Collective Brands (PSS) 10-Q/A 2005 Q3 Quarterly report (amended)

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q/A1

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

For The Quarterly Period Ended October 30, 2004

Commission File Number 1-14770

PAYLESS SHOESOURCE, INC.

(Exact name of registrant as specified in its charter)

DELAWARE (State or other jurisdiction of incorporation or organization)	43-1813160 (I.R.S. Employer Identification Number)
3231 SOUTHEAST SIXTH AVENUE, TOPEKA, KANSAS	66607-2207
(Address of principal executive offices)	(Zip Code)

(785) 233-5171
(Registrant’s telephone number,
including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months and (2) has been subject to such filing requirements for the past 90 days.

YESþ      NOo                                        

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934).

YESþ      NOo                                        

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Common Stock, $.01 par value
68,093,770 shares as of December 6, 2004

TABLE OF CONTENTS

PART I — FINANCIAL INFORMATION
	ITEM 1 — FINANCIAL STATEMENTS
	ITEM 2 — MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
	ITEM 3 — QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
	ITEM 4 — CONTROLS AND PROCEDURES
PART II — OTHER INFORMATION
	ITEM 1 — LEGAL PROCEEDINGS
	ITEM 2 – CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES
	ITEM 6 — EXHIBITS AND REPORTS ON FORM 8-K
SIGNATURES
Index to Exhibits
Certification Pursuant to Section 302
Certification Pursuant to Section 302
Certification Pursuant to Section 906
Certification Pursuant to Section 906

EXPLANATORY NOTE

This Form 10-Q/A amends the Company’s quarterly report on Form 10-Q for the fiscal quarter ended October 30, 2004 (“Original Filing”), initially filed with the Securities and Exchange Commission (“SEC”) on December 9, 2004, to reflect the restatement described in Note 3 to the condensed consolidated financial statements. As a result of the restatement, the Company also updated the financial statements for discontinued operations as discussed in Note 12, “Discontinued Operations.”

This Form 10-Q/A amends and restates Items 1, 2 and 4 of Part I of the Original Filing. Except for the effects of the restatement and discontinued operations, the foregoing items have not been updated to reflect other events that occurred after the Original Filing or to modify or update those disclosures affected by subsequent events. In addition, pursuant to the rules of the SEC, Item 6 of Part II of the Original Filing has been amended to contain currently-dated certifications from our Chief Executive Officer and Chief Financial Officer, as required by Sections 302 and 906 of the Sarbanes-Oxley Act of 2002. The certifications of our Chief Executive Officer and Chief Financial Officer are attached to this Form 10-Q/A as Exhibits 31.1, 31.2, 32.1 and 32.2, respectively.

Except for the foregoing amended information, this Form 10-Q/A continues to describe conditions as of the date of the Original Filing, and does not update disclosures contained herein to reflect events that occurred at a later date.

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PART I — FINANCIAL INFORMATION

ITEM 1 — FINANCIAL STATEMENTS

PAYLESS SHOESOURCE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)

(dollars in millions)

	(as restated, see Note 3)
	October 30,			November 1,			January 31,
	2004			2003			2004
ASSETS
Current Assets:
Cash and cash equivalents	$	216.2		$	129.6		$	136.7
Marketable securities, available for sale		9.0			10.0			10.0
Restricted cash		18.5			33.5			33.5
Inventories		361.7			391.8			375.2
Current deferred income taxes		26.8			13.6			17.1
Other current assets		66.8			75.1			64.9
Current assets of discontinued operations		17.9			25.2			24.2
Total current assets		716.9			678.8			661.6
Property and Equipment:
Land		8.0			8.0			8.0
Buildings and leasehold improvements		683.3			666.0			679.8
Furniture, fixtures and equipment		529.0			486.7			494.6
Property under capital leases		4.6			4.6			4.6
Total property and equipment		1,224.9			1,165.3			1,187.0
Accumulated depreciation and amortization		(802.4	)		(750.0	)		(763.5	)
Property and equipment, net		422.5			415.3			423.5
Favorable leases, net		22.7			30.1			28.8
Deferred income taxes		35.2			26.3			34.2
Goodwill, net		5.9			5.9			5.9
Other assets		25.7			30.0			22.7
Non-current assets of discontinued operations		8.1			30.2			27.6
Total Assets	$	1,237.0		$	1,216.6		$	1,204.3
LIABILITIES AND SHAREOWNERS’ EQUITY
Current Liabilities:
Current maturities of long-term debt	$	3.5		$	0.9		$	0.9
Notes payable		18.5			33.5			33.5
Accounts payable		106.0			127.9			129.6
Accrued expenses		164.6			129.1			123.9
Current liabilities of discontinued operations		5.9			5.1			5.8
Total current liabilities		298.5			296.5			293.7
Long-term debt		202.1			202.9			202.8
Other liabilities		87.4			81.2			85.6
Non-current liabilities of discontinued operations		8.5			2.2			2.1
Minority interest		7.5			16.2			15.7
Commitments and contingencies		—			—			—
Total shareowners’ equity		633.0			617.6			604.4
Total Liabilities and Shareowners’ Equity	$	1,237.0		$	1,216.6		$	1,204.3

See Notes to Condensed Consolidated Financial Statements.

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PAYLESS SHOESOURCE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS (LOSS)
(UNAUDITED)

(dollars and shares in millions, except per share)

	(as restated, see Note 3)
	13 Weeks Ended						39 Weeks Ended
	October 30, 2004			November 1, 2003			October 30, 2004			November 1, 2003
Net sales	$	661.4		$	679.4		$	2,049.3		$	2,044.7
Cost of sales		460.3			492.1			1,411.9			1,460.3
Selling, general and administrative expenses		175.7			181.0			545.6			531.4
Restructuring charges		3.9			—			17.6			—
Operating profit from continuing operations		21.5			6.3			74.2			53.0
Interest expense		5.5			6.0			16.7			15.3
Interest income		(1.2	)		(1.1	)		(3.5	)		(3.0	)
Earnings from continuing operations before income taxes and minority interest		17.2			1.4			61.0			40.7
Provision for income taxes		4.9			0.3			15.1			14.1
Earnings from continuing operations before minority interest		12.3			1.1			45.9			26.6
Minority interest, net of income tax		0.2			1.1			4.3			2.4
Net earnings from continuing operations		12.5			2.2			50.2			29.0
Loss from discontinued operations, net of income taxes and minority interest		(5.9	)		(4.4	)		(25.7	)		(11.9	)
Net earnings (loss)	$	6.6		$	(2.2	)	$	24.5		$	17.1
Diluted earnings (loss) per share:
Earnings from continuing operations	$	0.19		$	0.03		$	0.74		$	0.43
Loss from discontinued operations		(0.09	)		(0.06	)		(0.38	)		(0.18	)
Diluted earnings (loss) per share	$	0.10		$	(0.03	)	$	0.36		$	0.25
Basic earnings (loss) per share:
Earnings from continuing operations	$	0.19		$	0.03		$	0.74		$	0.43
Loss from discontinued operations		(0.09	)		(0.06	)		(0.38	)		(0.18	)
Basic earnings (loss) per share	$	0.10		$	(0.03	)	$	0.36		$	0.25
Diluted Weighted Average Shares Outstanding		68.0			68.1			68.0			68.1
Basic Weighted Average Shares Outstanding		68.0			68.1			68.0			68.0

See Notes to Condensed Consolidated Financial Statements.

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PAYLESS SHOESOURCE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

(dollars in millions)

	(as restated, see Note 3)
	39 Weeks Ended			39 Weeks Ended
	October 30, 2004			November 1, 2003
Operating Activities:
Net earnings	$	24.5		$	17.1
Loss from discontinued operations, net of income taxes and minority interest		(25.7	)		(11.9	)
Net earnings from continuing operations		50.2			29.0
Adjustments for non-cash items included in net earnings:
Non-cash component of restructuring charges		12.0			—
Loss on impairment of and disposal of assets		6.6			7.5
Depreciation and amortization		71.2			72.3
Amortization of deferred financing costs		0.9			3.8
Amortization of unearned restricted stock		0.5			0.5
Deferred income taxes		(12.9	)		13.0
Minority interest, net of tax		(4.3	)		(2.4	)
Income tax charge of stock option exercises		(0.1	)		—
Changes in working capital:
Inventories		15.7			44.7
Other current assets		(5.1	)		(18.9	)
Accounts payable		(23.7	)		26.1
Accrued expenses		41.0			9.6
Other assets and liabilities, net		5.7			3.7
Cash flow provided by (used in) discontinued operations		0.5			(12.1	)
Cash flow provided by operating activities		158.2			176.8
Investing Activities:
Capital expenditures		(82.0	)		(83.5	)
Disposition of property and equipment		—			1.0
Purchase of marketable securities		(13.0	)		(10.0	)
Sale of marketable securities		14.0			—
Cash flow used in investing activities		(81.0	)		(92.5	)
Financing Activities:
(Repayment) Issuance of notes payable		(15.0	)		5.0
Restricted cash		15.0			(5.0	)
Issuance of debt		2.4			196.7
Payment of deferred financing costs		(0.2	)		(9.3	)
Repayment of debt		(0.7	)		(216.8	)
Net purchases of common stock		(0.8	)		(0.3	)
Contributions by minority owners		1.9			3.6
Cash flow provided by (used in) financing activities		2.6			(26.1	)
Effect of exchange rate changes on cash		(0.3	)		(0.3	)
Increase in cash and cash equivalents		79.5			57.9
Cash and cash equivalents, beginning of year		136.7			71.7
Cash and cash equivalents, end of period	$	216.2		$	129.6
Cash paid during the period for:
Interest	$	20.8		$	11.6
Income Taxes	$	1.6		$	17.1

See Notes to Condensed Consolidated Financial Statements

5

PAYLESS SHOESOURCE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

NOTE 1. INTERIM RESULTS. These unaudited Condensed Consolidated Financial Statements of Payless ShoeSource, Inc., a Delaware corporation, and subsidiaries (the “Company”) have been prepared in accordance with the instructions to Form 10-Q of the United States Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, the unaudited Condensed Consolidated Financial Statements are fairly presented and all adjustments (consisting only of normal recurring adjustments) necessary for a fair statement of the results for the interim periods have been included; however, certain items are included in these statements based upon estimates for the entire year. During 2003, the Company changed the reporting period for its operations in the Central American and South American Regions to use a December 31 year-end. The Central American Region is composed of operations in Costa Rica, the Dominican Republic, El Salvador, Guatemala, Honduras, Nicaragua, Panama and Trinidad & Tobago. The South American Region is composed of operations in Chile, Ecuador and Peru. The Company also has a 60-percent ownership interest in a Japanese joint venture. Japanese operations are reported on a one-month lag using a December 31 year-end. The effect of this one-month lag on the Company’s financial position and results of operations is not significant. The results for the three-month period and nine-month period ended October 30, 2004, are not necessarily indicative of the results that may be expected for the entire fiscal year ending January 29, 2005.

NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Use of Estimates

Management makes estimates and assumptions that affect the amounts reported within the condensed consolidated balance sheets and the statements of earnings, cash flows, and the notes to condensed consolidated financial statements. Actual results could differ from these estimates.

Net Sales

Net sales (“sales”) are recognized at the time the sale is made to the customer, are net of estimated returns and current promotional discounts and exclude sales tax. Third-party liquidation sales related to restructuring are recognized at the time the sale is made to the customer, are calculated based upon contractually guaranteed amounts pursuant to our agreements with liquidators and are net of associated fees.

Gift Cards

The Company records a liability in the period in which a gift card is issued and proceeds are received. As gift cards are redeemed, this liability is reduced and revenue is recognized as a sale.

Cost of Sales

Cost of sales includes the cost of merchandise sold and the Company’s buying and occupancy costs.

Rent Expense

Certain of the Company’s lease agreements provide for scheduled rent increases during the lease term, as well as provisions for renewal options. Rent expense is recognized on a straight-line basis over the term of the lease from the time at which the Company takes possession of the property. In instances where failure to exercise renewal options would result in an economic penalty, the calculation of straight-line rent expense includes renewal option periods. Also, landlord-provided tenant improvement allowances are recorded in other liabilities and amortized as a credit to rent expense over the term of the lease.

Pre-Opening Expenses

Costs associated with the opening of new stores are expensed as incurred.

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Advertising Costs

Advertising costs and sales promotion costs are expensed at the time the advertising takes place.

Income Taxes

Income taxes are accounted for using a balance sheet approach known as the liability method. The liability method accounts for deferred income taxes by applying enacted statutory tax rates to differences between the book basis and the tax basis of assets and liabilities.

Cash and Cash Equivalents

Cash equivalents consist of liquid investments with an original maturity of three months or less. Receivables in the amount of $19.2 million, $15.3 million and $11.0 million from banks and credit card companies for the settlement of credit card transactions are included in cash and cash equivalents as of October 30, 2004, November 1, 2003 and January 31, 2004, respectively, as they are generally collected within three business days. Cash equivalents are stated at cost, which approximates fair value.

Marketable Securities

As of October 30, 2004, November 1, 2003 and January 31, 2004 marketable securities include $9.0 million, $10.0 million and $10.0 million, respectively, of auction rate securities, which are available to support the Company’s current operations. These investments are classified as available-for-sale securities and are recorded at fair value with unrealized gains or losses reported in other comprehensive income (loss). Due to the short time period between the reset dates of the interest rates, there are no unrealized gains or losses associated with these securities. All of the auction rate securities have contractual maturities of more than ten years.

