2006. The Company is currently assessingthe impact adoption of FIN 48 will have on the consolidated financial statements beginning in thefirst quarter of fiscal 2007.     In June 2006, the FASB issued Emerging Issues Task Force Issue (“EITF”) No. 06-3, *How SalesTaxes Collected From Customers and Remitted to Governmental Authorities Should Be Presented in theIncome Statement*(“EITF 06-3”), which discusses the presentation of sales taxes in the incomestatement on either a gross or net basis. It requires entities to disclose, if significant, on aninterim and annual basis for all periods presented: (a) the accounting policy elected for thesetaxes and (b) the amounts of the taxes reflected gross (as revenues) in the income statement. Theguidance is effective for periods beginning after December 15, 2006. The Company presents sales netof applicable sales taxes. With the adoption of EITF 06-3 in the first quarter of fiscal 2007, theCompany will not change its method for recording sales taxes net in the consolidated financialstatements.     In November 2004, the FASB issued SFAS No. 151, *Inventory Costs*(“SFAS No. 151”). SFAS No. 151amends Accounting Research Bulletin No. 43 to clarify the accounting for abnormal amounts of idlefacility expense, freight, handling costs and spoilage. SFAS No. 151 also requires the allocationof fixed production overheads to inventory be based on normal production capacity. SFAS No. 151 iseffective for inventory costs incurred during fiscal years beginning after June 15, 2005, and,accordingly, the Company adopted SFAS No. 151 in the first quarter of 2006. Adoption of SFAS No.151 did not have a significant impact on the Company’s consolidated financial statements.**2 Other comprehensive income**     The Company reports accumulated other comprehensive income as a separate item in theshareholders’ equity section of the consolidated balance sheets. Other comprehensive incomeconsists of foreign currency translation adjustments. For the three-month and year-to-date periodsending July 29, 2006, and July 30, 2005, the amounts were not significant.**3 Long-term debt**     Long-term debt at July 29, 2006, and January 28, 2006, consisted of the following (inthousands):           **July 29,**  **January 28,**   **2006**  **2006** Term B promissory note $20,000  $20,000        Total debt  20,000   20,000 Less: current portion  —   —        Total long-term debt $20,000  $20,000             *Term B promissory note and senior credit facility*     General Electric Capital Corporation and a syndicate of banks have provided the Company with asenior credit facility, as amended, that provides for borrowings of up to $150.0 million inaggregate principal amount, including a $25.0 million Term B promissory note and a $75.0 millionletter of credit subfacility. The senior credit facility expiration date is June 28, 2008, at whichtime all borrowings, including the Term B promissory note, will become due and payable.     The Term B promissory note is collateralized by the Company’s inventory. The remainder of thesenior credit facility is collateralized by the Company’s inventory, equipment and credit card andwholesale receivables. Through the third quarter of 2005 interest on cash borrowings under thesenior credit facility was at LIBOR plus 1.50%, the commercial paper rate plus 1.50% or the primerate plus 0.25%. Commencing with the fourth quarter of 2005, interest is payable on revolvingcredit borrowings at variable rates determined by LIBOR plus 1.25% to 1.75%, or the prime rate plus0.0% to 0.5% (commercial paper rate plus 1.25% to 1.75% if the loan is made under the “swing line”portion of the revolver). The applicable rate will be adjusted quarterly on a prospective basisbased on achievement of defined quarterly targets of earnings before interest, taxes, depreciationand amortization (“EBITDA”). With respect to the Term B promissory note, the interest rate in 2005 was the prime rate plus 4.0%,plus an additional 2.75% pursuant to a separate letter agreement with General Electric CapitalCorporation. On January 31, 2006, the Company executed another letter agreement with GeneralElectric Capital Corporation whereby the additional 2.75% is no longer applicable. The Company paysmonthly fees of 0.375% per annum on the unused portion of the senior credit facility, as defined,and 3.25% per annum on the average daily amount of letters of credit outstanding during each month.The revolving credit portion of the senior credit facility is subject to a 1.0% prepayment feeunder most circumstances. The remaining $20.0 million of the Term B promissory note is prepayableonly with the consent of the senior lenders under the senior credit facility.
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     The senior credit facility contains certain restrictions and covenants, which, among otherthings, restrict the Company’s ability to make capital expenditures; acquire or merge with anotherentity; make investments, loans or guarantees; incur additional indebtedness; create liens or otherencumbrances; or pay cash dividends or make other distributions. The senior credit facility, asamended, does allow for the investment in and development of the Company’s wholesale business. AtJuly 29, 2006, the Company was in compliance with all covenants related to the senior creditfacility.     At July 29, 2006, and January 28, 2006, there were no borrowings under the revolving portionof the credit facility. At July 29, 2006, and January 28, 2006, there were $5.0 million and $4.3million, respectively, in letters of credit outstanding. The Term B promissory note had a balanceof $20.0 million on July 29, 2006 and January 28, 2006.**4 Employee stock benefit plans**     *Stock options*     The Company has adopted the amended 1996 Stock Option Plan (the “1996 Plan”), the 1998 StockOption Plan (the “1998 Plan”) and the Amended and Restated 2000 Long Term Incentive Plan (the “2000Plan”)(collectively the “Plans”), pursuant to which options to acquire an aggregate of 6,450,000shares of its common stock may be granted. As of July 29, 2006, the 1996 Plan had expired and nofuture awards may be granted under it. In addition, with the adoption of the 2000 Plan, no furthergrants are to be made under the 1998 Plan.     The Compensation Committee of the board of directors is responsible for administering thePlans and approves grants in connection therewith. The 2000 Plan provides that the CompensationCommittee may grant incentive stock options, non-qualified stock options, stock appreciationrights, non-vested shares (restricted stock), performance share awards and other stock-basedawards, and determine the terms and conditions of each grant. All outstanding stock options grantedsince the Company became a publicly held corporation have been granted at an option price equal tothe fair market value of the common stock on the date of grant and generally vest, cumulatively, ona prorated basis on the first, second and third anniversaries from the date of the grant and expirefive to 10 years from the date of grant. In addition, the stock options generally provide foraccelerated vesting if there is a change in control (as defined in the Plans).     The following is a summary of stock option information, weighted average exercise prices andremaining contractual life (in years) for the Company’s stock option plans as of and for the sixmonths ended July 29, 2006:               **As of and for the year-to-date period ended July 29, 2006**       **Weighted Average**  **Weighted Average**   **Shares**  **Exercise Price**  **Remaining Life** Outstanding, beginning of period  3,470,736  $6.79     Granted  282,000  $3.65     Exercised  (44,040) $2.92     Forfeited  (275,332) $5.50     Expired  (199,413) $11.70                 Outstanding, end of period  3,233,951  $6.38   4.55           Exercisable, end of period  1,463,986  $7.62   4.45           Available for grant, end of period  1,095,234(1)                    **(1)** Amended and Restated 2000 Long Term Incentive Plan only.     During the six months ended July 29, 2006, the total intrinsic value of options exercised(the difference between the market price at exercise and the price paid by optionees to exercisethe option) was $32,816 and the total amount of cash received from the exercise of these optionswas $128,396. As of July 29, 2006, total unrecognized compensation costs related to unvestedstock-based awards was $4.4 million, which is expected to be recognized over a weighted averageperiod of approximately 1.9 years.     The following table summarizes information about the weighted average remaining contractedlife (in years), the weighted average exercise prices and the aggregate intrinsic value for stockoptions outstanding as of July 29, 2006:                               **Options Outstanding and Exercisable by Price Range as of July 29, 2006**   **Options Outstanding**  **Options Exercisable**       **Weighted**  **Weighted**          **Weighted**    **Range of Exercise** **Number of**  **Average**  **Average**  **Aggregate**  **Number of**  **Average**  **Aggregate** **Prices** **Options**  **Remaining Life**  **Exercise Price**  **Intrinsic Value**  **Options**  **Exercise Price**  **Intrinsic Value** $  2.07 - $  4.14  562,550   5.4  $3.59  $—   182,550  $3.56  $— $  4.14 - $  6.21  2,133,619   4.3  $5.74   —   869,320  $5.75   — $  6.21 - $  8.28  154,127   3.8  $6.74   —   28,461  $6.82   — $  8.28 - $10.34  9,603   1.9  $9.33   —   9,603  $9.33   — $10.34 - $12.41  160,696   5.0  $11.19   —   160,696  $11.19   — $12.41 - $14.48  108,375   5.7  $13.75   —   108,375  $13.75   — $14.48 - $16.55  35,306   4.1  $16.03   —   35,306  $16.03   — $16.55 - $18.62  2,475   4.0  $16.98   —   2,475  $16.98   — $18.62 - $20.69  67,200   4.4  $19.77   —   67,200  $19.77   —                            3,233,951   4.5  $6.38  $—   1,463,986  $7.62  $—                            The aggregate intrinsic value in the preceding table represents the total pretaxintrinsic value of in-the-money stock options based on Wilsons closing stock price of $3.52 as ofJuly 28, 2006, which would have been received by the option holders had all such options beenexercised as of that date. As of July 29, 2006, based on the weighted average exercise price,there were no outstanding in-the-money stock options.
