Bakers Footwear (BKRS) 10-Q 2011 Q3 Quarterly report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

þ Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended October 30, 2010

o Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from                    to                    

Commission File Number: 000-50563

BAKERS FOOTWEAR GROUP, INC.

(Exact name of registrant as specified in its charter)

Missouri	43-0577980
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

2815 Scott Avenue,
St. Louis, Missouri	63103
(Address of principal executive offices)	(Zip Code)

(314) 621-0699
(Registrant’s telephone number, including area code)

Not Applicable
(Former name, former address and former fiscal year, if changed since last report)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yeso Noo

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filero	Accelerated filero	Non-accelerated filero	Smaller reporting companyþ
		(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).oYesþ No

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

Common Stock, par value $0.0001 per share, 9,228,916 shares issued and outstanding as of December 4, 2010.

BAKERS FOOTWEAR GROUP, INC.
INDEX TO FORM 10-Q

	Page
Part I Financial Information
Item 1. Financial Statements (Unaudited)		3
Condensed Balance Sheets		3
Condensed Statements of Operations		4
Condensed Statement of Shareholders’ Equity (Deficit)		5
Condensed Statements of Cash Flows		6
Notes to Condensed Financial Statements		7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		15
Item 3. Quantitative and Qualitative Disclosures About Market Risk		27
Item 4. Controls and Procedures		27
Part II Other Information
Item 1. Legal Proceedings		28
Item 1A. Risk Factors		28
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		29
Item 3. Defaults Upon Senior Securities		29
Item 4. [Reserved]		29
Item 5. Other Information		29
Item 6. Exhibits		29
Signatures		30
Exhibit Index		31
Certification of Chief Executive Officer
Certification of Chief Financial Officer
Certification of CEO and CFO

2

PART I — FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

BAKERS FOOTWEAR GROUP, INC.

CONDENSED BALANCE SHEETS

	October 31,			January 30,			October 30,
	2009			2010			2010
	(Unaudited)						(Unaudited)
Assets
Current assets:
Cash and cash equivalents	$	164,538		$	154,685		$	137,467
Accounts receivable		1,580,717			1,387,358			1,903,112
Inventories		23,335,432			20,233,207			27,477,487
Prepaid expenses and other current assets		978,128			1,234,787			965,404
Total current assets		26,058,815			23,010,037			30,483,470
Property and equipment, net		26,183,851			24,757,395			19,586,088
Other assets		934,700			851,035			1,098,792
Total assets	$	53,177,366		$	48,618,467		$	51,168,350
Liabilities and shareholders’ equity (deficit)
Current liabilities:
Accounts payable	$	12,558,384		$	10,138,635		$	16,292,855
Accrued expenses		8,348,935			7,320,595			8,640,830
Subordinated secured term loan		3,375,229			2,785,112			901,407
Subordinated convertible debentures		4,000,000			4,000,000			—
Sales tax payable		997,137			1,152,277			1,043,072
Deferred income		1,384,472			1,366,252			1,133,335
Revolving credit facility		16,693,755			10,531,687			17,495,501
Total current liabilities		47,357,912			37,294,558			45,507,000
Accrued rent liabilities		9,364,217			9,183,756			8,911,771
Subordinated convertible debentures		—			—			4,000,000
Subordinated debenture		—			—			4,000,000
Shareholders’ equity (deficit):
Preferred stock, $0.0001 par value, 5,000,000 shares authorized, no shares outstanding		—			—			—
Common Stock, $0.0001 par value; 40,000,000 shares authorized, 7,382,856 shares outstanding at October 31, 2009 and January 30, 2010 and 9,228,916 shares outstanding at October 30, 2010		738			738			923
Additional paid-in capital		39,184,879			39,279,600			40,349,781
Accumulated deficit		(42,730,380	)		(37,140,185	)		(51,601,125	)
Total shareholders’ equity (deficit)		(3,544,763	)		2,140,153			(11,250,421	)
Total liabilities and shareholders’ equity (deficit)	$	53,177,366		$	48,618,467		$	51,168,350

See accompanying notes.

3

BAKERS FOOTWEAR GROUP, INC.