Inventories

Merchandise inventories in our stores are valued by the retail method and are stated at the lower of cost, determined using the first-in, first-out (FIFO) basis, or market. Prior to shipment to a specific store, inventories are valued at the lower of cost using the FIFO basis, or market. The retail method is widely used in the retail industry due to its practicality. Under the retail method, cost is determined by applying a calculated cost-to-retail ratio across groupings of similar items, known as departments. As a result, the retail method results in an averaging of inventory costs across similar items within a department. The cost-to-retail ratio is applied to ending inventory at its current owned retail valuation to determine the cost of ending inventory on a department basis. Current owned retail represents the retail price for which merchandise is offered for sale on a regular basis reduced for any permanent or clearance markdowns. As a result, the retail method normally results in an inventory valuation that is lower than a traditional FIFO cost basis.

Inherent in the retail method calculation are certain significant management judgments and estimates including initial mark-up, markdowns and shrinkage, which can significantly impact the owned retail and, therefore, the ending inventory valuation at cost. Specifically, the failure to take permanent or clearance markdowns on a timely basis can result in an overstatement of carrying cost under the retail method. Management believes that its application of the retail method reasonably states inventory at the lower of cost or market.

The Company maintains a global sourcing structure to focus on cost reduction initiatives from procurement of materials through distribution of finished product. As a result, the Company takes ownership of certain raw materials as the materials enter the production process. These raw materials of $8.3 million, $15.6 million and $19.5 million are included in inventories in the condensed consolidated balance sheets at October 30, 2004, November 1, 2003, and January 31, 2004, respectively, and are accounted for under the FIFO basis.

Property and Equipment

Property and equipment are recorded at cost and are depreciated on a straight-line basis over their estimated useful lives. The costs of repairs and maintenance are expensed when incurred, while expenditures for store remodels, refurbishments and improvements that

7

significantly add to the productive capacity or extend the useful life of an asset are capitalized. The estimated useful life for each major class of property and equipment is as follows:

Buildings	10 to 30 years
Leasehold improvements	the lesser of 10 years or the remaining expected lease term that is reasonably assured (which may exceed the current non-cancelable term)
Furniture, fixtures and equipment	3 to 8 years
Property under capital lease	10 to 30 years

Property and equipment are reviewed for recoverability on a store-by-store basis if an indicator of impairment exists to determine whether the carrying amount of the assets is recoverable. Estimated future cash flows are used to determine if impairment exists. The Company uses current operating results and historical performance to estimate future cash flows on a store-by-store basis.

Insurance Programs

The Company retains its normal expected losses related primarily to workers’ compensation, physical loss to property and business interruption resulting from such loss and comprehensive general, product, and vehicle liability. The Company purchases third-party coverage for losses in excess of the normal expected levels. Provisions for losses expected under these programs are recorded based upon estimates of the aggregate liability for claims incurred utilizing independent actuarial calculations based on historical results.

Foreign Currency Translation

Local currencies are the functional currencies for all subsidiaries. Accordingly, assets and liabilities of foreign subsidiaries are translated at the rate of exchange at the balance sheet date. Adjustments from the translation process are accumulated as part of other comprehensive income and are included within shareowners’ equity (see Note 9). The changes in foreign currency translation adjustments were not adjusted for income taxes since they relate to indefinite term investments in non-United States subsidiaries. Income and expense items of these subsidiaries are translated at average rates of exchange.

Financial Derivatives

The Company has used derivative financial instruments to reduce its exposure to fluctuations in interest rates and foreign currencies and to minimize the risk associated with investments in foreign operations. Statement of Financial Accounting Standards No. 133 (“SFAS 133”), “Accounting for Derivative Instruments and Hedging Activities”, requires that all derivatives be reflected as either assets or liabilities on the balance sheet based on their fair value. If the derivative is a hedge, depending on the nature of the hedge, changes in the fair value of derivatives will either be offset against the change in the fair value of the hedged asset, liability or firm commitment through earnings, or recognized in other comprehensive income until the hedged item is recognized in earnings. The change in a derivative’s fair value related to the ineffective portion of a hedge, if any, will be immediately recognized in earnings. As of October 30, 2004, November 1, 2003 and January 31, 2004, the Company had no derivative instruments in place.

Reclassification

Certain reclassifications have been made to prior year balances to conform to the current year presentation.

NOTE 3. RESTATEMENT OF FINANCIAL STATEMENTS. Subsequent to the issuance of the Company’s interim condensed consolidated financial statements of the quarterly period ended October 30, 2004, and following a comprehensive review of its accounting treatment for leases and lease-related items, the Company’s management determined that the previous accounting policies used were inappropriate. As a result, the Company has corrected its accounting practices in this area and restated its condensed consolidated financial statements.

Historically, when accounting for leases with renewal options, the Company had recorded rent expense on a straight-line basis over the initial non-cancelable lease term, with the term commencing when the store opened for business. The Company amortized leasehold improvements on those properties over a period of typically 10 years that, in certain cases, would have included a portion of the renewal option periods. In connection with the restatement, the Company corrected its accounting to accelerate the recognition of rent expense on leases by recording lease expense from the time at which it takes possession of the property, rather than at the time the store opens for business. In addition, the Company corrected its calculation of rent expense on a straight line basis to include certain option periods that are reasonably assured of renewal, because failure to exercise such options would result in an economic penalty. When the renewal option periods are not reasonably assured, the leasehold improvements are amortized over a period not to exceed the existing non-cancelable lease term.

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Also, the Company had followed the practice of netting landlord-provided tenant improvement allowances against property and equipment. The restatement corrects the manner in which the Company accounts for tenant improvement allowances to record the allowances as a deferred credit. There was no impact to earnings for this correction. Further, the amount of tenant improvement allowances received each year are shown within the operating activities on the condensed consolidated statement of cash flows rather than a reduction of capital expenditures.

In addition, the Company discovered an error relating to its accounting for deferred income taxes. Beginning in a period prior to 1998, deferred income tax assets were understated by approximately $4.5 million. In connection with the restatement mentioned above, the Company recorded a correction to increase deferred tax assets by approximately $4.5 million. The correction has no impact on earnings in fiscal years 2004 or 2003.

Following is a summary of the effects of the corrections to the Company’s condensed consolidated balance sheets as of October 30, 2004, November 1, 2003 and January 31, 2004 and the Company’s condensed consolidated statements of earnings and cash flows for the thirteen and thirty-nine weeks ended October 30, 2004 and November 1, 2003. The “As previously reported” amounts have been adjusted for the reclassifications discussed in Notes 2 and 12 of the Notes to Condensed Consolidated Financial Statements.

	Condensed Consolidated Statements of Earnings
	As previously
(in millions, except per share data)	Reported			Adjustments			As restated
Thirteen weeks ended October 30, 2004
Cost of sales	$	460.4		$	(0.1	)	$	460.3
Operating profit from continuing operations		21.4			0.1			21.5
Earnings from continuing operations before income taxes and minority interest		17.1			0.1			17.2
Provision for income taxes		4.9			—			4.9
Earnings from continuing operations before minority interest		12.2			0.1			12.3
Minority interest, net of income taxes		0.2			—			0.2
Earnings from continuing operations		12.4			0.1			12.5
Loss from discontinued operations, net of income taxes and minority interest		(5.9	)		—			(5.9	)
Net earnings	$	6.5		$	0.1		$	6.6
Diluted earnings (loss) per share:
Earnings from continuing operations	$	0.19		$	—		$	0.19
Loss from discontinued operations		(0.09	)		—			(0.09	)
Diluted earnings per share	$	0.10		$	—		$	0.10
Basic earnings (loss) per share:
Earnings from continuing operations	$	0.19		$	—		$	0.19
Loss from discontinued operations		(0.09	)		—			(0.09	)
Basic earnings per share	$	0.10		$	—		$	0.10

	Condensed Consolidated Statements of Loss
	As previously
(in millions, except per share data)	Reported			Adjustments		As restated
Thirteen weeks ended November 1, 2003
Cost of sales	$	492.1		$	—	$	492.1
Operating profit from continuing operations		6.3			—		6.3
Earnings from continuing operations before income taxes and minority interest		1.4			—		1.4
Provision for income taxes		0.3			—		0.3
Earnings from continuing operations before minority interest		1.1			—		1.1
Minority interest, net of income taxes		1.1			—		1.1
Earnings from continuing operations		2.2			—		2.2
Loss from discontinued operations, net of income taxes and minority interest		(4.4	)		—		(4.4	)
Net loss	$	(2.2	)	$	—	$	(2.2	)
Diluted earnings (loss) per share:
Earnings from continuing operations	$	0.03		$	—	$	0.03
Loss from discontinued operations		(0.06	)		—		(0.06	)
Diluted earnings per share	$	(0.03	)	$	—	$	(0.03	)
Basic earnings (loss) per share:
Earnings from continuing operations	$	0.03		$	—	$	0.03
Loss from discontinued operations		(0.06	)		—		(0.06	)
Basic earnings per share	$	(0.03	)	$	—	$	(0.03	)

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	Condensed Consolidated Statements of Earnings
	As previously
(in millions, except per share data)	Reported			Adjustments			As restated
Thirty-nine weeks ended October 30, 2004
Cost of sales	$	1,411.9		$	—		$	1,411.9
Operating profit from continuing operations		74.2			—			74.2
Earnings from continuing operations before income taxes and minority interest		61.0			—			61.0
Provision for income taxes		15.0			0.1			15.1
Earnings from continuing operations before minority interest		46.0			(0.1	)		45.9
Minority interest, net of income taxes		4.2			0.1			4.3
Earnings from continuing operations		50.2			—			50.2
Loss from discontinued operations, net of income taxes and minority interest		(26.2	)		0.5			(25.7	)
Net earnings	$	24.0		$	0.5		$	24.5
Diluted earnings (loss) per share:
Earnings from continuing operations	$	0.74		$	—		$	0.74
Loss from discontinued operations		(0.39	)		0.01			(0.38	)
Diluted earnings per share	$	0.35		$	0.01		$	0.36
Basic earnings (loss) per share:
Earnings from continuing operations	$	0.74		$	—		$	0.74
Loss from discontinued operations		(0.39	)		0.01			(0.38	)
Basic earnings per share	$	0.35		$	0.01		$	0.36

	Condensed Consolidated Statements of Earnings
	As previously
(in millions, except per share data)	Reported			Adjustments		As restated
Thirty- nine weeks ended November 1, 2003
Cost of sales	$	1,460.3		$	—	$	1,460.3
Operating profit from continuing operations		53.0			—		53.0
Earnings from continuing operations before income taxes and minority interest		40.7			—		40.7
Provision for income taxes		14.1			—		14.1
Earnings from continuing operations before minority interest		26.6			—		26.6
Minority interest, net of income taxes		2.4			—		2.4
Earnings from continuing operations		29.0			—		29.0
Loss from discontinued operations, net of income taxes and minority interest		(11.9	)		—		(11.9	)
Net earnings	$	17.1		$	—	$	17.1
Diluted earnings (loss) per share:
Earnings from continuing operations	$	0.43		$	—	$	0.43
Loss from discontinued operations		(0.18	)		—		(0.18	)
Diluted earnings per share	$	0.25		$	—	$	0.25
Basic earnings (loss) per share:
Earnings from continuing operations	$	0.43		$	—	$	0.43
Loss from discontinued operations		(0.18	)		—		(0.18	)
Basic earnings per share	$	0.25		$	—	$	0.25

10

	Condensed Consolidated Balance Sheets
	As previously
October 30, 2004(1)	Reported		Adjustments			As restated
Property and equipment, net	$	404.1	$	18.4		$	422.5
Deferred income taxes (asset)		26.4		8.8			35.2
Total assets	$	1,209.8	$	27.2		$	1,237.0
Other liabilities	$	57.3	$	30.1		$	87.4
Non-current liabilities of discontinued operations		8.4		0.1			8.5
Minority interest		7.8		(0.3	)		7.5
Total shareowners’ equity		635.7		(2.7	)		633.0
Total liabilities and shareowners’ equity	$	1,209.8	$	27.2		$	1,237.0
November 1, 2003(2)
Property and equipment, net	$	401.3	$	14.0		$	415.3
Deferred income taxes (asset)		17.5		8.8			26.3
Non-current assets of discontinued operations		30.5		(0.3	)		30.2
Total assets	$	1,194.1	$	22.5		$	1,216.6
Other liabilities	$	55.7	$	25.5		$	81.2
Non-current liabilities of discontinued operations		1.9		0.3			2.2
Minority interest		16.4		(0.2	)		16.2
Total shareowners’ equity		620.7		(3.1	)		617.6
Total liabilities and shareowners’ equity	$	1,194.1	$	22.5		$	1,216.6
January 31, 2004(3)
Property and equipment, net	$	409.0	$	14.5		$	423.5
Deferred income taxes (asset)		25.4		8.8			34.2
Non-current assets of discontinued operations		27.9		(0.3	)		27.6
Total assets	$	1,181.3	$	23.0		$	1,204.3
Other liabilities	$	59.5	$	26.1		$	85.6
Non-current liabilities of discontinued operations		1.8		0.3			2.1
Minority interest		16.0		(0.3	)		15.7
Total shareowners’ equity		607.5		(3.1	)		604.4
Total liabilities and shareowners’ equity	$	1,181.3	$	23.0		$	1,204.3

	Condensed Consolidated Statements of Cash Flows
	As previously
Thirty-nine weeks ended October 30, 2004	Reported			Adjustments			As restated
Cash flow provided by operating activities	$	152.0		$	6.2		$	158.2
Cash flow used in investing activities		(87.2	)		(6.2	)		(81.0	)
Thirty-nine weeks ended November 1, 2003
Cash flow provided by operating activities	$	172.6		$	4.2		$	176.8
Cash flow used in investing activities		(88.3	)		(4.2	)		(92.5	)

(1)	Previously reported amounts include reclassifications to decrease cash by $9.0 million, and increase marketable securities, other current assets and accrued expenses by $9.0 million, $6.8 million and $6.8 million, respectively, as of October 30, 2004.
(2)	Previously reported amounts include reclassifications to decrease cash and increase marketable securities by $10.0 million, respectively, as of November 1, 2003.
(3)	Previously reported amounts include reclassifications to decrease cash by $10.0 million, and increase marketable securities, other current assets, other assets and accrued expenses by $10.0 million, $2.7 million, $1.7 million and $4.4 million, respectively, as of January 31, 2004.