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     A summary of the Company’s unvested stock options as of July 29, 2006 and changes duringthe six months ended July 29, 2006 is as follows:           **As of and for theyear-to-date period ended**   **July 29, 2006**       **Weighted**       **Average Grant**   **Shares**  **Date Fair Value** Unvested, beginning of period  2,256,666  $3.28 Granted  282,000  $2.11 Vested  (493,369) $3.42 Forfeited  (275,332) $3.18         Unvested, end of period  1,769,965  $3.08             *Stock-based compensation*     On January 29, 2006, the Company adopted the provisions of SFAS No. 123 (Revised 2004),*Share-Based Payment*(“SFAS No. 123R”), which requires the recognition of compensation expense in anamount equal to the fair market value of share-based payments granted to employees and non-employeedirectors. These share-based payments include employee stock options, employee stock purchasesrelated to the Company’s employee stock purchase plan and other stock-based awards (“stock-basedcompensation”). Prior to January 29, 2006, the Company accounted for employee stock-basedcompensation using the intrinsic-value method pursuant to Accounting Principles Board Opinion No.25, *Accounting for Stock Issued to Employees*(“APB No. 25”) and its related implementation guidanceunder which no compensation cost had been recognized. As permitted by SFAS No. 123, *Accounting forStock-Based Compensation*(“SFAS No. 123”), the Company adopted the disclosure provisions foremployee stock-based compensation and only disclosed such compensation pro forma in the notes tothe consolidated financial statements.     The Company adopted SFAS No. 123R using the modified prospective transition method. Under thismethod, the Company recognizes compensation costs for new grants of stock-based awards, awardsmodified on or after the effective date of January 29, 2006, and the remaining portion of the fairvalue of the unvested awards at January 29, 2006. The Company’s consolidated financial statementsas of and for the three and six months ended July 29, 2006 reflect the impact of SFAS No. 123R. Inaccordance with the modified prospective transition method, prior periods have not been restatedand do not include the impact of SFAS No. 123R.     SFAS No. 123R requires companies to measure the cost of stock-based awards based on the fairvalue of the award at the date of grant. In measuring the value of stock-based compensation underSFAS No. 123R, or previously under SFAS No. 123, the Company uses the Black-Scholes option pricingmodel to estimate the grant date fair value of each stock-based award. The Company’s estimates offair value are affected by the price of the Company’s common stock, the nature of the share-basedaward, and other complex and subjective variables including but not limited to, expected term ofthe stock-based awards, the expected volatility of the Company’s stock price over the term of theaward, and actual and projected employee stock option behavior.     The following weighted average assumptions were used in the Black-Scholes option pricing modelto estimate the grant date fair value of awards granted in the three and six months ended July 29,2006 and July 30, 2005:                   **For the three months ended** **For the year-to-date period ended**  **July 29,** **July 30,** **July 29,** **July 30,**  **2006** **2005** **2006** **2005** Expected term (in years)  4.1     4.5     4.1     4.5   Expected volatility  69.5  %  69.7  %  69.9  %  69.7  %Risk-free interest rate  5.0  %  3.9  %  4.8  %  3.9  %Dividend yield  0.0  %  0.0  %  0.0  %  0.0  %Weighted average fair valueof options granted $2.04  $3.43  $2.11  $3.43      The weighted average expected term reflects the period of time for which options are expectedto be outstanding. That is from grant date to expected exercise or other expected settlement. TheCompany’s calculation of expected term is based on historical experience of its option plans aswell expectations of future employee stock option behavior. The expected volatility of theCompany’s stock price is based on the actual historical volatility over a period that iscommensurate to the expected term of the option. The risk-free interest rate is based on theaverage implied yield on U.S. Treasury instruments with a term approximating the expected term ofthe option. The expected dividend yield is zero, as the Company has not declared a dividend in thepast and the ability to pay cash dividends in the future is limited by certain provisions in theCompany’s senior credit facility.
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     The Company’s SFAS No. 123R fair value calculations are based on a single-option valuationapproach and applicable compensation cost is recognized on a straight-line basis over the vestingperiod of the stock-based award. A similar approach was taken for periods prior to January 29, 2006under SFAS No. 123 for the required pro forma disclosures. In addition, the amount of stock-basedcompensation cost recognized during a period is based on the value of the portion of the awardsthat are ultimately expected to vest. SFAS No. 123R requires forfeitures to be estimated at thetime of grant and revised, if necessary, in subsequent periods if actual forfeitures differ fromthose estimates. In the pro forma disclosures required under SFAS No. 123 for the periods prior to2006, the Company factored estimated forfeitures as of the grant date into the compensation expenseto be recognized. Pursuant to SFAS No. 123R, the stock-based compensation expense recognized in thefirst six months of 2006 has been reduced for estimated forfeitures. The estimated forfeiture rateis based on historical experience of the Company’s option plans and any adjustment to theforfeiture rate in the future will result in a cumulative adjustment in the period that thisestimate is changed. Ultimately, the total compensation expense recognized for any givenstock-based award over its vesting period will only be for those shares that actually vest.     Stock-based compensation expense recognized under SFAS No. 123R for the second quarter of 2006and the year-to-date period ended July 29, 2006, totaled $0.6 million and $1.2 million,respectively, before income taxes primarily for expenses related to employee stock options. All ofthe Company’s stock-based compensation is recognized as part of selling, general and administrativeexpenses. As a result of adopting SFAS No. 123R on January 29, 2006, the Company’s net loss for thequarter ended July 29, 2006 is higher by $0.6 million due to this policy change. Basic and dilutedloss per share for the quarter ended July 29, 2006 would have been $0.61 prior to the adoption ofSFAS No. 123R compared to the reported per share loss of $0.63. Similarly, the Company’s net lossfor the six-month period ended July 29, 2006 is higher by $1.2 million and the basic and dilutedloss per share would have been $0.76 prior to adoption of SFAS No. 123R compared to the reportedper share loss of $0.79.     Had compensation cost for stock-based awards been determined and recorded consistent with SFASNo. 123 in prior periods, the Company’s net income (loss) and basic and diluted net income (loss)per share would have been the following pro forma amounts (in thousands, except per share amounts):           **For the three**  **For the year-to-**   **months ended**  **date period ended**   **July 30,**  **July 30,**   **2005**  **2005** **Net Loss:**        As reported   $(13,993)   $(17,786)Stock based employeecompensation expense includedin net loss  —   — Stock based employeecompensation determined underfair value based method forall awards  (542)  (690)   Pro forma loss   $(14,535)   $(18,476)            **Basic and diluted loss per share:**        As reported   $(0.36)   $(0.46)Stock based employeecompensation expense includedin net loss  —   — Stock based employeecompensation determined underfair value based method forall awards  (0.01)  (0.01)   Pro forma loss   $(0.37)   $(0.47)        For purposes of this pro forma disclosure, the value of the stock options was estimated usingthe Black-Scholes option pricing model and amortized to expense over the options’ vesting periods.Pro forma disclosures for the three and six months ended July 29, 2006 are not presented as theamounts are recognized in the consolidated financial statements.     In addition to the recognition of expense in the financial statements, under SFAS No. 123R,any excess tax benefits received upon exercise of options is to be presented as a financingactivity inflow in the statement of cash flows. Prior to the adoption of SFAS No.123R, all tax benefits resulting from the exercise of stock options were included as operatingcash flows. However, due to Wilsons’ net operating loss carryforward position and the valuationallowance recorded against the Company’s deferred tax assets, there is no cash flow effect for anyexcess tax benefits from stock option exercises for the three and six month periods ended July 29,2006. Once Wilsons is no longer in a full valuation allowance position, excess tax benefits will berecorded when a deduction reported for income tax purposes related to settlement of a stock-basedaward exceeds the compensation costs recognized for financial reporting purposes.     *Non-vested shares and other stock-related awards*     The Company can and has awarded non-vested share awards (restricted stock grants) to selectedemployees under the 2000 Plan. These non-vested share awards generally vested ratably over fouryears from the date of grant, subject to acceleration if certain performance targets were met. Asof July 2004, all unvested outstanding non-vested share awards became vested due to achange-in-control pursuant to the Company’s Plans, defined above. There have been no non-vestedshare awards granted since that time. Under SFAS No. 123R, the fair value of any future non-vestedshare awards will be estimated on the grant date based on the then current market value of theCompany’s stock and will be amortized to compensation expense on a straight-line basis over therelated vesting period. The total number of non-vested share awards expected to vest will beadjusted by an estimated forfeiture rate.     Under the 2000 Plan, the Company may also issue other stock-based awards. Beginning with theCompany’s 2005 Annual Meeting of Shareholders held on June 1, 2006, each member of the Board ofDirectors who is not an officer or employee of the Company receives one-half of their $25,000annual retainer in unrestricted shares of the Company’s common stock. In the second quarter of2006, 17,120 shares of the Company’s common stock were issued as annual retainers. These fullyvested shares were issued based on the $3.65 fair market value of the Company’s common stock on theday preceding the Annual Meeting of Shareholders. The fair value of the annual stock retainer wasamortized over the applicable twelve-month period.
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     *Employee stock purchase plan*     The Company has an employee stock purchase plan (“ESPP”) that is qualified under Section 423of the Internal Revenue Code of 1986. Employees are entitled to have payroll deductions withheldthat are used to purchase company stock at a 15% discount at defined times during the year. TheCompany has allowed for 625,000 shares of common stock to be purchased under the ESPP. As of July29, 2006, 391,874 shares had been issued under the plan and 233,126 were available for futureissuance. Prior to January 29, 2006, under APB No. 25, the Company was not required to recognizestock-based compensation expense for the cost of stock options or shares issued under the ESPP.However, based on the provisions of the ESPP regarding purchase discounts, the plan is deemedcompensatory under SFAS No. 123R. As such, compensation expense is recognized for the fair value ofthe option features of the ESPP purchases as of January 29, 2006. The ESPP fair value is estimatedusing the Black-Scholes option pricing model with applicable assumptions and input variables.Stock-based compensation expense recognized under SFAS No. 123R for the second quarter andyear-to-date period ended July 29, 2006 related to the ESPP was insignificant.**5 Legal proceedings**     The Company is involved in various other legal actions arising in the ordinary course ofbusiness. In the opinion of management, the ultimate disposition of these matters will not have amaterial adverse effect on the Company’s consolidated financial position and results of operations.**6 Supplemental balance sheet information**           **July 29,**  **January 28,** (In thousands) **2006**  **2006**                   Accounts receivable, net:        Trade receivables   $2,413    $2,579 Other receivables  1,271   1,641        Total  3,684   4,220 Less — Allowance for doubtful accounts  (47)  (76)Less — Deferred sales  (60)  (81)       Total accounts receivable, net   $3,577    $4,063                 Inventories:        Raw materials   $1,859    $2,040 Finished goods  62,251   83,605        Total inventories   $64,110    $85,645                 Property and equipment, net:        Equipment and furniture   $76,846    $75,250 Leasehold improvements  41,746   40,101        Total  118,592   115,351 Less-Accumulated depreciation and amortization  (78,594)  (74,306)       Net property and equipment   $39,998    $41,045                 Other assets, net:        Debt issuance costs   $5,384    $5,384 Less-Accumulated amortization  (4,181)  (3,867)       Debt issuance costs, net  1,203   1,517 Other intangible assets, net  59   59        Total   $1,262    $1,576        **ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**     The following discussion of the financial condition and results of operations of Wilsons TheLeather Experts Inc. and its wholly owned subsidiaries should be read in conjunction with our mostrecent audited consolidated financial statements and related notes included in our 2005 AnnualReport on Form 10-K. When we refer to “we,” “our,” “us” or “Wilsons Leather,” we mean Wilsons TheLeather Experts Inc. and its subsidiaries.     Our fiscal year ends on the Saturday closest to January 31. The periods that will end or haveended on February 3, 2007, January 28, 2006, January 29, 2005, and January 31, 2004, are referredto herein as 2006, 2005, 2004, and 2003, respectively. The year ended February 3, 2007, consistsof 53 weeks as compared to 52 weeks for all other years presented in this Form 10-Q.