11

NOTE 4. STOCK-BASED COMPENSATION. The Company follows the disclosure provisions of Statement of Financial Accounting Standards (“SFAS”) No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure, an amendment of FASB Statement No. 123.” The Statement requires prominent disclosures in both annual and interim financial statements regarding the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company accounts for stock compensation awards under the intrinsic value method of Accounting Principles Board (“APB”) Opinion No. 25. APB Opinion No. 25 requires compensation cost to be recognized based on the excess, if any, between the quoted market price of the stock at the date of grant and the amount an employee must pay to acquire the stock. All options awarded under all of the Company’s plans are granted with an exercise price equal to the fair market value on the date of the grant.

SFAS 123, “Accounting for Stock-Based Compensation,” provides an alternative method of accounting for stock-based compensation, which establishes a fair value based method of accounting for employee stock options or similar equity instruments. The Company uses the Black-Scholes option pricing model to estimate the grant date fair value of its 1996 and later option grants. The fair value is recognized over the option vesting period. The following table presents the effect on net earnings (loss) and earnings (loss) per share had the Company adopted the fair value based method of accounting for stock-based compensation under SFAS No. 123, “Accounting for Stock-Based Compensation.”

(dollars in millions, except per share amounts)

	13 Weeks Ended					39 Weeks Ended
	October 30, 2004		November 1, 2003			October 30, 2004		November 1, 2003
Net earnings (loss):
As reported	$	6.6	$	(2.2	)	$	24.5	$	17.1
Add: Total stock-based employee compensation expense included in net earnings as reported, net of related income taxes		0.2		0.2			0.8		0.4
Less: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related income taxes		0.8		1.3			2.7		4.1
Pro forma	$	6.0	$	(3.3	)	$	22.6	$	13.4
Diluted earnings (loss) per share:
As reported	$	0.10	$	(0.03	)	$	0.36	$	0.25
Pro forma	$	0.09	$	(0.05	)	$	0.33	$	0.19
Basic earnings (loss) per share:
As reported	$	0.10	$	(0.03	)	$	0.36	$	0.25
Pro forma	$	0.09	$	(0.05	)	$	0.33	$	0.19

NOTE 5. INTANGIBLES. The Company follows SFAS No. 142, “Goodwill and Other Intangible Assets.” SFAS No. 142 requires that an intangible asset that is acquired other than by business combination shall be initially recognized and measured based on its fair value. This Statement also provides that goodwill and indefinitely-lived intangible assets should not be amortized, but shall be tested for impairment annually, or more frequently if circumstances indicate potential impairment, through a comparison of fair value to its carrying amount. Intangible assets with finite lives will continue to be amortized over their useful lives. No impairment loss was recorded during the first nine months of 2004 related to goodwill; however, as part of the $44.0 million restructuring charge discussed in Footnote 11, the Company reduced the carrying value of the favorable leases associated with the Payless stores to be closed by $1.9 million during the quarter ended July 31, 2004.

Favorable leases subject to amortization pursuant to SFAS 142 are as follows:

			��
(dollars in millions)	October 30, 2004			November 1, 2003		January 31, 2004
Gross carrying amount	$	80.4		$	87.5	$	87.0
Less: accumulated amortization		57.6			57.4		58.2
Carrying amount, end of period	$	22.7		$	30.1	$	28.8

Amortization expense on favorable leases was as follows:

(dollars in millions)

	13 Weeks Ended				39 Weeks Ended
	October 30, 2004		November 1, 2003		October 30, 2004		November 1, 2003
Amortization expense on favorable leases	$	1.0	$	1.2	$	3.1	$	3.6

12

The Company expects annual amortization expense for favorable leases for the next five years to be as follows (dollars in millions):

Year	Amount
Remainder of 2004	$1.0
2005	3.8
2006	3.4
2007	2.9
2008	2.6

NOTE 6. LONG-TERM DEBT AND LINE OF CREDIT. In January 2004, the Company replaced its $150 million senior secured revolving credit facility (the “Old Facility”) with a new $200 million senior secured revolving credit facility (the “New Facility”). Funds borrowed under the New Facility are secured by domestic merchandise inventory and receivables. The Company may borrow up to $200 million through the New Facility, subject to a sufficient borrowing base. The New Facility bears interest at the London Inter-bank Offered Rate (“LIBOR”), plus a variable margin of 1.25 percent to 2.0 percent, or the base rate as defined in the agreement governing the New Facility. The margin on the New Facility varies based upon certain borrowing levels specified in the agreement governing the New Facility. The variable interest rate including the applicable variable margin at October 30, 2004, was 3.4 percent. A monthly commitment fee of 0.30 percent per annum is payable on the unborrowed balance. The New Facility is scheduled to expire in January 2008, with a one-year extension to January 2009 at the Company’s option. No amounts were drawn on the New Facility as of October 30, 2004. Based on its borrowing base, the Company may borrow up to $200.0 million under its New Facility, less $17.4 million in outstanding letters of credit as of October 30, 2004.

In July 2003, the Company sold $200.0 million of 8.25% Senior Subordinated Notes (the “Notes”) for $196.7 million, due 2013. The discount of $3.3 million is being amortized to interest expense over the life of the Notes. The Notes are guaranteed by all of the Company’s domestic subsidiaries. Interest on the Notes is payable semi-annually, beginning February 1, 2004. The Notes contain various covenants including those that may limit the Company’s ability to pay dividends, repurchase stock, accelerate the retirement of other subordinated debt or make certain investments. As of October 30, 2004, the Company was in compliance with all covenants. The proceeds of the Notes and additional general funds were used to repay the entire $200.0 million term loan portion of the Company’s Old Facility. As of October 30, 2004, the fair value of the Notes was $195.0 million based on recent trading activity of the Notes. On or after August 1, 2008, the Company may, on any one or more occasions, redeem all or a part of the Notes at the redemption prices set forth below, plus accrued and unpaid interest, if any, on the Notes redeemed, to the applicable redemption date:

Year	Percentage
2008		104.125	%
2009		102.750	%
2010		101.375	%
2011 and thereafter		100.000	%

NOTE 7. PENSION PLAN. The Company has a nonqualified, supplementary defined benefit plan for certain management employees. The plan is an unfunded, noncontributory plan and provides for benefits based upon years of service and cash compensation during employment.

Pension expense is based on information provided to an outside actuarial firm that uses assumptions to estimate the total benefits ultimately payable to management employees and allocates this cost to service periods. The actuarial assumptions used to calculate pension expense are reviewed annually for reasonableness.

13

The components of net periodic benefit costs for the plan were:

(dollars in millions)

	13 Weeks Ended				39 Weeks Ended
	October 30, 2004		November 1, 2003		October 30, 2004		November 1, 2003
Components of pension expense:
Service cost	$	0.3	$	0.3	$	0.7	$	0.7
Interest cost		0.4		0.3		1.0		0.9
Amortization of prior service cost		—		0.1		0.2		0.1
Amortization of actuarial loss		—		—		0.2		0.2
Total	$	0.7	$	0.7	$	2.1	$	1.9

NOTE 8. INCOME TAXES. The Company’s effective income tax rate was 28.5 percent in the third quarter and 24.8 percent for the first nine months of 2004. In order to reflect the estimated effective tax rate for the year, a 28.5 percent effective tax rate for the third quarter and a 24.8 percent effective tax rate for the first nine months of the year were utilized to record income taxes. The Company anticipates a tax benefit at the rate of 24.8 percent for the full fiscal year 2004. The Company’s effective income tax rate was 21.4 percent in the third quarter and 34.6 for the first nine months of 2003.

NOTE 9. COMPREHENSIVE INCOME (LOSS). The following table shows the computation of comprehensive income (loss):

(dollars in millions)

	13 Weeks Ended					39 Weeks Ended
	October 30, 2004		November 1, 2003			October 30, 2004		November 1, 2003
Net Earnings (Loss)	$	6.6	$	(2.2	)	$	24.5	$	17.1
Other Comprehensive Gain (Loss):
Change in fair value of derivatives		—		—			—		0.1
Derivative losses translated into interest expense		—		—			—		1.7
Foreign currency translation adjustments		5.2		(0.8	)		4.4		3.4
Total other comprehensive gain (loss)		5.2		(0.8	)		4.4		5.2
Total Comprehensive Income (Loss)	$	11.8	$	(3.0	)	$	28.9	$	22.3

The changes in the Company’s cumulative foreign currency translation adjustment were not adjusted for income taxes, as they relate to specific indefinite investments in foreign subsidiaries.

NOTE 10. EARNINGS PER SHARE. Basic earnings per share are computed by dividing net earnings by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share include the effect of conversions of stock options and unearned restricted stock. The calculation of diluted earnings (loss) per share for the thirteen week and thirty-nine-week periods ended October 30, 2004, and November 1, 2003, excludes the impact of 7,898,570 and 7,895,231 stock options and 8,048,796 and 8,047,453 stock options, respectively, because to include them would be anti-dilutive.

14

The following table presents a reconciliation of the numerators and denominators of basic and diluted earnings per share from continuing operations:

(dollars and shares in millions, except per share )

	13 Weeks Ended				39 Weeks Ended
	October 30, 2004		November 1, 2003		October 30, 2004		November 1, 2003
Diluted Computation:
Net earnings from continuing operations	$	12.5	$	2.2	$	50.2	$	29.0
Weighted average common shares outstanding		68.0		68.1		68.0		68.0
Net effect of dilutive stock options and unearned restricted stock based on the treasury stock method		0.0		0.0		0.0		0.1
Outstanding shares for diluted earnings per share		68.0		68.1		68.0		68.1
Diluted earnings per share from continuing operations	$	0.19	$	0.03	$	0.74	$	0.43
Basic Computation:
Net earnings from continuing operations	$	12.5	$	2.2	$	50.2	$	29.0
Weighted average common shares outstanding		68.0		68.1		68.0		68.0
Basic earnings per share from continuing operations	$	0.19	$	0.03	$	0.74	$	0.43

NOTE 11. RESTRUCTURING CHARGES. During the second quarter of 2004, the Company initiated a restructuring plan to build long-term shareowner value. Components of the restructuring plan include:

•   Exiting all 181 Parade stores, and related operations;

•   Exiting all 32 Payless ShoeSource stores in Chile and Peru;

•   The closing of approximately 260 Payless ShoeSource stores. These store closings differ from closings in the normal course of business in that they have longer remaining lease terms;

•   The reduction of wholesale businesses that provide no significant growth opportunity, and;

•   A comprehensive review of the Company’s expense structure and appropriate reductions to improve profitability.

As part of the restructuring, during the second quarter of 2004 the Company recorded a non-cash impairment charge of $36.7 million ($13.7 million relating to continuing operations and $23.0 million relating to discontinued operations) in connection with a reassessment of the carrying value of the long-lived assets associated with the 32 stores in Chile and Peru, the 181 Parade stores and the approximately 260 Payless stores to be closed. The impairment charge includes a $1.9 million reduction in the carrying value of favorable leases.

During the third quarter of 2004, the Company recorded $7.3 million in restructuring charges primarily related to severance costs, contract termination costs and the reduction in carrying value of assets. The $7.3 million charge was comprised of $3.9 million related to continuing operations and $3.4 million related to discontinued operations. The Company eliminated approximately 200 management and administrative positions, closed 65 stores and began to liquidate inventory in its Payless and Parade stores identified for closing. In conjunction with the liquidation, the Company recorded $0.4 million in inventory markdowns to reflect inventory at lower of cost or market. Such markdowns are reflected in cost of sales in the condensed consolidated statement of earnings (loss).

15

Third-party liquidation sales are recognized at the time the sale is made to the customer, are calculated based upon contractually guaranteed amounts pursuant to our agreements with liquidators and are net of associated fees. On October 27, 2004, the Company entered into an agreement to transfer ownership of its Peruvian entity and related operations and liabilities to Orion Investment Capital Inc. (“Orion”), an entity comprised of some owners of the Company’s South American joint venture partner, effective November 15, 2004. In conjunction with this transaction, the Company recorded approximately $1 million of reductions in the carrying value of assets during the third quarter.

The Company estimates that the total charge related to the restructuring will be in the range of $77 to $90 million, consisting of contract termination costs of $31 to $44 million, asset impairments and net disposal losses of approximately $36 million, employee severance costs of approximately $9 million and other costs of approximately $1 million. The cash component of the total expected charge of $77 to $90 million is expected to be approximately $40 to $53 million. The Company is in the process of negotiating contract terminations, and the ultimate cost related to these terminations will depend upon the results of the negotiations. The Company expects to incur substantially all such charges in 2004.

The significant components of the restructuring charge incurred to date are summarized as follows:

(dollars in millions)

	13 Weeks Ended		39 Weeks Ended
	October 30, 2004		October 30, 2004
Asset impairments and net disposal losses	$	0.1	$	36.8
Employee severance costs		5.3		5.3
Contract termination costs		1.1		1.1
Other exit costs		0.8		0.8
Total	$	7.3	$	44.0

The status of the restructuring-related liabilities, which are included in accrued expenses ($3.5 million) and current liabilities of discontinued operations ($0.8 million) in the condensed consolidated balances sheets, are summarized below:

(dollars in millions)

	13 Weeks Ended October 30, 2004
					Accrual Balance as of
	Cash Charges		Cash Payments		October 30, 2004
Employee severance costs	$	5.4	$	1.7	$	3.7
Contract termination costs		1.4		0.8		0.6
Other exit costs		0.8		0.8		—
Total	$	7.6	$	3.3	$	4.3

In accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” the fair value of the long-lived assets evaluated for recoverability was determined using the present value of estimated future cash flows. In accordance with SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities,” employee severance, contract termination and other exit costs are recorded at their fair value when they are incurred.