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**Overview**     We are the leading specialty retailer of quality leather outerwear, accessories and apparel inthe United States. Our multi-channel store locations are designed to target a broad customer basewith a superior level of customer service. Through our international leather sourcing network andin-house design capabilities, we are able to consistently provide our customers with quality,fashionable merchandise at attractive prices. Our business structure results in shorter lead times,allowing us to react quickly to popular and emerging fashion trends and customer preferences,rapidly replenish fast-selling merchandise and minimize fashion risk.     As of July 29, 2006, we operated a total of 422 stores located in 45 states, including 296mall stores, 112 outlet stores and 14 airport locations. We have historically supplemented ourpermanent stores with temporary seasonal stores during our peak selling season, which totaled 118in 2005. Operation of our temporary seasonal stores will be suspended in 2006 and for theforeseeable future, but may be reconsidered in the future. Our mall stores average approximately2,600 total leased square feet and feature a large assortment of classic and contemporary leatherouterwear, accessories and apparel. Our outlet stores operate primarily under the Wilsons LeatherOutlet(SM) name, average approximately 4,000 total leased square feet and offer a combination ofclearance merchandise from our mall stores, special outlet-only merchandise and key in-seasongoods. Our airport stores average approximately 650 total leased square feet, featuretravel-related products as well as leather accessories and provide us the opportunity to showcaseour products and the *Wilsons Leather*brand to millions of potential customers each year in some ofthe busiest airports in the United States. Our e-commerce site, www.wilsonsleather.com,offers an extension of our store experience and is intended to increase brand awareness, strengthenthe relationship with our customers, make our merchandise more accessible to our customers andfacilitate cross-marketing with our stores. The name and reputation of the *Wilsons Leather*brandassures customers they are purchasing quality and fashionable merchandise.     We measure performance using such key operating statistics as comparable store sales, salesper square foot, gross margin percentage and store operating expenses, with a focus on labor, as apercentage of net sales. These results translate into store operating contribution and store cashflow, which we use to evaluate overall performance on an individual store basis. Store operatingcontribution is calculated by deducting a store’s operating expenses from its gross margin and ismeasured as a percentage of net sales. Store operating contribution gives us an overall measure asto whether or not individual locations and markets are meeting our financial objectives.     In addition, general and administrative expenses are monitored in absolute amount, as well ason a percentage of net sales basis. We continue to monitor product costing and promotionalactivity, which allows us to generally maintain acceptable margin levels. Our gross margins areinfluenced by the mix of merchandise between outerwear and accessories in our total net sales aswell as the volume of our markdown activity, which was higher than historical levels in the secondquarter of 2006.     We also measure and evaluate investments in our retail locations, including inventory andproperty and equipment. Inventory performance is primarily measured by inventory turns, or thenumber of times store inventory turns over in a given period, and amounts of owned inventory atvarious times based on payment terms from our vendors. The most significant investments in propertyand equipment are made at the time we open a store.     We generate a significant portion of our sales from October through January, which includesthe holiday selling season. We generated 52.5% of our annual sales in that time period in 2005 and27.7% in December alone. As part of our strategy to improve operating margins and maximize revenueand profitability during non-peak selling seasons, we have increased the number of outlet locationssince 2000, which are less seasonal, and modified our product mix to emphasize accessories. Inaddition, our continued focus on accessory penetration has resulted in accessory sales growth as apercentage of our total sales to 38.3% in 2005 from 35.6% in 2004 and 33.6% in 2003. During thethird quarter of 2005, we initiated an accessory intensification strategy in 113 of our storesoffering an increased assortment of handbags, wallets, shoes and women’s executive products.     Comparable store sales decreased 16.2% and 13.0% in the three-and six-month periods ended July29, 2006, respectively, compared to increases of 8.7% and 12.8% in comparable store sales in thesimilar periods of the prior year. A store is included in the comparable store sales calculationafter it has been opened and operated by us for more than 52 weeks. The percentage change iscomputed by comparing total net sales for comparable stores as thus defined at the end of theapplicable reporting period with total net sales from comparable stores for the same period in theprior year.     In 2006, our focus is on creating a new model that will lead to consistent top-lineperformance while maintaining merchandise margins, cash position, the health of our balance sheetand a rational store count. To this end we are pursuing four initiatives: **•** reengineering our Wilsons Leather mall stores with greater accessory penetration,migration to a product mix with higher price points, introduction of new signage, productticketing and store set-ups giving our mall stores a fresh and clean look that is easier toshop. This will be completed in our mall stores during the third quarter in advance of theholiday selling season;  **•** revitalizing our outlet division with marketing packages differentiated from our mallstores and improved merchandising within the outlet stores;  **•** planning the launch of a new store concept in the future, which will focus onmid-to-higher-end accessory offerings with a limited assortment of outerwear; and  **•** laying the foundation for a future wholesale business to sell proprietary licensed andbranded leather products in geographies and product categories outside our current marketsand product mix.     This is a multi-year, multi-format strategy intended to move Wilsons Leather into a strongerposition as a company and a more relevant brand for the future. We believe the impact of ourstrategies will not be realized until after 2006.     We intend the discussion of our financial condition and results of operations that follows toprovide information that will assist in understanding our consolidated financial statements, thechanges in certain key items in those consolidated financial statements from period to period, andthe primary factors that accounted for those changes, as well as how certain accounting principles,policies and estimates affect our consolidated financial statements.
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     *Critical accounting policies*     We consider our critical accounting policies to be those related to inventories and propertyand equipment impairment as discussed in the section with this title in Item 7. “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” that begins on page 26 ofour 2005 Annual Report on Form 10-K. No material changes occurred to these policies in the periodscovered by this quarterly report.**RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED JULY 29, 2006, COMPARED TO THE THREE MONTHS ENDED JULY 30, 2005**     ***Net Sales.***Net sales decreased 15.8% to $49.2 million in the three months ended July 29, 2006,from $58.4 million in the comparable period last year. The decrease was experienced in alldivisions with men’s down 22.7%, women’s down 29.4% and accessories down 7.9% on a comparable storesales basis. Both mall and outlet comparable store sales were down 22.6% and 9.2%, respectively,as we continue to transition our merchandise mix and reengineer our mall stores to a newer, fresherand less outerwear dependent product mix. During the second quarter of 2006, receipts of newmerchandise were limited to focus on repositioning our inventory and eliminating non-go-forward andoverstocked inventory including styles carried over from prior years. These lower receiptscontributed to the decline in net sales. This continues to be a period of significant transitionfor our Wilsons Leather mall stores and as we implement these changes it has had a negative impacton our comparable store sales, which decreased 16.2% for the three months ended July 29, 2006,compared to an increase of 8.7% in comparable store sales in the same period last year. Weanticipate that these changes will continue to negatively impact comparable store sales in thethird quarter of 2006. In addition, we operated on average eight fewer stores in the second quarterof 2006 as compared to the similar period in 2005.     We opened two stores and closed one store in the three months ended July 29, 2006, compared toopening four stores and closing four stores in the comparable period last year. As of July 29,2006, we operated 422 stores compared to 429 stores at July 30, 2005. We have historicallysupplemented our permanent mall stores with seasonal stores during our peak selling season fromOctober to January. We have no plans to operate any seasonal stores during the 2006 holiday sellingseason or in the foreseeable future, but may reconsider if circumstances warrant.     ***Cost of Goods Sold, Buying and Occupancy Costs.***Cost of goods sold, buying and occupancy costsincreased $2.3 million, or 5.1%, in the three months ended July 29, 2006, compared to thecomparable period last year in spite of the decreased sales volume. This increase was primarilydriven by a $4.5 million increase in markdowns as we took extensive markdowns during the quarter toliquidate and reposition our inventory pursuant to our strategic initiative relating to thereengineering of our mall stores’ product mix. During the second quarter of 2006 it becameapparent that the level of markdowns required to execute our reengineering were greater thaninitially estimated in the first quarter, as our product mix strategy continued to evolve. Inaddition, buying and occupancy costs increased $0.4 million including increased rent costs andincreased expenditures related to the new merchandising strategies in both our mall and outletstores. These increases were somewhat offset by a $2.7 million decrease in product costs due tothe lower sales volume experienced during the quarter. As in the beginning of this fiscal year, wecontinued to take aggressive actions in the second quarter to reduce our outerwear inventories aswell as accelerating markdowns on existing handbag and accessory inventory all in preparation ofthe fall implementation of the new look and feel of our mall stores. We anticipate that theincreased markdown activity will continue into the third quarter of 2006.     Gross margin as a percentage of net sales decreased 1,920 basis points to 3.8% in the secondquarter of 2006 compared to 23.0% in the similar period of 2005. This decrease in gross margin ratewas primarily driven by a 1,230 basis point decrease in merchandise margins resulting from slightlylower initial markups as a percentage of net sales and significantly higher markdowns as discussedabove. In addition, buying, occupancy and delivery costs as a percentage of net sales increased by670 basis points which represents the de-leveraging resulting from our comparable store salesdecrease.     ***Selling, General and Administrative Expenses.***Selling, general and administrative (“SG&A”)expenses decreased $0.5 million or 1.9% to $24.1 million in the second quarter of 2006 from $24.6million in the second quarter of 2005. As a percentage of net sales, 2006 SG&A increased to 49.0%from 42.1% in the prior year. The $0.5 million decrease was primarily due to: (1) a $0.6 milliondecrease in incentive bonuses accrued in the second quarter of 2006 as compared to the similarperiod in 2005 due to our lower sales volume, (2) a $0.5 million decrease in promotional spending,(3) a $0.5 million decrease in executive payroll expenditures primarily related to severance costsincurred in 2005, and (4) a $0.2 million decrease in store related expenses with lower payrollcosts and shrink expense related to our operating on average eight fewer stores in the currentquarter as compared to the similar period last year being somewhat offset by decreased layawayservice fees.