The Payless and Parade stores located in Chile, Peru, Puerto Rico and Canada are components of the Payless International segment. The Parade and Payless stores located in the United States are components of the Payless Domestic segment. The Company estimates the total restructuring charge related to the Payless Domestic segment to be between $64 and $73 million, and the total restructuring

16

charge related to the Payless International segment to be between $13 million and $17 million. A summary of the restructuring charge by segment is as follows:

(dollars in millions)

	13 Weeks Ended		39 Weeks Ended
	October 30, 2004		October 30, 2004
Payless Domestic	$	4.6	$	32.1
Payless International		2.7		11.9
Total	$	7.3	$	44.0

NOTE 12. DISCONTINUED OPERATIONS. Due to the updating of this filing for the restatement described in Note 3, the condensed consolidated financial statements have been updated to include discontinued operations presentation in order to conform to the current presentation of the Company’s operations.

In accordance with SFAS No. 144, the results for the thirteen and thirty-nine weeks ended October 30, 2004 and November 1, 2003 have been reclassified to show the results of operations for Parade, Peru, Chile and 26 Payless closed stores as discontinued operations. The following is a summary of these results by segment:

Thirteen Weeks Ended October 30, 2004

	Payless			Payless			Payless
(dollars in millions)	Domestic			International			Consolidated
Net sales	$	23.7		$	2.1		$	25.8
Loss from discontinued operations before income taxes and minority interest		(5.4	)		(1.1	)		(6.5	)
Benefit for income taxes		(2.1	)		—			(2.1	)
Loss from discontinued operations before minority interest		(3.3	)		(1.1	)		(4.4	)
Minority interest, net of income taxes		—			0.5			0.5
Loss on disposal of discontinued operations, net of income taxes of $0.8 and $0.0, respectively, and minority interest of $0.0 and $0.6, respectively		(1.1	)		(0.9	)		(2.0	)
Loss from discontinued operations, net of income taxes and minority interest	$	(4.4	)	$	(1.5	)	$	(5.9	)

Thirteen Weeks Ended November 1, 2003

	Payless			Payless			Payless
(dollars in millions)	Domestic			International			Consolidated
Net sales	$	27.4		$	2.9		$	30.3
Loss from discontinued operations before income taxes and minority interest		(5.8	)		(1.2	)		(7.0	)
Benefit for income taxes		(2.1	)		(0.2	)		(2.3	)
Loss from discontinued operations before minority interest		(3.7	)		(1.0	)		(4.7	)
Minority interest, net of income taxes		—			0.3			0.3
Loss from discontinued operations, net of income taxes and minority interest	$	(3.7	)	$	(0.7	)	$	(4.4	)

17

Thirty-Nine Weeks Ended October 30, 2004

	Payless			Payless			Payless
(dollars in millions)	Domestic			International			Consolidated
Net sales	$	80.6		$	7.0		$	87.6
Loss from discontinued operations before income taxes and minority interest		(11.0	)		(5.0	)		(16.0	)
(Benefit) provision for income taxes		(4.5	)		0.3			(4.2	)
Loss from discontinued operations before minority interest		(6.5	)		(5.3	)		(11.8	)
Minority interest, net of income taxes		—			2.1			2.1
Loss on disposal of discontinued operations, net of income taxes of $6.4 and $0.0, respectively, and minority interest of $0.0 and $4.0, respectively		(10.0	)		(6.0	)		(16.0	)
Loss from discontinued operations, net of income taxes and minority interest	$	(16.5	)	$	(9.2	)	$	(25.7	)

Thirty-Nine Weeks Ended November 1, 2003

	Payless			Payless			Payless
(dollars in millions)	Domestic			International			Consolidated
Net sales	$	85.8		$	8.2		$	94.0
Loss from discontinued operations before income taxes and minority interest		(14.7	)		(5.1	)		(19.8	)
Benefit for income taxes		(5.3	)		(1.0	)		(6.3	)
Loss from discontinued operations before minority interest		(9.4	)		(4.1	)		(13.5	)
Minority interest, net of income taxes		—			1.6			1.6
Loss from discontinued operations, net of income taxes and minority interest	$	(9.4	)	$	(2.5	)	$	(11.9	)

Additionally, the Company has made certain reclassifications to its consolidated balance sheets to reflect the assets of Parade, Peru, Chile and the 26 Payless closed stores as discontinued operations. As of October 30, 2004, November 1, 2003 and January 31, 2004, the current and non-current assets and liabilities of discontinued operations by financial reporting segment were as follows:

18

October 30, 2004

	Payless		Payless		Payless
(dollars in millions)	Domestic		International		Consolidated
Assets
Current assets:
Cash and cash equivalents	$	0.2	$	0.7	$	0.9
Inventories		13.0		1.2		14.2
Current deferred income taxes	$	0.2	$	—	$	0.2
Other current assets		2.4		0.2		2.6
Total current assets of discontinued operations	$	15.8	$	2.1	$	17.9
Property and equipment, net	$	1.1	$	—	$	1.1
Favorable leases, net		—		—		—
Deferred income taxes		6.5		—		6.5
Other assets	$	0.1	$	0.4	$	0.5
Total non-current assets of discontinued operations	$	7.7	$	0.4	$	8.1
Liabilities
Current liabilities:
Accounts payable	$	4.4	$	0.3	$	4.7
Accrued expenses		0.9		0.3		1.2
Total current liabilities of discontinued operations	$	5.3	$	0.6	$	5.9
Other liabilities	$	8.4	$	0.1	$	8.5
Total non-current liabilities of discontinued operations	$	8.4	$	0.1	$	8.5

November 1, 2003

	Payless		Payless		Payless
(dollars in millions)	Domestic		International		Consolidated
Assets
Current assets:
Cash and cash equivalents	$	0.2	$	1.0	$	1.2
Inventories		15.8		3.1		18.9
Current deferred income taxes		0.2		0.1		0.3
Other current assets		2.7		2.1		4.8
Total current assets of discontinued operations	$	18.9	$	6.3	$	25.2
Property and equipment, net	$	14.9	$	6.9	$	21.8
Favorable leases, net		0.5		—		0.5
Deferred income taxes		2.6		3.1		5.7
Other assets		0.1		2.1		2.2
Total non-current assets of discontinued operations	$	18.1	$	12.1	$	30.2
Liabilities
Current liabilities:
Accounts payable	$	3.0	$	0.3	$	3.3
Accrued expenses		1.5		0.3		1.8
Total current liabilities of discontinued operations	$	4.5	$	0.6	$	5.1
Other liabilities	$	2.1	$	0.1	$	2.2
Total non-current liabilities of discontinued operations	$	2.1	$	0.1	$	2.2

19

January 31, 2004

	Payless		Payless		Payless
(dollars in millions)	Domestic		International		Consolidated
Assets
Current assets:
Cash and cash equivalents	$	0.1	$	2.1	$	2.2
Inventories		14.4		2.8		17.2
Current deferred income taxes		0.2		—		0.2
Other current assets		2.4		2.2		4.6
Total current assets of discontinued operations	$	17.1	$	7.1	$	24.2
Property and equipment, net	$	15.3	$	7.1	$	22.4
Favorable leases, net		0.4		—		0.4
Deferred income taxes		2.6		—		2.6
Other assets		0.1		2.1		2.2
Total non-current assets of discontinued operations	$	18.4	$	9.2	$	27.6
Liabilities
Current liabilities:
Accounts payable	$	2.7	$	0.7	$	3.4
Accrued expenses		2.0		0.4		2.4
Total current liabilities of discontinued operations	$	4.7	$	1.1	$	5.8
Other liabilities	$	2.0	$	0.1	$	2.1
Total non-current liabilities of discontinued operations	$	2.0	$	0.1	$	2.1

NOTE 13. SEGMENT REPORTING. The Company and its subsidiaries are principally engaged in the operation of retail locations offering family footwear and accessories. The Company operates its business in two reportable business segments: Payless Domestic and Payless International. These segments have been determined based on internal management reporting and management responsibilities. The Payless Domestic segment includes retail operations in the United States, Guam and Saipan and sourcing operations. The Payless International segment includes retail operations in Canada, the South American Region, the Central American Region, Puerto Rico, the U.S. Virgin Islands and operations in Japan. The Company’s operations in its Central American Region, its South American Region and Japan are operated as joint ventures in which the Company maintains a 60-percent ownership interest. Minority interest represents the Company’s joint venture partners’ share of net earnings or losses on applicable international operations. Certain management costs for services performed by Payless Domestic and certain royalty fees and sourcing fees charged by Payless Domestic are allocated to the Payless International segment. These total costs and fees amounted to $5.9 million during the third quarter of 2004 and $4.2 million during the same period in 2003. For the first nine months of 2004, these total costs and fees amounted to $15.3 million, compared with $12.4 million for the first nine months of 2003. The Company’s reporting period for its operations in the South American Region, the Central American Region and Japan is a December 31 year-end. The effect of this one-month lag on the Company’s financial position and results of operations is not significant. Information on the segments is as follows:

(dollars in millions)

	Payless Domestic		Payless International			Payless Consolidated
Thirteen weeks ended October 30, 2004
Revenues from external customers	$	579.2	$	82.2		$	661.4
Operating profit from continuing operations		16.5		5.0			21.5
Thirty-nine weeks ended October 30, 2004
Revenues from external customers	$	1,811.2	$	238.1		$	2,049.3
Operating profit from continuing operations		62.0		12.2			74.2
Total assets		1,056.0		181.0			1,237.0
Thirteen weeks ended November 1, 2003
Revenues from external customers	$	604.9	$	74.5		$	679.4
Operating profit (loss) from continuing operations		7.0		(0.7	)		6.3
Thirty-nine weeks ended November 1, 2003
Revenues from external customers	$	1,827.6	$	217.1		$	2,044.7
Operating profit (loss) from continuing operations		53.9		(0.9	)		53.0
Total assets		1,013.1		203.5			1,216.6

Total assets for the Payless Domestic segment include $5.9 million in goodwill as of October 30, 2004, and November 1, 2003.

20

NOTE 14. CONTINGENCIES. On or about December 20, 2001, a First Amended Complaint was filed against the Company in the U.S. District Court for the District of Oregon, captioned Adidas America, Inc. and Adidas-Salomon AG v. Payless ShoeSource, Inc. The First Amended Complaint seeks injunctive relief and unspecified monetary damages for trademark and trade dress infringement, unfair competition, deceptive trade practices and breach of contract. The Company believes it has meritorious defenses to claims asserted in the lawsuit and has filed an answer and a motion for summary judgment which the court granted in part. An estimate of the possible loss, if any, or the range of loss cannot be made.

On or about January 20, 2000, a complaint was filed against the Company in the U.S. District Court for the District of New Hampshire, captioned Howard J. Dananberg, D.P.M. v. Payless ShoeSource, Inc. The Complaint seeks injunctive relief, unspecified treble monetary damages, attorneys’ fees, interest and costs for patent infringement. The Company believes it has meritorious defenses to claims asserted in the lawsuit. An estimate of the possible loss, if any, or the range of loss cannot be made.

NOTE 15. IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS. During May 2003, the FASB issued SFAS 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” SFAS 150 clarifies the accounting for certain financial instruments with characteristics of both liabilities and equity and requires that those instruments be classified as liabilities in statements of financial position. SFAS 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003, except that certain provisions have been deferred pursuant to FASB Staff Position No. FAS 150-3. The application of SFAS 150-3 is not expected to have a material impact on the Company’s consolidated financial statements, and the adoption of SFAS 150 did not have a material impact on the Company’s consolidated financial statements.

In December 2003, the FASB issued FASB Interpretation No. 46R, “Consolidation of Variable Interest Entities and Interpretation of ARB No. 51.” This interpretation, which replaces FASB Interpretation No. 46, “Consolidation of Variable Interest Entities,” clarifies the application of Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support. This interpretation is required in financial statements for periods ending after March 15, 2004, for those companies that have yet to adopt the provisions of FIN 46. The application of FASB Interpretation No. 46R did not have a material impact on the Company’s condensed consolidated financial statements.

In January 2003, the FASB issued SFAS 132 (revised 2003), “Employers’ Disclosures about Pensions and Other Postretirement Benefits,” which retains all of the disclosures that are required by SFAS 132 and includes several additional disclosures. It also amends APB Opinion 28, “Interim Financial Reporting,” to require certain disclosures about pension and other postretirement benefit plans in interim financial statements. The provisions of SFAS 132 (revised 2003) are effective for fiscal years ending after June 15, 2004. The interim disclosure provisions are effective for interim periods beginning after December 15, 2003. The Company adopted the provisions of SFAS 132 (revised 2003) in the first quarter of fiscal year 2004.

NOTE 16. SUBSIDIARY GUARANTORS OF SENIOR NOTES – CONDENSED CONSOLIDATING FINANCIAL INFORMATION. The Company has issued Notes guaranteed by all of its domestic subsidiaries (the “Guarantor Subsidiaries”). The Guarantor Subsidiaries are direct or indirect wholly owned domestic subsidiaries of the Company. The guarantees are full and unconditional, to the extent allowed by law, and joint and several.

The following supplemental financial information sets forth, on a consolidating basis, the condensed statements of earnings (loss) and cash flows for Payless ShoeSource, Inc., a Delaware corporation (the “Parent Company”), for the Guarantor Subsidiaries and for the Company’s non-guarantor subsidiaries (the “Non-guarantor Subsidiaries”) and the Company for the thirteen-week and thirty-nine-week periods ended October 30, 2004, and November 1, 2003, and the related condensed consolidating balanced sheets as of October 30, 2004, November 1, 2003, and January 31, 2004. The intercompany investment for each subsidiary is recorded by its parent in Other Assets.

The Non-guarantor Subsidiaries are made up of the Company’s retail operations in the Central American and South American Regions, Canada, Saipan, and Puerto Rico, operations in Japan and the Company’s sourcing organization in Hong Kong, Taiwan, China, Indonesia and Brazil. During 2003, the Company changed the reporting period for its operations in the Central American and South American Regions to use a December 31 year-end. Operations in the Central American Region, the South American Region and Japan are included in our results on a one-month lag relative to results from other regions. The effect of this one-month lag on our financial position and results of operations is not significant.

21

CONDENSED CONSOLIDATING BALANCE SHEET
(UNAUDITED)
As of October 30, 2004 (Restated)

(dollars in millions)

	Parent		Guarantor			Non-guarantor
	Company		Subsidiaries			Subsidiaries			Eliminations			Consolidated
ASSETS
Current Assets:
Cash and cash equivalents	$	—	$	158.2		$	58.0		$	—		$	216.2
Marketable securities, available for sale		—		9.0			—			—			9.0
Restricted cash		—		—			18.5			—			18.5
Inventories		—		295.7			69.2			(3.2	)		361.7
Current deferred income taxes		—		26.8			—			—			26.8
Other current assets		14.1		63.4			40.0			(50.7	)		66.8
Current assets of discontinued operations		—		15.6			2.3			—			17.9
Total current assets		14.1		568.7			188.0			(53.9	)		716.9
Property and Equipment:
Land		—		8.0			—			—			8.0
Buildings and leasehold improvements		—		607.3			76.0			—			683.3
Furniture, fixtures and equipment		—		469.1			59.9			—			529.0
Property under capital leases		—		4.6			—			—			4.6
Total property and equipment		—		1,089.0			135.9			—			1,224.9
Accumulated depreciation and amortization		—		(737.8	)		(64.6	)		—			(802.4	)
Property and equipment, net		—		351.2			71.3			—			422.5
Favorable leases, net		—		22.7			—			—			22.7
Deferred income taxes		—		24.5			10.7			—			35.2
Goodwill, net		—		5.9			—			—			5.9
Other assets		1,106.1		453.1			1.6			(1,535.1	)		25.7
Non-current assets of discontinued operations		—		7.7			0.4			—			8.1
Total assets	$	1,120.2	$	1,433.8		$	272.0		$	(1,589.0	)	$	1,237.0
LIABILITIES AND SHAREOWNERS’ EQUITY
Current Liabilities:
Current maturities of long-term debt	$	—	$	1.1		$	2.4		$	—		$	3.5
Notes payable		—		—			18.5			—			18.5
Accounts payable		—		89.3			57.1			(40.4	)		106.0
Accrued expenses		3.1		150.9			24.1			(13.5	)		164.6
Current liabilities of discontinued operations		—		5.3			0.6			—			5.9
Total current liabilities		3.1		246.6			102.7			(53.9	)		298.5
Long-term debt		480.0		1.1			4.0			(283.0	)		202.1
Other liabilities		1.5		103.7			14.6			(32.4	)		87.4
Non-current liabilities of discontinued operations				8.4			0.1			—			8.5
Minority interest		—		—			7.5			—			7.5
Commitments and contingencies		—		—			—			—			—
Total shareowners’ equity		635.6		1,074.0			143.1			(1,219.7	)		633.0
Total liabilities and shareowners’ equity	$	1,120.2	$	1,433.8		$	272.0		$	(1,589.0	)	$	1,237.0

22

CONDENSED CONSOLIDATING BALANCE SHEET
(UNAUDITED)
As of November 1, 2003 (Restated)

(dollars in millions)

	Parent		Guarantor			Non-guarantor
	Company		Subsidiaries			Subsidiaries			Eliminations			Consolidated
ASSETS
Current Assets:
Cash and cash equivalents	$	—	$	96.1		$	33.5		$	—		$	129.6
Marketable securities, available for sale		—		10.0			—			—			10.0
Restricted cash		—		—			33.5			—			33.5
Inventories		—		296.3			95.5			—			391.8
Current deferred income taxes		—		12.9			0.7			—			13.6
Other current assets		5.7		88.0			42.5			(61.1	)		75.1
Current assets of discontinued operations		—		18.9			6.3			—			25.2
Total current assets		5.7		522.2			212.0			(61.1	)		678.8
Property and Equipment:
Land		—		8.0			—			—			8.0
Buildings and leasehold improvements		—		597.2			68.8			—			666.0
Furniture, fixtures and equipment		—		433.3			53.4			—			486.7
Property under capital leases		—		4.6			—			—			4.6
Total property and equipment		—		1,043.1			122.2			—			1,165.3
Accumulated depreciation and amortization		—		(697.7	)		(52.3	)		—			(750.0	)
Property and equipment, net		—		345.4			69.9			—			415.3
Favorable leases, net		—		30.1			—			—			30.1
Deferred income taxes		—		18.8			7.5			—			26.3
Goodwill, net		—		5.9			—			—			5.9
Other assets		1,105.5		426.1			12.1			(1,513.7	)		30.0
Non-current assets of discontinued operations		—		18.2			12.0			—			30.2
Total assets	$	1,111.2	$	1,366.7		$	313.5		$	(1,574.8	)	$	1,216.6
LIABILITIES AND SHAREOWNERS’ EQUITY
Current Liabilities:
Current maturities of long-term debt	$	—	$	0.9		$	—		$	—		$	0.9
Notes payable		—		—			33.5			—			33.5
Accounts payable		—		82.7			99.9			(54.7	)		127.9
Accrued expenses		10.6		109.8			15.1			(6.4	)		129.1
Current liabilities of discontinued operations		—		4.6			0.5			—			5.1
Total current liabilities		10.6		198.0			149.0			(61.1	)		296.5
Long-term debt		479.9		2.1			4.0			(283.1	)		202.9
Other liabilities		—		121.2			12.6			(52.6	)		81.2
Non-current liabilities of discontinued operations		—		2.1			0.1			—			2.2
Minority interest		—		—			16.2			—			16.2
Commitments and contingencies		—		—			—			—			—
Total shareowners’ equity		620.7		1,043.3			131.6			(1,178.0	)		617.6
Total liabilities and shareowners’ equity	$	1,111.2	$	1,366.7		$	313.5		$	(1,574.8	)	$	1,216.6

23

CONDENSED CONSOLIDATING BALANCE SHEET
(UNAUDITED)
As of January 31, 2004 (Restated)

(dollars in millions)

	Parent		Guarantor			Non-guarantor
	Company		Subsidiaries			Subsidiaries			Eliminations			Consolidated
ASSETS
Current Assets:
Cash and cash equivalents	$	—	$	67.4		$	69.3		$	—		$	136.7
Marketable securities, available for sale		—		10.0			—			—			10.0
Restricted cash		—		—			33.5			—			33.5
Inventories		—		308.5			70.9			(4.2	)		375.2
Current deferred income taxes		—		17.0			0.1			—			17.1
Other current assets		6.6		71.9			41.7			(55.3	)		64.9
Current assets of discontinued operations		—		17.0			7.2			—			24.2
Total current assets		6.6		491.8			222.7			(59.5	)		661.6
Property and Equipment:
Land		—		8.0			—			—			8.0
Buildings and leasehold improvements		—		610.7			69.1			—			679.8
Furniture, fixtures and equipment		—		439.7			54.9			—			494.6
Property under capital leases		—		4.6			—			—			4.6
Total property and equipment		—		1,063.0			124.0			—			1,187.0
Accumulated depreciation and amortization		—		(711.6	)		(51.9	)		—			(763.5	)
Property and equipment, net		—		351.4			72.1			—			423.5
Favorable leases, net		—		28.8			—			—			28.8
Deferred income taxes		—		27.7			6.5			—			34.2
Goodwill, net		—		5.9			—			—			5.9
Other assets		1,085.1		440.7			1.4			(1,504.5	)		22.7
Non-current assets of discontinued operations		—		18.4			9.2			—			27.6
Total assets	$	1,091.7	$	1,364.7		$	311.9		$	(1,564.0	)	$	1,204.3
LIABILITIES AND SHAREOWNERS’ EQUITY
Current Liabilities:
Current maturities of long-term debt	$	—	$	0.9		$	—		$	—		$	0.9
Notes payable		—		—			33.5			—			33.5
Accounts payable		—		84.3			97.3			(52.0	)		129.6
Accrued expenses		7.5		108.1			15.8			(7.5	)		123.9
Current liabilities of discontinued operations		—		4.8			1.0			—			5.8
Total current liabilities		7.5		198.1			147.6			(59.5	)		293.7
Long-term debt		479.8		2.0			4.0			(283.0	)		202.8
Other liabilities		—		137.3			8.8			(60.5	)		85.6
Non-current liabilities of discontinued operations				2.0			0.1			—			2.1
Minority interest		—		—			15.7			—			15.7
Commitments and contingencies		—		—			—			—			—
Total shareowners’ equity		604.4		1,025.3			135.7			(1,161.0	)		604.4
Total liabilities and shareowners’ equity	$	1,091.7	$	1,364.7		$	311.9		$	(1,564.0	)	$	1,204.3

24

CONDENSED CONSOLIDATING STATEMENT OF EARNINGS (LOSS)
(UNAUDITED)
For the Thirteen Weeks Ended October 30, 2004 (Restated)

(dollars in millions)

	Parent			Guarantor			Non-guarantor
	Company			Subsidiaries			Subsidiaries			Eliminations			Consolidated
Net sales	$	—		$	611.6		$	163.9		$	(114.1	)	$	661.4
Cost of sales		—			442.3			130.0			(112.0	)		460.3
Selling, general and administrative expense		0.8			145.1			31.9			(2.1	)		175.7
Restructuring charges		—			3.9			—			—			3.9
Operating (loss) profit from continuing operations		(0.8	)		20.3			2.0			—			21.5
Interest expense		6.9			0.1			0.8			(2.3	)		5.5
Interest income		—			(2.9	)		(0.6	)		2.3			(1.2	)
Equity in (loss) earnings of subsidiaries		(11.8	)		3.2			—			8.6			—
Earnings (loss) from continuing operations before income taxes and minority interest		4.1			19.9			1.8			(8.6	)		17.2
(Benefit) provision for income taxes		(2.5	)		3.7			3.7			—			4.9
Earnings (loss) from continuing operations before minority interest		6.6			16.2			(1.9	)		(8.6	)		12.3
Minority interest, net of income tax		—			—			0.2			—			0.2
Net earnings (loss) from continuing operations		6.6			16.2			(1.7	)		(8.6	)		12.5
Loss from discontinued operations, net of income taxes and minority interest		—			(4.4	)		(1.5	)		—			(5.9	)
Net earnings (loss)	$	6.6		$	11.8		$	(3.2	)	$	(8.6	)	$	6.6

25

CONDENSED CONSOLIDATING STATEMENT OF LOSS
(UNAUDITED)
For the Thirteen Weeks Ended November 1, 2003 (Restated)

(dollars in millions)

	Parent			Guarantor			Non-guarantor
	Company			Subsidiaries			Subsidiaries			Eliminations			Consolidated
Net sales	$	—		$	639.7		$	159.4		$	(119.7	)	$	679.4
Cost of sales		—			481.2			129.1			(118.2	)		492.1
Selling, general and administrative expense		1.3			158.7			22.5			(1.5	)		181.0
Operating (loss) profit from continuing operations		(1.3	)		(0.2	)		7.8			—			6.3
Interest expense		5.3			2.0			1.0			(2.3	)		6.0
Interest income		—			(2.5	)		(0.9	)		2.3			(1.1	)
Equity in (loss) earnings of subsidiaries		(2.0	)		(8.1	)		—			10.1			—
Earnings (loss) from continuing operations before income taxes and minority interest		(4.6	)		8.4			7.7			(10.1	)		1.4
(Benefit) provision for income taxes		(2.4	)		2.7			—			—			0.3
Earnings (loss) from continuing operations before minority interest		(2.2	)		5.7			7.7			(10.1	)		1.1
Minority interest, net of income tax		—			—			1.1			—			1.1
Net earnings (loss) from continuing operations		(2.2	)		5.7			8.8			(10.1	)		2.2
Loss from discontinued operations, net of income taxes and minority interest		—			(3.7	)		(0.7	)		—			(4.4	)
Net earnings (loss)	$	(2.2	)	$	2.0		$	8.1		$	(10.1	)	$	(2.2	)

26

CONDENSED CONSOLIDATING STATEMENT OF EARNINGS
(UNAUDITED)

For the Thirty-nine Weeks Ended October 30, 2004 (Restated)

(dollars in millions)

	Parent			Guarantor			Non-guarantor
	Company			Subsidiaries			Subsidiaries			Eliminations			Consolidated
Net sales	$	—		$	1,901.5		$	492.0		$	(344.2	)	$	2,049.3
Cost of sales		—			1,345.8			403.9			(337.8	)		1,411.9
Selling, general and administrative expense		1.8			464.0			86.2			(6.4	)		545.6
Restructuring charges		—			17.0			0.6			—			17.6
Operating (loss) profit from continuing operations		(1.8	)		74.7			1.3			—			74.2
Interest expense		19.6			0.4			3.5			(6.8	)		16.7
Interest income		—			(7.9	)		(2.4	)		6.8			(3.5	)
Equity in (loss) earnings of subsidiaries		(38.4	)		3.5			—			34.9			—
Earnings (loss) from continuing operations before income taxes and minority interest		17.0			78.7			0.2			(34.9	)		61.0
(Benefit) provision for income taxes		(7.5	)		23.8			(1.2	)		—			15.1
Earnings (loss) from continuing operations before minority interest		24.5			54.9			1.4			(34.9	)		45.9
Minority interest, net of income tax		—			—			4.3			—			4.3
Net earnings (loss) from continuing operations		24.5			54.9			5.7			(34.9	)		50.2
Loss from discontinued operations, net of income taxes and minority interest		—			(16.5	)		(9.2	)		—			(25.7	)
Net earnings (loss)	$	24.5		$	38.4		$	(3.5	)	$	(34.9	)	$	24.5