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     These spending decreases were partially offset by: (1) a $0.6 million charge related tostock-based compensation costs recorded in the second quarter of 2006 with the adoption of SFAS No.123R with no corresponding amount in the similar period last year, and (2) a $0.5 million increasein other administrative costs primarily related to higher spending on medical insurance andworkers’ compensation as well as increased, legal fees and professional service fees, (3) a $0.1million increase in spending related to administration of our e-commerce site due to higher on-linesales volume year-over-year, and (4) $0.1 million of spending related to the start-up of ourwholesale operations.     ***Depreciation and Amortization.***Depreciation and amortization decreased to $3.1 million in thethree months ended July 29, 2006, from $3.6 million in the comparable period last year. However,as a percentage of net sales depreciation and amortization increased to 6.3% in the second quarterof 2006 from 6.1% in the comparable period last year. The decrease of $0.5 million was primarilydue to: (1) a 1.9% decrease in average store count for the second quarter of 2006 compared to thesimilar period in 2005, and (2) $0.2 million in accelerated depreciation recorded in the secondquarter of 2005 related to known store closings in excess of comparable deductions in the similarperiod this year.     ***Operating Loss.***As a result of the above, the operating loss was $25.3 million in the threemonths ended July 29, 2006, compared to a $14.7 million loss for the comparable period last year,or 51.5% of second quarter net sales in 2006 as compared to 25.2% of net sales in the comparableperiod of 2005. This increase in operating loss was due to: (1) $11.6 million in lower grossmargin dollars as compared to the prior year period partially offset by, (2) $0.5 million decreasein SG&A spending in 2006 compared to 2005, and (3) $0.5 million in decreased depreciation andamortization expense. The decreased operating performance in the current quarter is reflective ofthe significant efforts we are undertaking to transition WilsonsLeather pursuant to our strategicinitiatives.     ***Interest Expense, Net.***Net interest expense decreased to $0.3 million in the second quarter of2006 from $0.7 million in 2005, primarily due to higher interest income earned on our higheraverage cash balances in the second quarter of 2006 compared to 2005.     ***Income Tax Benefit.***A net income tax benefit of $1.1 million was recorded in the secondquarter of 2006 primarily relating to the reduction of the income tax provision we recorded in thefourth quarter of 2005. Due to our July tax year end, we recorded a provision in the fourth quarterof 2005 for income taxes due based on estimated taxable income for the first half of the tax year.As a result of the net loss incurred in the first and second quarters of 2006, the taxable incomeestimate and related income taxes due have been reduced. An income tax benefit of $1.4 million wasrecorded in the comparable period of 2005 related primarily to the resolution of certain income taxcontingencies that had previously been accrued.     Due to cumulative losses sustained over the past five fiscal years and in the currentyear-to-date period ended July 29, 2006, we believe that it is more likely than not that ourdeferred tax assets will not be realized. Accordingly, a full valuation allowance has beenrecorded against the net deferred tax assets including potentially unrealizable net operatinglosses. The ability to utilize net operating loss carryforwards is limited under various provisionsof the Internal Revenue Code, as disclosed in our 2005 Annual Report on Form 10-K.     ***Net Loss.***Net loss for the three months ended July 29, 2006, was $24.5 million, or $0.63 perbasic and diluted common share, compared to a net loss of $14.0 million, or $0.36 per basic anddiluted common share, in the comparable period last year. The $10.5 million increase in net lossover the prior year is due to: (1) $11.6 million in lower gross margin dollars, and (2) a $0.3million decrease in net income tax benefit recorded in the current quarter, partially offset by (3)a $0.5 million decrease in SG&A spending, (4) $0.5 million decreased depreciation and amortization,and (5) a $0.4 million decrease in interest expense (all discussed above).**RESULTS OF OPERATIONS FOR THE YEAR-TO-DATE PERIOD ENDED JULY 29, 2006, COMPARED TO THE YEAR-TO-DATEPERIOD ENDED JULY 30, 2005**     ***Net Sales.***Net sales decreased 13.2% to $123.8 million in the year-to-date period ended July29, 2006, from $142.7 million in the comparable period last year. The year-to-date decrease wasalso experienced in all divisions with men’s down 16.0%, women’s down 21.9% and accessories down5.5% on a comparable store sales basis. Both mall and outlet comparable store sales were down17.9% and 6.4%, respectively. Throughout the first half of 2006, we aggressively pursued ourstrategic initiative related to the reengineering of our mall stores. As discussed above, thisincluded transitioning our merchandise mix and significantly reducing year-to-date receipts whichcontributed to our lower sales volume in the six months ended July 29, 2006 as compared to thesimilar period last year. Year-to-date, comparable store sales decreased 13.0% as compared to anincrease of 12.8% in the same period last year. We also operated on average 10 fewer stores in thefirst six months of 2006 as compared to the similar period in 2005.
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     Year-to-date we openedfour stores and closed four stores compared to opening four stores andclosing 11 stores in the comparable period last year. Again, we have no current plans to operateany seasonal stores during the 2006 holiday selling season or in the foreseeable future.     ***Cost of Goods Sold, Buying and Occupancy Costs.***Cost of goods sold, buying and occupancy costsdecreased $1.7 million to $102.2 million for the year-to-date period ended July 29, 2006, ascompared to $103.9 million in the similar period last year. This decrease was primarily driven byan $8.5 million decrease in product costs related to the lower sales volume experienced during thefirst six months of 2006. This decrease in product costs was mostly offset by: (1) a $6.0 millionincrease in markdowns as we have taken aggressive markdowns year-to-date to liquidatenon-go-forward and overstocked inventory to transition our merchandise mix, (2) a $0.1 millionincrease in delivery costs, and (3) a $0.7 million increase in buying and occupancy costs includingincreased rent costs and increased expenditures related to our new mall and outlet merchandisingstrategies.     Year-to-date, gross margin as a percentage of net sales decreased 980 basis points to 17.4% ascompared to 27.2% in the first six months of 2005, primarily as a result of decreased merchandisemargins. Merchandise margins as a percentage of net sales were 510 basis points lower due to theextensive markdowns discussed above which were only somewhat offset by slightly higher initialmarkups. In addition, buying, occupancy and delivery costs as a percentage of net sales increased450 basis points again representing the de-leveraging resulting from our comparable store salesdecrease.     ***Selling, General and Administrative Expenses.***SG&A increased to $49.7 million, up $0.3 millionor less than 1.0%, from $49.4 million in the similar period last year. As a percentage of netsales, 2006 year-to-date SG&A increased to 40.1% as compared to 34.6% last year. The $0.3 millionincrease in 2006 SG&A was primarily due to: (1) a $1.2 million charge related to stock-basedcompensation costs recorded year-to-date 2006 with the adoption of SFAS No. 123R with nocorresponding amount in the similar period last year, (2) a $1.3 million increase in otheradministrative costs primarily related to higher spending on medical insurance and workers’compensation as well as increased, legal fees and professional service fees, (3) a $0.3 millionincrease in spending related to administration of our e-commerce site due to higher on-line salesvolume year-over-year, and (4) $0.2 million of spending related to the start-up of our wholesaleoperations.     These increased expenses were mostly offset by: (1) a $1.4 million decrease in incentivebonuses accrued in the first six months of 2006 as compared to the similar period in 2005, (2) a$0.8 million decrease in promotional spending, and (3) a $0.5 million decrease in store-relatedexpenses due to lower sales volume as well as reduced store count as we operated on average 10fewer stores in the six months ended July 29, 2006 as compared to the similar period last year.     ***Depreciation and Amortization.***Depreciation and amortization decreased $1.0 million in theyear-to-date period ended July 29, 2006 to $6.3 million, from $7.3 million in the comparable periodlast year. The decrease was primarily the result of: (1) a decrease in store depreciation due to a2.3% decrease in the year-to-date average store count, and (2) accelerated depreciation related toknown store closings was $0.5 million higher in the first six months of 2005 than in the similarperiod this year. Depreciation and amortization as a percentage of net sales was flat at 5.1% forthe comparable six-month periods.     ***Operating Loss.***For the year-to-date period ended July 29, 2006, the operating loss was $34.3million as compared to $17.9 million a year ago, or 27.7% of year-to-date net sales in 2006 ascompared to 12.5% of net sales in the comparable period of 2005. This decline in operatingperformance was due to: (1) a $17.2 million decrease in gross margin, and (2) a $0.3 millionincrease in SG&A spending in the current year-to-date period as compared to last year beingsomewhat offset by (3) a $1.0 million decrease in depreciation and amortization.     ***Interest Expense.***Year-to-date net interest expense of $0.5 million in 2006 decreased $0.8million as compared to $1.3 million in 2005, due to an increase in interest income of $0.5 millionrelated to higher average cash balances in the first six months of 2006 as compared to the similarperiod last year as well as a $0.3 million decrease in interest expense due to lower average debtlevels through the second quarter of 2006.     ***Income Tax Benefit.***We recorded an income tax benefit of $3.9 million in the year-to-dateperiod ending July 29, 2006 primarily relating to the reduction of the income tax provision werecorded in the fourth quarter of 2005. Due to our July tax year end, we recorded a provision inthe fourth quarter of 2005 for income taxes due based on estimated taxable income for the firsthalf of the tax year. As a result of the net loss incurred in the first six months of 2006, thetaxable income estimate and related income taxes due have been reduced. An income tax benefit of$1.4 million was recorded in the comparable period of 2005 related primarily to the resolution ofcertain income tax contingencies that had previously been accrued.