27

CONDENSED CONSOLIDATING STATEMENT OF EARNINGS
(UNAUDITED)
For the Thirty-nine Weeks Ended November 1, 2003 (Restated)

(dollars in millions)

	Parent			Guarantor			Non-guarantor
	Company			Subsidiaries			Subsidiaries			Eliminations			Consolidated
Net sales	$	—		$	1,916.7		$	511.5		$	(383.5	)	$	2,044.7
Cost of sales		—			1,417.9			420.4			(378.0	)		1,460.3
Selling, general and administrative expense		1.4			470.3			65.2			(5.5	)		531.4
Operating (loss) profit from continuing operations		(1.4	)		28.5			25.9			—			53.0
Interest expense		11.8			9.1			3.1			(8.7	)		15.3
Interest income		—			(9.2	)		(2.5	)		8.7			(3.0	)
Equity in (loss) earnings of subsidiaries		(25.5	)		(25.4	)		—			50.9			—
Earnings (loss) from continuing operations before income taxes and minority interest		12.3			54.0			25.3			(50.9	)		40.7
(Benefit) provision for income taxes		(4.8	)		19.1			(0.2	)		—			14.1
Earnings (loss) from continuing operations before minority interest		17.1			34.9			25.5			(50.9	)		26.6
Minority interest, net of income tax		—			—			2.4			—			2.4
Net earnings (loss) from continuing operations		17.1			34.9			27.9			(50.9	)		29.0
Loss from discontinued operations, net of income taxes and minority interest		—			(9.4	)		(2.5	)		—			(11.9	)
Net earnings (loss)	$	17.1		$	25.5		$	25.4		$	(50.9	)	$	17.1

28

CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
(UNAUDITED)
For the Thirty-nine Weeks Ended October 30, 2004 (Restated)

(dollars in millions)

	Parent			Guarantor			Non-guarantor
	Company			Subsidiaries			Subsidiaries			Eliminations			Consolidated
Operating Activities:
Net earnings	$	24.5		$	38.4		$	(3.5	)	$	(34.9	)	$	24.5
Loss from discontinued operations, net of income taxes and minority interest		—			(16.5	)		(9.2	)		—			(25.7	)
Net earnings from continuing operations		24.5			54.9			5.7			(34.9	)		50.2
Adjustments for non-cash items included in earnings from continuing operations:
Non-cash component of restructuring charges		—			12.0			—			—			12.0
Loss on impairment of and disposal of assets		—			5.5			1.1			—			6.6
Depreciation and amortization		—			62.6			8.6			—			71.2
Amortization of deferred financing costs		—			0.9			—			—			0.9
Amortization of unearned restricted stock		0.5			—			—			—			0.5
Deferred income taxes		—			(6.6	)		(6.3	)		—			(12.9	)
Minority interest, net of tax		—			—			(4.3	)		—			(4.3	)
Income tax charge of stock option exercises		(0.1	)		—			—			—			(0.1	)
Changes in working capital:
Inventories		—			12.8			3.9			(1.0	)		15.7
Other current assets		(7.5	)		8.5			(1.5	)		(4.6	)		(5.1	)
Accounts payable		—			5.0			(40.3	)		11.6			(23.7	)
Accrued expenses		(4.4	)		42.8			8.6			(6.0	)		41.0
Other assets and liabilities, net		(12.2	)		(32.2	)		15.2			34.9			5.7
Cash flow provided by (used in) discontinued operations		—			2.5			(2.0	)		—			0.5
Cash flow provided by (used in) operating activities from continuing operations		0.8			168.7			(11.3	)		—			158.2
Investing Activities:
Capital expenditures		—			(75.1	)		(6.9	)		—			(82.0	)
Purchase of marketable securities		—			(13.0	)		—			—			(13.0	)
Sale of marketable securities		—			14.0			—			—			14.0
Investment in subsidiaries		—			(2.9	)		—			2.9			—
Cash flow used in investing activities from continuing operations		—			(77.0	)		(6.9	)		2.9			(81.0	)
Financing Activities:
Repayment on notes payable		—			—			(15.0	)		—			(15.0	)
Restricted cash		—			—			15.0			—			15.0
Issuance of debt		—			—			2.4			—			2.4
Payment of deferred financing costs		—			(0.2	)		—			—			(0.2	)
Repayment of debt		—			(0.7	)		—			—			(0.7	)
Net purchases of common stock		(0.8	)		—			—			—			(0.8	)
Contributions by parents		—			—			2.9			(2.9	)		—
Contributions by minority owners		—			—			1.9			—			1.9
Cash flow (used in) provided by financing activities from continuing operations		(0.8	)		(0.9	)		7.2			(2.9	)		2.6
Effect of exchange rate changes on cash		—			—			(0.3	)		—			(0.3	)
Increase (decrease) in cash and cash equivalents		—			90.8			(11.3	)		—			79.5
Cash and cash equivalents, beginning of period		—			67.4			69.3			—			136.7
Cash and cash equivalents, end of period	$	—		$	158.2		$	58.0		$	—		$	216.2

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CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
(UNAUDITED)
For the Thirty-nine Weeks Ended November 1, 2003 (Restated)

(dollars in millions)

	Parent			Guarantor			Non-guarantor
	Company			Subsidiaries			Subsidiaries			Eliminations			Consolidated
Operating Activities:
Net earnings	$	17.1		$	25.5		$	25.4		$	(50.9	)	$	17.1
Loss from discontinued operations, net of income taxes and minority interest		—			(9.4	)		(2.5	)		—			(11.9	)
Net earnings from continuing operations		17.1			34.9			27.9			(50.9	)		29.0
Adjustments for non-cash items included in earnings from continuing operations:
Loss on impairment of and disposal of assets		—			7.4			0.1			—			7.5
Depreciation and amortization		—			62.9			9.4			—			72.3
Amortization of deferred financing costs		—			3.8			—			—			3.8
Amortization of unearned restricted stock		0.5			—			—			—			0.5
Deferred income taxes		—			13.4			(0.4	)		—			13.0
Minority interest, net of tax		—			—			(2.4	)		—			(2.4	)
Changes in working capital:
Inventories		—			56.2			(5.8	)		(5.7	)		44.7
Other current assets		(0.1	)		78.1			(24.2	)		(72.7	)		(18.9	)
Accounts payable		—			17.9			29.0			(20.8	)		26.1
Accrued expenses		(59.4	)		3.7			(3.9	)		69.2			9.6
Other assets and liabilities, net		(28.3	)		(57.6	)		8.7			80.9			3.7
Cash flow used in discontinued operations		—			(3.0	)		(9.1	)		—			(12.1	)
Cash flow (used in) provided by operating activities from continuing operations		(70.2	)		217.7			29.3			—			176.8
Investing Activities:
Capital expenditures		—			(69.9	)		(13.6	)		—			(83.5	)
Disposition of property and equipment		—			1.0			—			—			1.0
Purchase of marketable securities		—			(10.0	)		—			—			(10.0	)
Repayment of loan from parent/subsidiary		—			146.9			—			(146.9	)		—
Investment in subsidiaries		—			(5.4	)		—			5.4			—
Cash flow provided by (used in) investing activities from continuing operations		—			62.6			(13.6	)		(141.5	)		(92.5	)
Financing Activities:
Issuance on notes payable		—			—			5.0			—			5.0
Restricted cash		—			—			(5.0	)		—			(5.0	)
Issuance of debt		196.7			—			—			—			196.7
Payment of deferred financing costs		(9.3	)		—			—			—			(9.3	)
Repayment of debt		—			(216.8	)		—			—			(216.8	)
Loan from parent/subsidiary		(116.9	)		—			(30.0	)		146.9			—
Net purchases of common stock		(0.3	)		—			—			—			(0.3	)
Contributions by parents		—			—			5.4			(5.4	)		—
Contributions by minority owners		—			—			3.6			—			3.6
Cash flow provided by (used in) financing activities from continuing operations		70.2			(216.8	)		(21.0	)		141.5			(26.1	)
Effect of exchange rate changes on cash		—			—			(0.3	)		—			(0.3	)
Increase (decrease) in cash and cash equivalents		—			63.5			(5.6	)		—			57.9
Cash and cash equivalents, beginning of period		—			32.6			39.1			—			71.7
Cash and cash equivalents, end of period	$	—		$	96.1		$	33.5		$	—		$	129.6

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ITEM 2 — MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This discussion and analysis should be read in conjunction with the Condensed Consolidated Financial Statements and Notes to the Condensed Consolidated Financial Statements included in this Form 10-Q/A.

FORWARD-LOOKING STATEMENTS

This report contains forward-looking statements relating to such matters as anticipated financial performance, international expansion opportunities, consumer spending patterns, capital expenditure plans, business prospects, products, future store openings and closings, possible strategic initiatives and similar matters. Forward looking statements are identified by words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” or variations of such words. A variety of known and unknown risks and uncertainties and other factors could cause actual results and expectations to differ materially from the anticipated results or expectations which include, but are not limited to: changes in consumer spending patterns; changes in consumer preferences and overall economic conditions; the impact of competition and pricing; changes in weather patterns; the financial condition of the Company’s suppliers and manufacturers; changes in existing or potential duties, tariffs or quotas; changes in relationships between the United States and foreign countries, changes in relationships between Canada and foreign countries; economic and political instability in foreign countries, or restrictive actions by the governments of foreign countries in which suppliers and manufacturers from whom the Company sources are located or in which the Company has retail locations or otherwise does business; changes in trade, customs and/or tax laws; fluctuations in currency exchange rates; availability of suitable store locations on acceptable terms; the ability to terminate leases on acceptable terms; the ability to hire and retain associates; performance of other parties in strategic alliances; general economic, business and social conditions in the countries from which we source products, supplies or have or intend to open stores; performance of partners in joint ventures; the ability to comply with local laws in foreign countries; threats or acts of terrorism; strikes, work stoppages and/or slowdowns by unions that play a significant role in the manufacture; distribution or sale of product; congestion at major ocean ports; changes in the value of the dollar relative to the Chinese yuan and other currencies. Please refer to the Company’s 2003 Annual Report and its Form 10-K for the fiscal year ended January 31, 2004 for more information on these and other risk factors that could cause actual results to differ. The Company does not undertake any obligation to release publicly any revisions to such forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

RESTATEMENT

The accompanying Management’s Discussion and Analysis of Financial Condition and Results of Operations gives effect to the restatement described in Note 3 to the Condensed Consolidated Financial Statements.

OVERVIEW

We are the largest specialty family footwear retailer in the Western Hemisphere with retail stores in the United States, Canada, the Caribbean, and the Central American and South American Regions. The Central American Region is composed of operations in Costa Rica, the Dominican Republic, El Salvador, Guatemala, Honduras, Nicaragua, Panama and Trinidad & Tobago. The South American Region is composed of operations in Chile, Ecuador and Peru; however, we intend to dispose of all store operations in Chile during 2004 and we have transferred ownership of our Peruvian entity and related operations and liabilities to an entity comprised of some owners of our South American joint venture partner effective November 15, 2004. Our stores offer fashionable, quality, private and branded label footwear and accessories for women, men and children at affordable prices in a self-selection shopping format.

During the third quarter of 2004, we announced a series of strategic initiatives as part of a restructuring plan designed to sharpen our focus on our core business strategy, reduce expenses, accelerate decision-making, increase profitability, improve our operating margin and build value for shareowners over the long-term. The strategic initiatives include:

•   Exiting all 181 Parade stores, and related operations;

•   Exiting all 32 Payless ShoeSource stores in Chile and Peru;

•   The closing of approximately 260 Payless ShoeSource stores. These store closings differ from closings in the normal course of business in that they have longer remaining lease terms;

•   The reduction of wholesale businesses that provide no significant growth opportunity, and;

•   A comprehensive review of the Company’s expense structure and appropriate reductions to improve profitability.

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Due to the restatement described in Note 3 to the Condensed Consolidated Financial Statements, we have reflected the financial information of the Parade, Peru and Chile stores and 26 of the Payless ShoeSource stores as discontinued operations in order to conform to the current presentation. Unless otherwise noted, the amounts and discussions included in this Management’s Discussion and Analysis relate to continuing operations.

As part of the strategic initiatives, during the third quarter we eliminated approximately 200 management and administrative positions, closed 65 stores and began to liquidate inventory in our Payless and Parade stores identified for closing. During the third quarter, we recorded $7.3 million in restructuring charges ($3.9 million relating to continuing operations and $3.4 million relating to discontinued operations) primarily related to employee severance costs, contract termination costs and a reduction of the carrying value of our assets in Peru. This is in addition to a non-cash restructuring charge of $36.7 million recorded in the second quarter related to the impairment of the assets associated with Chile, Peru, Parade and the approximately 260 Payless stores to be closed. If the $36.7 million second quarter charge, $13.7 million related to continuing operations and $23.0 million related to discontinued operations.

We expect that the total restructuring costs will be in the range of $77 million to $90 million, with estimated remaining expenses of $33 million to $46 million expected in the fourth quarter. However, we are in the process of negotiating contract terminations, and the ultimate restructuring charge will depend upon the results of these negotiations. We intend to complete the strategic initiatives by the end of fiscal 2004.