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     Due to cumulative losses sustained over the past five fiscal years and in the currentyear-to-date period ended July 29, 2006, we believe that it is more likely than not that ourdeferred tax assets will not be realized. Accordingly, a full valuation allowance has beenrecorded against the net deferred tax assets including potentially unrealizable net operatinglosses. The ability to utilize net operating loss carryforwards is limited under various provisionsof the Internal Revenue Code, as disclosed in our 2005 Annual Report on Form 10-K.     ***Net Loss.***As a result of the above, the year-to-date net loss for the first six months of 2006was $31.0 million, or $0.79 per basic and diluted common share, compared to a net loss of $17.8million, or $0.46 per basic and diluted common share, in the similar period last year. The $13.2million increase in net loss year-over-year is due to: (1) a $17.2 million decrease in grossmargin, and (2) a $0.3 million increase in SG&A spending, partially offset by, (3) a $1.0 milliondecrease in depreciation and amortization, (4) a $0.8 million decrease in net interest expense, and(5) a $2.5 million increase in income tax benefit recorded in 2006 as compared to 2005.**Liquidity and capital resources**     Our capital requirements are primarily driven by our seasonal working capital needs,investments in new stores, remodeling existing stores, enhancing information systems and increasingcapacity and efficiency for our distribution center. In addition, implementation of our four keyinitiatives relating to establishing a new multi-format model, reengineering our mall stores,revitalizing our outlet division, developing a wholesale business, and planning the launch of a newconcept store, requires significant resources including capital dollars. Our peak working capitalneeds typically occur during the period from August through early December as inventory levels areincreased in advance of our peak selling season from October through January.     Our future capital requirements depend on the sustained demand for our leather products. Manyfactors affect the level of consumer spending on our products, including, among others, generaleconomic conditions, including rising energy prices, customer shopping patterns, interest rates,the availability of consumer credit, weather, the outbreak of war, acts of terrorism or the threatof either, other significant national and international events, taxation and consumer confidence infuture economic conditions. Consumer purchases of discretionary items, such as our leatherproducts, tend to decline during periods when disposable income is lower. The uncertain outlook inthe United States’ economy has shifted consumer spending habits toward large discount retailers,which has decreased mall traffic, resulting in lower net sales on a quarterly and annual basis.     Our ability to meet our debt service obligations depends upon our future performance, whichwill be subject to general economic conditions and financial, business and other factors affectingour operations. If we are unable to generate sufficient cash flow from operations in the future toservice our debt, we may be required to refinance all or a portion of our existing debt or obtainadditional financing. There can be no assurance that any such refinancing or additional financingwould be possible or could be obtained on terms that are favorable to us.     General Electric Capital Corporation and a syndicate of banks have provided us with a seniorcredit facility, as amended, that provides for borrowings of up to $150.0 million in aggregateprincipal amount, including a $25.0 million Term B promissory note and a $75.0 million letter ofcredit subfacility. The maximum amount available under the revolving credit portion of the seniorcredit facility is limited to: **•** 85% of net inventories (excluding wholesale inventory), provided that such percentage atno time may exceed 85% of the then applicable discount rate applied in appraising suchinventories to reflect their value as if sold in an orderly liquidation, except that thediscount rate is gradually increased from August 17 to October 1 of each year and graduallydecreased from December 17 to February 1 of each year, and except that such amount isreduced by the amount of certain in-transit inventory to the extent such in-transitinventory reflects a disproportionate amount of our total inventory;  **•** plus the lesser of $10.0 million or 50% of the book value of wholesale inventory which is not in-transit;  **•** plus the lesser of $2.0 million or 50% of the book value of wholesale inventory in-transit;  **•** plus 85% of outstanding and undrawn trade letters of credit (excluding those related towholesale inventory), provided that such percentage at no time may exceed 85% of thediscount rate applied in appraising the future inventories related to such letters of creditto reflect their value as if sold in an orderly liquidation;  **•** plus 85% of outstanding and undrawn wholesale trade letters of credit related towholesale inventory, provided that such percentage at no time may exceed 50% of the bookvalue of the Company’s future wholesale inventories related to such letters of credit;
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 **•** plus 85% of credit card receivables;  **•** plus the lesser of $5.0 million or 85% of wholesale accounts receivable; and  **•** minus a $10.0 million reserve.     In addition, borrowings under the senior credit facility are subject to the furtherlimitations that: **•** the revolving credit portion of such borrowings cannot exceed the sum of 85% of creditcard and wholesale receivables, plus 85% of the appraised value of inventory (includinginventory subject to trade letters of credit) as if sold on a going-out-of-business basis;  **•** the total borrowings (i.e. the revolving credit portion of the facility and the Term Bpromissory note) cannot exceed the sum of 85.0% of the book value of credit card andwholesale receivables, plus 92.5% of the appraised value of inventory (including inventorysubject to trade letters of credit) as if sold on a going-out-of-business basis; and  **•** from December 31 of each year, through March 31 of the following year, we must have noborrowings under the revolving credit portion of the facility and outstanding letters ofcredit must be no greater than $20.0 million.     As of July 29, 2006, we had no borrowings under the revolving portion of the senior creditfacility and the Term B promissory note had a balance of $20.0 million, and we had $5.0 million inoutstanding letters of credit.     Through the third quarter of 2005, interest was payable on revolving credit borrowings atvariable rates determined by the applicable LIBOR (seven to 30 days) plus 1.50%, or the prime rateplus 0.25% (commercial paper rate plus 1.50% if the loan is made under the “swing line” portion ofthe revolver). Commencing with the fourth quarter of 2005, interest is payable on revolving creditborrowings at variable rates determined by the applicable LIBOR plus 1.25% to 1.75%, or the primerate plus 0.0% to 0.5% (commercial paper rate plus 1.25% to 1.75% if the loan is made under the“swing line” portion of the revolver). The applicable margin will be adjusted quarterly on aprospective basis based on achievement of defined quarterly EBITDA targets. Interest is payable onthe Term B promissory note at a variable rate equal to the prime rate plus 4.0%. We pay monthlyfees on the unused portion of the senior credit facility and on the average daily amount of lettersof credit outstanding during each month. The senior credit facility expiration is June 28, 2008, atwhich time all borrowings, including the Term B promissory note, become due and payable. Prepaymentof the Term B promissory note is subject to a 0.5% prepayment fee if prepayment is made on or priorto July 31, 2007. After July 31, 2007, any remaining balance of the Term B promissory note isprepayable without penalty only with the consent of the senior lenders. The revolving creditportion of the senior credit facility is subject to a 1.0% prepayment fee under most circumstances.     The senior credit facility contains certain restrictions and covenants, which, among otherthings, restrict our ability to make capital expenditures; acquire or merge with another entity;make investments, loans or guarantees; incur additional indebtedness; create liens or otherencumbrances; or pay cash dividends or make other distributions. The senior credit facility, asamended, does allow for the investment in and development of our wholesale business. At July 29,2006, we were in compliance with all covenants related to the senior credit facility.     We plan to use the senior credit facility for our immediate and future working capital needs.We are dependent on the senior credit facility to fund working capital and letter of credit needs.We believe that the borrowing capacity under the senior credit facility, together with cash onhand, current and anticipated cash flow from operations, and cost reductions associated with thelower store count will be adequate to meet our working capital and capital expenditure requirementsthrough 2006.     **Cash flow analysis**     *Operating Activities.*Operating activities for the six months ended July 29, 2006, utilizedcash of $7.0 million compared to $11.3 million in the corresponding period of 2005.     For the first six months of 2006, the $7.0 million of cash used in operating activitiesincluded: (1) the year-to-date loss net loss of $31.0 million, (2) a $1.5 million increase inprepaid expenses primarily related to prepaid rents and marketing costs, and (3) a $4.2 million decrease inincome taxes payable and other liabilities primarily related to the income tax benefit recordedyear-to-date.
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     These were somewhat offset by the following sources of cash: (1) a $21.5 million decrease ininventories as we aggressively managed our inventory levels including the reduction of receipts inthe first six months of 2006 and the liquidation of non-go-forward and overstocked inventorypursuant to our strategic initiative related to reengineering our Mall stores, includingtransitioning our product mix, (2) $6.6 million in non-cash adjustments for depreciation andamortization, (3) $1.2 million in non-cash charges related to stock-based compensation costs, and(4) a $0.5 million volume driven decrease in net accounts receivable.     The $11.3 million of cash used by operating activities in 2005 was comprised primarily of: (1)a net loss from operations of $17.8 million, (2) a $3.4 million decrease in accounts payable andaccrued expenses primarily as a result of lower inventory levels and payout of accrued 2004incentives, (3) a $2.9 million increase in prepaid expenses due to the timing of rent payments, and(4) a $1.7 million decrease in income taxes payable and other liabilities as a result of therelease of certain tax contingency reserves.     These uses of cash were somewhat offset by: (1) a $6.2 million decrease in inventories, (2) a$0.8 million reduction in accounts receivable due to lower seasonal sales volumes, and (3) $7.4million in non-cash adjustments for depreciation, amortization and property and equipmentimpairment.     *Investing Activities.*Year-to-date investing activities for 2006 totaled $5.2 millioncomprised primarily of $3.9 million in capital expenditures related to the renovation andimprovement of existing stores as well as $1.3 million for certain information systems projects,distribution center equipment and other home office projects. For 2006, capital expenditures arecapped by our senior credit facility at $15.0 million.     Investing activities of $4.8 million for the six months ended July 30, 2005, were comprised of$4.9 million in capital expenditures primarily for the renovation of and improvements to existingstores, including new store fixtures and certain distribution center equipment, offset by $0.2million in proceeds on the sale of property and equipment.     *Financing Activities.*Financing activities in the first six months of 2006 totaled $0.3million relating to the issuance of common stock from the exercise of stock options, share grantsto our non-employee directors and from our employee stock purchase plan.     Cash used for financing activities for the six months ended July 30, 2005, was $4.5 millionand was comprised of $5.0 million used for pre-payment of a portion of the Term B promissory noteoffset by $0.5 million provided from the issuance of common stock primarily from the exercise ofstock options.     **Off-balance sheet arrangements**     We have no off-balance sheet arrangements that have or are reasonably likely to have a currentor future effect on our financial condition, changes in our financial condition, revenues orexpenses, results of operations, liquidity, capital expenditures or capital resources that arematerial to investors.     **Contractual obligations and commercial commitments**     We had $5.0 million of standby and documentary letters of credit outstanding at July 29, 2006.We also had a Term B promissory note for $20.0 million outstanding at July 29, 2006. Thesecommitments are further discussed in the “Liquidity and capital resources” section of this Form10-Q. In addition, we have licensing obligations and store operating leases that we have committedto in the ordinary course of business.     **Seasonality and inflation**     A majority of our net sales and operating profit is generated in the peak selling period fromOctober through January, which includes the holiday selling season. As a result, our annualoperating results have been, and will continue to be, heavily dependent on the results of our peakselling period. Net sales are generally lowest during the period from April through July, and wetypically do not become profitable, if at all, until the fourth quarter of a given year. Most ofour stores are unprofitable during the first three quarters. Conversely, in a typical year nearlyall of our stores are profitable during the fourth quarter, even those that may be unprofitable forthe full year. Historically, we have opened most of our stores during the last half of the year. Asa result, new mall stores opened just prior to the fourth quarter produce profits in excess oftheir annualized profits since the stores typically generate losses in the first nine months of theyear.
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     We do not believe that inflation has had a material effect on the results of operationsduring the past three years; however, there can be no assurance that our business will not beaffected by inflation in the future. Increased energy prices have put additional pressure onconsumer purchases of discretionary items and may potentially increase our shipping and deliverycosts, which could negatively affect our net sales and merchandise margins.     **Recently issued accounting pronouncements**     In July 2006, the FASB issued Financial Interpretation No. 48, *Accounting for Uncertainty inIncome Taxes*—an interpretation of FASB Statement No. 109 (“FIN 48”). FIN 48 clarifies theaccounting for and disclosure of uncertainty in income taxes recognized in accordance with SFAS No.109, *“Accounting for Income Taxes.”*FIN 48 prescribes a recognition threshold and measurementattribute for financial statement recognition and measurement of a tax position taken or expectedto be taken in a tax return. FIN 48 also provides guidance on derecognition, classification,interest and penalties, accounting in interim periods and disclosure. FIN 48 is effective forfiscal years beginning after December 15, 2006. We are currently assessing the impact adoption ofFIN 48 will have on our consolidated financial statements beginning in the first quarter of fiscal2007.     In June 2006, the FASB issued Emerging Issues Task Force Issue No. 06-3, *How Sales TaxesCollected From Customers and Remitted to Governmental Authorities Should Be Presented in the IncomeStatement*(“EITF 06-3”), which discusses the presentation of sales taxes in the income statement oneither a gross or net basis. It requires entities to disclose, if significant, on an interim andannual basis for all periods presented: (a) the accounting policy elected for these taxes and (b)the amounts of the taxes reflected gross (as revenues) in the income statement The guidance iseffective for periods beginning after December 15, 2006. We present sales net of applicable salestaxes. With the adoption of EITF 06-3 in the first quarter of fiscal 2007, we will not change ourmethod for recording sales taxes net in our consolidated financial statements.     In November 2004, the FASB issued SFAS No. 151, *Inventory Costs*(“SFAS No. 151”). SFAS No. 151amends Accounting Research Bulletin No. 43 to clarify the accounting for abnormal amounts of idlefacility expense, freight, handling costs and spoilage. SFAS No. 151 also requires the allocationof fixed production overheads to inventory be based on normal production capacity. SFAS No. 151 iseffective for inventory costs incurred during fiscal years beginning after June 15, 2005, and,accordingly, the Company adopted SFAS No. 151 in the first quarter of 2006. Adoption of SFAS No.151 did not have a significant impact on the Company’s consolidated financial statements.     **Forward-looking statements**     Except for historical information, matters discussed in Item 2. “Management’s Discussion andAnalysis of Financial Condition and Results of Operations” contain certain forward-lookingstatements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section21E of the Securities Exchange Act of 1934, as amended. These statements involve risks anduncertainties, and actual results may be materially different. Because actual results may differ,readers are cautioned not to place undue reliance on forward-looking statements. Such statementsare based on information available to management as of the time of such statements and includestatements related to future comparable store sales results, business strategies, changes tomerchandise mix and future sales results. Factors that could cause actual results to differinclude: changes in customer shopping patterns; competition in our markets; uncertainty in generaleconomic conditions, including rising energy prices; risks associated with our strategicinitiatives, including development of our new store concept and wholesale business; continueddeclines in comparable store sales; unseasonably warm weather; our inability to effectively respondto changes in fashion trends and consumer demands; our inability to grow the business as planned;decreased availability and increased cost of leather; risks associated with foreign sourcing andinternational business; seasonality of our business; our inability to renew existing licenseagreements and/or enter into new licensing agreements; the public sale into the market of commonstock issued pursuant to options granted under our employee benefit plans or shares issued in our2004 equity financing or issuable upon exercise of warrants delivered in connection with our equityfinancing; risks associated with our debt service; risks associated with estimates made bymanagement based on our critical accounting policies; changes to financial accounting standardsthat may affect our results of operations; loss of key members of our senior management team;concentration of our common stock; volatility of the market price of our common stock; failure ofresults of operations to meet expectations of research analysts; reliance on third parties forupgrading and maintaining our management information systems; war, acts of terrorism or the threatof either; and interruption in the operation of our corporate offices and distribution center. Fora further description of our risk factors, please see “Risk Factors” as detailed in Part I, Item1A. that begins on page 12 of our 2005 Annual Report on Form 10-K.**ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**     Our senior credit facility carries interest rate risk that is generally related to LIBOR, thecommercial paper rate or the prime rate. If any of those rates were to change while we wereborrowing under the senior credit facility, interest expense would increase or
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decrease accordingly. As of July 29, 2006, we had no borrowings under the revolving portion ofthe credit facility, $20.0 million under the Term B promissory note, and $5.0 million inoutstanding letters of credit.**ITEM 4. CONTROLS AND PROCEDURES**     As of the end of the period covered by this report, we conducted an evaluation, under thesupervision and with the participation of the principal executive officer and principal financialofficer, of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)under the Securities Exchange Act of 1934 (the “Exchange Act”)). Based on this evaluation, theprincipal executive officer and principal financial officer concluded that our disclosure controlsand procedures are effective to ensure that information we are required to disclose in reports thatwe file or submit under the Exchange Act is recorded, processed, summarized and reported within thetime periods specified in Securities and Exchange Commission rules and forms. There was no changein our internal control over financial reporting during our most recently completed fiscal quarterthat has materially affected, or is reasonably likely to materially affect, our internal controlover financial reporting.**PART II — OTHER INFORMATION****ITEM 1. LEGAL PROCEEDINGS**     We are involved in various legal actions arising in the ordinary course of business. In theopinion of our management, the ultimate disposition of these matters will not have a materialadverse effect on our consolidated financial position and results of operations.**ITEM 1A. RISK FACTORS**     There have been no material changes in the risk factors we disclosed under Part I, Item 1A.“Risk Factors” that begins on page 12 of our 2005 Annual Report on Form 10-K.**ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS**     See Part I, Item 2. “Management’s Discussion and Analysis of Financial Condition and Resultsof Operations—Liquidity and capital resources” contained herein for a description of workingcapital restrictions and limitations upon the payment of dividends. We did not repurchase anyshares of our common stock during the first six months of 2006.**ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**     At our annual meeting held on June 1, 2006, the shareholders approved the following: (a) The election of three directors for a three-year term. Each nominated director waselected as follows:         **Director-Nominee** **Votes For** **Votes Withheld**William F. Farley  38,262,683   230,888 Peter V. Handal  35,915,325   2,578,246 Michael J. McCoy  38,040,599   452,972  (b) Ratification of the appointment of KPMG LLP as our independent registered publicaccounting firm for the fiscal year ending February 3, 2007.     The proposal received 38,421,506 votes for and 55,653 votes against. There were 16,412abstentions and no broker non-votes.**ITEM 6. EXHIBITS**     The exhibits listed on the accompanying exhibit index are filed or incorporated by reference(as stated therein) as part of this Quarterly Report on Form 10-Q.
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**SIGNATURE**     Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto duly authorized.     WILSONS THE LEATHER EXPERTS INC.       By: /s/ STACY A. KRUSE     Stacy A. Kruse    Chief Financial Officer and Treasurer       Date: September 7, 2006
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**INDEX TO EXHIBITS**     **Exhibit**    **No** **Description** **Method of Filing**3.1 Amended and Restated Articles of Incorporation of Wilsons TheLeather Experts Inc. adopted June 16, 1998, as amended by theArticles of Amendment dated February 17, 2000, and the Articlesof Amendment dated May 23, 2002. (1) Incorporated by Reference     3.2 Restated Bylaws of Wilsons The Leather Experts Inc. as amendedJune 16, 1998, January 25, 2000, May 23, 2002, and February 5,2004. (2) Incorporated by Reference     4.1 Specimen of common stock certificate. (3) Incorporated by Reference     4.2 Registration Rights Agreement dated as of May 25, 1996, by andamong CVS New York, Inc. (formerly known as MelvilleCorporation), Wilsons The Leather Experts Inc., the Managerslisted on the signature pages thereto, Leather Investors LimitedPartnership I and the Partners listed on the signature pagesthereto. (4) Incorporated by Reference     4.3 Amendment to Registration Rights Agreement dated as of August 12,1999, by and among Wilsons The Leather Experts Inc. and theShareholders listed on the attachments thereto. (5) Incorporated by Reference     4.4 Common Stock and Warrant Purchase Agreement, dated as of April25, 2004, by and among Wilsons The Leather Experts Inc. and thePurchasers identified on the signatory pages thereto (the“Purchase Agreement”). (6) Incorporated by Reference     4.5 Registration Rights Agreement, dated as of April 25, 2004, by andamong Wilsons The Leather Experts Inc. and the Investorsidentified therein. (7) Incorporated by Reference     4.6 Form of Warrant issued to the Purchasers named in the PurchaseAgreement on April 25, 2004. (8) Incorporated by Reference     10.1 Limited Waiver and Tenth Amendment to Fourth Amended and RestatedCredit Agreement dated as of July 13, 2006, among Wilsons LeatherHoldings, Inc., General Electric Capital Corporation, as Lender,Term Lender, Swing Line Lender and as Agent, the Credit Partiessignatory thereto and the Lenders signatory thereto. Electronic Transmission     31.1 Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer. Electronic Transmission     31.2 Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer. Electronic Transmission     32.1 Certification of Chief Executive Officer pursuant to Section1350, Chapter 63 of Title 18, United States Code, as adoptedpursuant to Section 906 of the Sarbanes-Oxley Act of 2002. Electronic Transmission     32.2 Certification of Chief Financial Officer pursuant to Section1350, Chapter 63 of Title 18, United States Code, as adoptedpursuant to Section 906 of the Sarbanes-Oxley Act of 2002. Electronic Transmission 1. Incorporated by reference to the same numbered exhibit to the Company’s Report on Form 10-Qfor the quarter ended May 4, 2002 (File No. 000-21543). 2. Incorporated by reference to the same numbered exhibit to the Company’s Report on Form 10-Kfor the year ended January 31, 2004 (File No. 000-21543). 3. Incorporated by reference to the same numbered exhibit to Amendment No. 1 to the Company’sRegistration Statement on Form S-l (333-13967) filed with the Commission on December 24, 1996. 4. Incorporated by reference to Exhibit 4.8 to the Company’s Registration Statement on Form S-l(333-13967) filed with the Commission on October 11, 1996. 5. Incorporated by reference to Exhibit 4.5 to the Company’s Report on Form 10-K for the fiscalyear ended January 29, 2000, filed with the Commission (File No. 000-21543). 6. Incorporated by reference to Exhibit 4.1 to the Company’s Report on Form 8-K filed with theCommission on April 27, 2004. 7. Incorporated by reference to Exhibit 4.2 to the Company’s Report on Form 8-K filed with theCommission on April 27, 2004. 8. Incorporated by reference to Exhibit 4.3 to the Company’s Report on Form 8-K filed with theCommission on April 27, 2004.
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