For the third quarter of 2004, total sales decreased 2.6 percent, or $18.0 million, to $661.4 million as compared to the third quarter of the prior year. Same-store sales, one of the key indicators we consider as a measure of performance, decreased 2.8 percent. Gross margin was 30.4 percent of sales in the current year’s third quarter, versus 27.6 percent in the prior year’s third quarter. For the first nine months of 2004, total sales increased 0.2 percent, or $4.6 million, to $2,049.3 as compared to the first nine months of 2003. Same-store sales decreased 0.3 percent. Gross margin was 31.1 percent of sales in the first nine months of 2004, versus 28.6 percent in the same period in 2003. The competitive environment in the third quarter remained highly promotional, a continuation of the environment that developed in the second quarter. During August and September we continued to be less promotional than the prior year in order to protect our gross margins. Sales during the month of October benefited from an increase in markdowns and a higher level of advertising than the prior two months.

Our cash and cash equivalents balance at the end of the 2004 third quarter was $216.2 million, an increase of $79.5 million from the end of 2003 and $86.6 million over the 2003 third quarter. Total inventories at the end of the 2004 third quarter were $361.7 million, a reduction of $30.1 million from the 2003 third quarter. Inventory per store declined by 7 percent on a cost basis and 9 percent on a footwear unit basis over the same period.

We are committed to serving the interest of our shareowners by building long-term value through consistent execution of our core business strategy: to be the Merchandise Authority in value-priced footwear and accessories. To improve the near-term execution of our strategy, we have adjusted certain key tactics including:

•   Simplifying our process for planning and executing merchandise assortments;

•   Refocusing and intensifying our messaging, increasing the frequency of communication with customers through print and broadcast media; and

•   Adjusting our store-level execution to achieve better balance between the tasks necessary to run a best-of-kind retail store and customer service through the use of our key service behaviors that have been identified to impact conversion.

Looking to the balance of the year, our strategy is to position the Company for improved performance in 2005 and beyond. To do so, we intend to complete all of our strategic initiatives by the end of fiscal 2004. We will continue to carefully manage our inventory receipts to assure that we end the year with our inventory appropriately positioned for the 2005 spring season. Consistent with this objective, our promotional level is likely to increase during the fourth quarter compared with the third quarter. We also intend to increase advertising during the fourth quarter as compared with the same period last year.

REVIEW OF OPERATIONS

The following discussion summarizes the significant factors affecting operating results for the third quarter and nine months ended October 30, 2004 (2004) and November 1, 2003 (2003).

32

NET EARNINGS

We posted net earnings of $6.6 million in the third quarter of 2004 compared with a net loss of $2.2 million in the third quarter of 2003. For the first nine months of 2004 net earnings were $24.5 million compared with $17.1 million in the 2003 period.

The following table presents the components of costs and expenses, as a percent of revenues, for the third quarter and first nine months of 2004 and 2003.

	Third Quarter						First Nine Months
	2004			2003			2004			2003
Cost of sales		69.6	%		72.4	%		68.9	%		71.4	%
Selling, general and administrative expense		26.6			26.6			26.6			26.0
Restructuring charges		0.6			—			0.9			—
Operating profit from continuing operations		3.3			0.9			3.6			2.6
Interest expense, net		0.7			0.7			0.6			0.6
Earnings from continuing operations before income taxes and minority interest		2.6			0.2			3.0			2.0
Effective income tax rate*		28.5	%		21.4	%		24.8	%		34.6	%
Earnings from continuing operations before minority interest		1.9			0.2			2.2			1.3
Minority interest		—			0.1			0.2			0.1
Net earnings from continuing operations		1.9	%		0.3	%		2.4	%		1.4	%

* Percent of pre-tax earnings (loss)

NET SALES

Net sales are recognized at the time the sale is made to the customer, are net of estimated returns and current promotional discounts and exclude sales tax. Third-party liquidation sales are recognized at the time the sale is made to the customer, are calculated based upon contractually guaranteed amounts pursuant to our agreements with liquidators and are net of associated fees. Same-store sales are calculated on a weekly basis. If a store is open the entire week in each of the two years being compared, its sales are included in the same-store sales calculation for that week. Relocated and remodeled stores are also included in the same-store sales calculation if they were open during the entire week in each of the two years being compared. Same-store sales for the third quarter and first nine months of 2004 and 2003 exclude all stores in the South American and Central American Regions. In addition, beginning in October, all Parade stores and the North American Payless ShoeSource stores that are part of our previously announced strategic initiatives are excluded from same-store sales results.

Sales percent increases (decreases) are as follows:

	Third Quarter						First Nine Months
	2004			2003			2004			2003
Net Sales		(2.6	)%		(0.3	)%		0.2	%		(3.3	)%
Same-store Sales		(2.8	)		(1.1	)		(0.3	)		(4.0	)
Average selling price per unit		9.0			(0.2	)		8.4			2.4
Unit volume		(11.5	)		0.3			(7.8	)		(5.1	)
Footwear average selling price per unit		9.9			(5.2	)		5.4			1.0
Footwear unit volume		(12.4	)%		4.3	%		(5.4	)%		(5.2	)%

Net sales for the 2004 third quarter totaled $661.4 million compared with $679.4 million in the 2003 third quarter. Net sales and same-store sales decreased in the third quarter of 2004 from 2003 primarily due to a difficult competitive environment combined with our strategy to be less promotional than last year in order to protect our gross margins, particularly in the first two months of the quarter.

33

Net sales for the first nine months of 2004 were up slightly compared with the 2003 period. In the first nine months of 2004, net sales totaled $2,049.3 million compared with $2,044.7 million in the first nine months of 2003.

COST OF SALES

Cost of sales includes cost of merchandise sold, buying and occupancy costs and markdowns incurred to liquidate inventory in stores associated with the restructuring. Cost of sales was $460.3 million in the 2004 third quarter, down 6.5 percent from $492.1 million in the 2003 third quarter. For the first nine months of 2004, cost of sales was $1,411.9 million, down 3.3 percent from $1,460.3 million in 2003.

As a percentage of net sales, cost of sales was 69.6 percent in the third quarter of 2004, compared with 72.4 percent in the third quarter of 2003. As a percentage of net sales, cost of sales was 68.9 percent in the first nine months of 2004, compared with 71.4 percent in the first nine months of 2003. The decrease in cost of sales as a percentage of net sales was due primarily to more favorable initial markups and fewer markdowns relative to the same period last year.

During the third quarter, we began to liquidate inventory in our Payless ShoeSource and Parade stores identified for closing. In conjunction with the liquidation, we recorded $0.4 million in inventory markdowns to reflect inventory at lower of cost or market. Such markdowns are reflected in cost of sales in the condensed consolidated statement of earnings (loss).

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

Selling, general and administrative expenses were $175.7 million in the third quarter of 2004, a decrease of 2.9 percent from $181.0 million in the third quarter of 2003. For the first nine months of 2004, selling, general and administrative expenses were $545.6 million, an increase of 2.7 percent from $531.4 million in the 2003 period.

As a percentage of net sales, selling, general and administrative expenses were 26.6 percent during the third quarter of 2004 compared with 26.6 percent in the third quarter of 2003. For the first nine months of 2004, selling, general and administrative expenses as a percentage of net sales were 26.6 percent compared with 26.0 percent in the 2003 period.

The decrease in the third quarter of 2004 was primarily the result of a $4.1 million decrease in advertising expense, as well as lower expenses for payroll and supplies, offset by increased bonus and professional service costs and negative leverage due to lower same-store sales. The increase in the first nine months of 2004 was primarily the result of $13.0 million of additional payroll and payroll-related costs, $4.5 million in increased worker’s compensation insurance costs, and $6.6 million in increased professional services related to the proxy contest and Sarbanes-Oxley compliance, partially offset by $2.2 million in decreased medical insurance costs and the write-off of $3.1 million in debt costs in conjunction with our debt restructuring during the 2003 period.

RESTRUCTURING CHARGES

The $7.3 million restructuring charge ($3.9 million relating to continuing operations and $3.4 million relating to discontinued operations) primarily relates to employee severance costs, contract termination costs and a reduction in the carrying value of assets for our Peruvian operations. The third quarter charges are in addition to the $36.7 million non-cash restructuring charge recorded in the second quarter related to the impairment of long-lived assets associated with Chile, Peru, Parade and the approximately 260 Payless stores to be closed. Of the $36.7 million charge, $13.7 million related to continuing operations and $23.0 million related to discontinued operations.

INTEREST EXPENSE, NET

Net interest expense decreased from $4.9 million in the third quarter of 2003 to $4.3 million in the third quarter of 2004 due to increased interest income as a result of higher average invested cash balances compared to last year. Interest expense for the first nine months of 2004 was $13.2 million, an increase of $0.9 million over the same period last year. The increase in net interest expense reflects the higher interest rate associated with the Senior Subordinated Notes compared with the $200 million term loan portion of the credit facility that was in place during the first half of 2003.

EFFECTIVE INCOME TAX RATE

Our effective income tax rate was 28.5 percent in the third quarter and 24.8 percent for the first nine months of 2004. The effective income tax rate of 28.5 percent for the third quarter includes an adjustment to reflect an effective tax rate of 24.8 percent for the first nine months of the year. We anticipate a tax benefit at the rate of 24.8 percent for the full fiscal year 2004. Our effective income tax rate was 21.4 percent in the third quarter and 34.6 percent for the first nine months of 2003.

34

MINORITY INTEREST, NET OF TAX

Minority interest represents our joint venture partners’ share of net earnings or losses on applicable international operations.

LIQUIDITY AND CAPITAL RESOURCES

We ended the third quarter of 2004 with a cash balance of $216.2 million, an increase of $86.6 million over the 2003 third quarter. Internally generated cash flow from operations is expected to continue to be the most important component of our capital resources.

Cash Flow Provided by Operating Activities

Cash flow provided by operations was $158.2 million in the first nine months of 2004, compared with $176.8 million in the 2003 period. As a percentage of net sales, cash flow from operations was 7.7 percent in the first nine months of 2004, compared with 8.6 percent in the same period in 2003. The significant changes in cash flow during the first nine months of 2004 as compared with the 2003 period are as follows: higher net earnings (excluding $12.0 million in non-cash restructuring charges for continuing operations); inventory decreased by $15.7 million in 2004 compared to $44.7 million in 2003 for a net cash outflow of $29.0 million due primarily to lower inventory levels at the beginning of 2004 compared to 2003; accounts payable decreased $23.7 million in 2004 compared to a $26.1 million increase in 2003 for a net cash outflow of $49.8 million; and accrued expenses increased $41.0 million in 2004 compared to $9.6 million in 2003 for a net cash inflow of $31.4 million due primarily to accrued income taxes, accrued payroll-related costs, accrued insurance costs and accrued restructuring charges.

Cash Flow Used in Investing Activities

In the first nine months of 2004, our capital expenditures totaled $82.0 million, compared with $83.5 million for the same period in 2003. We estimate that capital expenditures for the remainder of the year will be approximately $32 million, including $0.6 million to be contributed by our joint venture partners in the Central American and South American Regions. We anticipate that internal cash flow and available financing from our $200 million revolving credit agreement will be sufficient to finance all of these expenditures.

Cash Flow Provided by Financing Activities

In January 2004, we replaced our $150 million senior secured revolving credit facility (the “Old Facility”) with a new $200 million senior secured revolving credit facility (the “New Facility”). Funds borrowed under the New Facility are secured by domestic merchandise inventory and receivables. We may borrow up to $200 million through the New Facility, subject to a sufficient borrowing base. The New Facility bears interest at the LIBOR rate, plus a variable margin of 1.25 percent to 2.0 percent, or the base rate defined in the agreement governing the New Facility. The margin on the New Facility varies based upon certain borrowing levels specified in the agreement governing the New Facility. The variable interest rate at October 30, 2004, was 3.4 percent. A monthly commitment fee of 0.30 percent per annum is payable on the unborrowed balance. The New Facility is scheduled to expire in January 2008, with a one-year extension to January 2009 at our option. No amounts were drawn on the New Facility as of October 30, 2004. Based on our borrowing base, we may borrow up to $200.0 million under the New Facility, less $17.4 million in outstanding letters of credit as of October 30, 2004.

In July 2003, we sold $200.0 million of 8.25% Senior Subordinated Notes (the “Notes”) for $196.7 million, due 2013. The discount of $3.3 million is being amortized to interest expense over the life of the Notes. The Notes are guaranteed by all of our domestic subsidiaries. Interest on the Notes is payable semi-annually, beginning February 1, 2004. The Notes contain various covenants including those that may limit our ability to pay dividends, repurchase stock, accelerate the retirement of other subordinated debt or make certain investments. As of October 30, 2004, we were in compliance with all covenants. The proceeds of the Notes and additional general funds were used to repay the entire $200.0 million term loan portion of our Old Facility. As of October 30, 2004, the fair value of the Notes was $195.0 million based on recent trading activity of the Notes. On or after August 1, 2008, we may, on any one or more occasions, redeem all or a part of the Notes at the redemption prices set forth below, plus accrued and unpaid interest, if any, on the Notes redeemed, to the applicable redemption date:

Year	Percentage
2008		104.125	%
2009		102.750	%
2010		101.375	%
2011 and thereafter		100.000	%

35

We have entered into $18.5 million of demand notes payable to efficiently finance our subsidiaries in the Central American Region. We maintain cash balances of $18.5 million in certificates of deposit as compensating balances to collateralize these notes payable. The notes payable accrue interest at a weighted average 8.52 percent. The certificates of deposit earn interest at a weighted average of 8.11 percent and are reflected as restricted cash in the accompanying condensed consolidated balance sheet.

Financial Commitments

As a result of the restructuring, we estimate that cash commitments for contract terminations, severance and other exit activities will be in the range of $40 million to $53 million. However, the final financial impact of the restructuring is dependent upon the ultimate exit transactions. We expect to incur substantially all such charges in 2004.

As of October 30, 2004, no amounts were drawn against our $200 million revolving credit facility. The availability under the New Facility has been reduced, however, by $17.4 million in outstanding letters of credit. As a result of the restatement discussed in Note 3 to the condensed consolidated financial statements, our operating lease obligations as of October 30, 2004, are as follows:

(dollars in millions)
Payments Due by Period	Operating lease obligations
Remainder of Year	$	69.4
1-3 Years		467.7
3-5 Years		353.9
More than Five Years		338.4
Total	$	1,229.4

For a discussion of our other contractual obligations, see a discussion of future commitments under Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” in our Form 10-K for the fiscal year ended January 31, 2004. With the exception of restructuring and restatement related obligations previously discussed, there have been no significant developments with respect to our contractual obligations since January 31, 2004.

FINANCIAL CONDITION RATIOS

A summary of key financial information for the periods indicated is as follows:

	October 30, 2004			November 1, 2003			January 31, 2004
Current Ratio		2.4			2.3			2.3
Debt-Capitalization Ratio*		26.1	%		27.8	%		28.2	%

* Debt-to-capitalization has been computed by dividing total debt by capitalization. Total debt is defined as long-term debt including current maturities, notes payable and borrowings under the revolving line of credit. Capitalization is defined as total debt and shareowners’ equity. The debt-to-capitalization ratio, including the present value of future minimum rental payments under operating leases as debt and as capitalization, was 67.0%, 67.1% and 66.8% respectively, for the periods referred to above.

STORE ACTIVITY

As of October 30, 2004, we operated 5,022 retail shoe stores offering quality footwear and accessories in all 50 of the United States, the District of Columbia, Puerto Rico, Guam, Saipan, the U.S. Virgin Islands, Canada, and the Central and South American Regions. The following table presents the change in store count for the entire company for the third quarter and first nine months of 2004 and 2003. We consider a store relocation to be both a store opening and a store closing.

	Third Quarter						First Nine Months
	2004			2003			2004			2003
Beginning of period		5,072			5,020			5,042			4,992
Stores opened		78			84			226			202
Stores closed		(128	)		(54	)		(246	)		(144	)
Ending store count		5,022			5,050			5,022			5,050

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As of October 30, 2004, we operated 148 stores in the Central America Region, 63 stores in the South America Region and 304 stores in Canada. We have entered into a joint venture agreement to operate Payless ShoeSource stores in Japan. We own 60 percent of the Japanese joint venture and, therefore, have consolidated the results of such operations in our financial statements. We opened the first test store in Japan during November 2004. We have curtailed any other expansion into new international markets to focus on our core business.

We intend to exit from all 32 stores in Chile and Peru, all Parade stores and approximately 260 Payless stores pursuant to the restructuring plan strategic initiatives. We began the year with 5,042 stores and expect to end the year with approximately 4,640 stores.

CRITICAL ACCOUNTING POLICIES

In preparing the condensed consolidated financial statements included in this Form 10-Q/A, management makes estimates and assumptions that affect the amounts reported within the financial statements. Actual results could differ from these estimates, and such differences may be material to the condensed consolidated financial statements. We believe that the following critical accounting policies involve a higher degree of judgment or complexity (see the notes to our condensed consolidated financial statements for a complete discussion of our significant accounting policies).

Inventories

Merchandise inventories in our stores are valued by the retail method and are stated at the lower of cost, determined using the first-in, first-out (FIFO) basis, or market. Prior to shipment to a specific store, inventories are valued at the lower of cost using the FIFO basis, or market. The retail method is widely used in the retail industry due to its practicality. Under the retail method, cost is determined by applying a calculated cost-to-retail ratio across groupings of similar items, known as departments. As a result, the retail method results in an averaging of inventory costs across similar items within a department. The cost-to-retail ratio is applied to ending inventory at its current owned retail valuation to determine the cost of ending inventory on a department basis. Current owned retail represents the retail price for which merchandise is offered for sale on a regular basis reduced for any permanent or clearance markdowns. As a result, the retail method normally results in an inventory valuation that is lower than a traditional FIFO cost basis.

Inherent in the retail method calculation are certain significant management judgments and estimates including initial mark-up, markdowns and shrinkage, which can significantly impact the owned retail and, therefore, the ending inventory valuation at cost. Specifically, the failure to take permanent or clearance markdowns on a timely basis can result in an overstatement of cost under the retail method. We believe that our application of the retail method reasonably states inventory at the lower of cost or market.

Property and Equipment

Property and equipment are recorded at cost and depreciated on a straight-line basis over their estimated useful lives. The useful lives of assets are based upon our expectations. Investments in properties under capital leases and leasehold improvements are amortized over the shorter of their useful lives or their related lease terms.

Property and equipment are reviewed on a store-by-store basis if an indicator of impairment exists to determine whether the carrying amount of the asset is recoverable. Estimated future cash flows are used to determine if impairment exists. We use current operating results and historical performance to estimate future cash flows on a store-by-store basis.

Rent Expense

Certain of the Company’s lease agreements provide for scheduled rent increases during the lease term, as well as provisions for renewal options. Rent expense is recognized on a straight-line basis over the term of the lease from the time at which the Company takes possession of the property. In instances where failure to exercise renewal options would result in an economic penalty, the calculation of straight-line rent expense includes renewal option periods. Also, landlord-provided tenant improvement allowances are recorded in other liabilities and amortized as a credit to rent expense over the term of the lease.

Insurance Programs

We retain our normal expected losses related primarily to workers’ compensation, physical loss to property and business interruption resulting from such loss and comprehensive general, product, and vehicle liability. We purchase third party coverage for losses in excess of the normal expected levels. Provisions for losses expected under these programs are recorded based upon estimates of aggregate liability for claims incurred utilizing independent actuarial calculations. These actuarial calculations utilize assumptions to

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estimate the frequency and severity of losses as well as the patterns surrounding the emergence, development and settlement of claims based on historical results.

Accounting for Taxes

We are routinely under audit by the United States federal, state, local or international tax authorities in the areas of income taxes and sales and use taxes. In evaluating the potential exposures associated with our various tax filings, we accrue charges for possible exposures. Based on the annual evaluations of tax positions, we believe we have appropriately filed our tax returns and accrued for possible exposures. To the extent we were to prevail in income tax matters for which accruals have been established or be required to pay amounts in excess of reserves, our effective income tax rate in a given financial period might be impacted. We have various state, local and international tax examinations currently in process. The fiscal years ending February 2, 2002 and after could still be subject to a U.S. federal income tax audit but currently there is none in process.

We record valuation allowances against our deferred tax assets, when necessary, in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 109, “Accounting for Income Taxes.” Realization of deferred tax assets (such as net operating loss carryforwards) is dependent on future taxable earnings and is therefore uncertain. We assess the likelihood that our deferred tax assets in each of the jurisdictions in which we operate will be recovered from future taxable income. Deferred tax assets are reduced by a valuation allowance to recognize the extent to which, more likely than not, the future tax benefits will not be realized.

ITEM 3 — QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

INTEREST RATE RISK

Interest on our senior secured revolving credit facility, which is entirely comprised of a revolving line of credit, is based on the London Inter-Bank Offered Rate (“LIBOR”) plus a variable margin of 1.25 percent to 2.0 percent, or the base rate, as defined in the credit agreement. There are no outstanding borrowings on the revolving line of credit; however, if we were to borrow against our revolving line of credit, borrowing costs may fluctuate depending upon the volatility of LIBOR and amounts borrowed.

FOREIGN CURRENCY RISK

We have retail operations in foreign countries; therefore, our cash flows in U.S. dollars are impacted by fluctuations in foreign currency exchange rates. We adjust our retail prices, when possible, to reflect changes in exchange rates to mitigate this risk. To further mitigate this risk, we may, from time to time, enter into forward contracts to purchase or sell foreign currencies. For the quarters and nine-month periods ended October 30, 2004, and November 1, 2003, fluctuations in foreign currency exchange rates did not have a material impact on our operations or cash flows and we did not enter into any forward contracts to purchase or sell foreign currencies .

In 2003, approximately 84 percent of our products, based on cost, were sourced from the People’s Republic of China (the “PRC”). The national currency of the PRC, the yuan, is currently not a freely convertible currency. The yuan may be made freely convertible or be revalued by the PRC government. If this occurs, the products we source from the PRC could become more expensive.

ITEM 4 — CONTROLS AND PROCEDURES

As of October 30, 2004, we carried out an evaluation, under the supervision and with the participation of our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures are effective in alerting them in a timely manner to material information required to be disclosed in our periodic reports filed with the Securities Exchange Commission . The Company does not consider the impact of correcting its previously issued financial statements for the restatement discussed in Note 3 to the condensed consolidated financial statements to be material to any individual reporting period.

In addition, there was no change in our internal control over financial reporting that occurred during the fiscal quarter to which this report relates that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II — OTHER INFORMATION

ITEM 1 — LEGAL PROCEEDINGS

Other than as described below, there are no material pending legal proceedings other than ordinary, routine litigation incidental to the business to which the Company is a party or of which any of its property is subject.

On or about December 20, 2001, a First Amended Complaint was filed against the Company in the U.S. District Court for the District of Oregon, captioned Adidas America, Inc. and Adidas-Salomon AG v. Payless ShoeSource, Inc. The First Amended Complaint seeks injunctive relief and unspecified monetary damages for trademark and trade dress infringement, unfair competition, deceptive trade practices and breach of contract. The Company believes it has meritorious defenses to claims asserted in the lawsuit and has filed an answer and a motion for summary judgment which the court granted in part. An estimate of the possible loss, if any, or the range of loss cannot be made.

On or about January 20, 2000, a complaint was filed against the Company in the U.S. District Court for the District of New Hampshire, captioned Howard J. Dananberg, D.P.M. v. Payless ShoeSource, Inc. The Complaint seeks injunctive relief, unspecified treble monetary damages, attorneys’ fees, interest and costs for patent infringement. The Company believes it has meritorious defenses to claims asserted in the lawsuit. An estimate of the possible loss, if any, or the range of loss cannot be made.

ITEM 2 – CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES

The following table provides information about purchases by the Company (and its affiliated purchasers) during the quarter ended October 30, 2004, of equity securities that are registered by the Company pursuant to Section 12 of the Exchange Act:

ISSUER PURCHASES OF EQUITY SECURITIES

					Total Number of Shares		Approximate Dollar Value of
	Total Number of				Purchased as Part of		Shares that May Yet Be
	Shares Purchased (1)		Average Price Paid		Publicly Announced		Purchased Under the Plans or
Period	(in Thousands)		per Share		Plans or Programs (2)		Programs (in Millions) (3)
08/01/04 – 08/28/04		7	$	10.75		0	$	248.2
08/29/04 – 10/01/04		5		10.96		0		248.2
10/02/04 – 10/30/04		5		10.17		0		248.2
Total		17	$	10.64		0	$	248.2

(1) We repurchased an aggregate of 17,238 shares of our common stock in connection with our employee stock purchase and stock incentive plans.

(2) In 2001, our Board of Directors approved the repurchase of our common stock having a value of up to $250 million in the aggregate pursuant to the Program.

(3) The timing and amount of share repurchases, if any, are limited by the terms of the Company’s Credit Agreement and Senior Subordinated Notes.

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ITEM 6 — EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits:

Number	Description
31.1	Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 of the Chairman of the Board and Chief Executive Officer*
31.2	Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 of the Senior Vice President, Chief Financial Officer and Treasurer*
32.1	Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 of the Chairman of the Board and Chief Executive Officer*
32.2	Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 of the Senior Vice President, Chief Financial Officer and Treasurer*

* Filed herewith

(b) Reports on Form 8-K

On December 2, 2004, the Company filed a Current Report on Form 8-K furnishing under item 7.01 the Company’s press release announcing its sales for the fiscal month of November, which ended November 27, 2004.

On November 12, 2004, the Company filed a Current Report on Form 8-K furnishing under Items 5.02 and 7.01 the Company’s press release announcing its results for the third fiscal quarter of 2004, which ended October 30, 2004.

On November 4, 2004, the Company filed a Current Report on Form 8-K furnishing under Item 7.01 the Company’s press release announcing its sales for the fiscal month of October, which ended October 30, 2004.

On October 7, 2004, the Company filed a Current Report on Form 8-K furnishing under Items 7.01 and 8.01 the Company’s press release announcing its sales for the fiscal month of September, which ended October 2, 2004.

On September 2, 2004, the Company filed a Current Report on Form 8-K furnishing under Items 5.02, 7.01 and 8.01 the Company’s press release announcing its sales for the fiscal month of August, which ended August 28, 2004 and certain management restructuring actions.

On August 12, 2004, the Company filed a Current Report on Form 8-K furnishing under Items 9 and 12 the Company’s press release announcing its results for the second fiscal quarter of 2004, which ended July 31, 2004, and certain strategic initiatives.

On August 5, 2004, the Company filed a Current Report on Form 8-K furnishing under Items 5 and 9 the Company’s press release announcing its sales for the fiscal month of July, which ended July 31, 2004.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

		PAYLESS SHOESOURCE, INC.
Date: June 7, 2005	By:	/s/ Steven J. Douglass
	Steven J. Douglass
	Chairman of the Board and
	Chief Executive Officer
	(Principal Executive Officer)
Date: June 7, 2005	By:	/s/ Ullrich E. Porzig
	Ullrich E. Porzig
	Senior Vice President
	Chief Financial Officer and Treasurer
	(Principal Financial and Accounting Officer)

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Index to Exhibits

Number	Description
31.1	Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 of the Chairman of the Board and Chief Executive Officer*
31.2	Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 of the Senior Vice President, Chief Financial Officer and Treasurer*
32.1	Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 of the Chairman of the Board and Chief Executive Officer*
32.2	Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 of the Senior Vice President, Chief Financial Officer and Treasurer*

* Filed herewith