CONDENSED STATEMENTS OF OPERATIONS
(Unaudited)

	Thirteen			Thirteen			Thirty-nine			Thirty-nine
	Weeks			Weeks			Weeks			Weeks
	Ended			Ended			Ended			Ended
	October 31, 2009			October 30, 2010			October 31, 2009			October 30, 2010
Net sales	$	39,042,191		$	40,575,879		$	127,739,083		$	127,393,042
Cost of merchandise sold, occupancy, and buying expenses		32,275,828			34,225,698			95,354,173			98,373,653
Gross profit		6,766,363			6,350,181			32,384,910			29,019,389
Operating expenses:
Selling		9,655,891			9,570,751			29,640,515			29,000,060
General and administrative		3,872,358			3,831,426			12,270,014			11,524,740
Loss on disposal of property and equipment		3,460			7,172			297,891			67,449
Impairment of long-lived assets		2,762,273			1,415,979			2,762,273			1,415,979
Operating loss		(9,527,619	)		(8,475,147	)		(12,585,783	)		(12,988,839	)
Other income (expense):
Interest expense		(680,580	)		(542,348	)		(2,179,478	)		(1,537,184	)
Other, net		41,219			82,514			92,970			116,787
Loss before income taxes		(10,166,980	)		(8,934,981	)		(14,672,291	)		(14,409,236	)
Provision for income taxes		—			—			—			51,704
Net loss	$	(10,166,980	)	$	(8,934,981	)	$	(14,672,291	)	$	(14,460,940	)
Basic loss per share	$	(1.38	)	$	(1.03	)	$	(2.01	)	$	(1.85	)
Diluted loss per share	$	(1.38	)	$	(1.03	)	$	(2.01	)	$	(1.85	)

See accompanying notes.

4

BAKERS FOOTWEAR GROUP, INC.

CONDENSED STATEMENT OF SHAREHOLDERS’ EQUITY (DEFICIT)
(Unaudited)

	Common Stock
	Shares				Additional
	Issued and				Paid-In		Accumulated
	Outstanding		Amount		Capital		Deficit			Total
Balance at January 30, 2010		7,382,856	$	738	$	39,279,600	$	(37,140,185	)	$	2,140,153
Stock-based compensation expense		—		—		269,981		—			269,981
Issuance of common stock		1,844,860		184		799,816		—			800,000
Shares issued in connection with exercise of stock options		1,200		1		384		—			385
Net loss		—		—		—		(14,460,940	)		(14,460,940	)
Balance at October 30, 2010		9,228,916	$	923	$	40,349,781	$	(51,601,125	)	$	(11,250,421	)

See accompanying notes.

5

BAKERS FOOTWEAR GROUP, INC.

CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)

	Thirty-nine			Thirty-nine
	Weeks Ended			Weeks Ended
	October 31, 2009			October 30, 2010
Operating activities
Net loss	$	(14,672,291	)	$	(14,460,940	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		5,021,487			4,389,813
Accretion of debt discount		391,280			178,795
Stock-based compensation expense		490,620			269,981
Interest expense recognized for issuing common stock related to amending the subordinated secured term loan		187,500			—
Loss on disposal of property and equipment		297,891			67,450
Impairment of long-lived assets		2,762,273			1,415,979
Changes in operating assets and liabilities:
Accounts receivable		(207,330	)		(352,385	)
Inventories		(2,359,080	)		(7,244,280	)
Prepaid expenses and other current assets		49,467			269,383
Other assets		127,707			(13,713	)
Accounts payable		5,001,400			6,154,220
Accrued expenses and deferred income		303,709			978,113
Accrued rent liabilities		(410,612	)		(271,985	)
Net cash used in operating activities		(3,015,979	)		(8,619,569	)
Investing activities
Purchase of property and equipment		(331,746	)		(852,334	)
Proceeds from sale of property and equipment		27			3,282
Net cash used in investing activities		(331,719	)		(849,052	)
Financing activities
Net advances under revolving credit facility		5,210,893			6,963,814
Net proceeds from the issuance of subordinated secured term loan and common stock		—			4,549,704
Costs of issuing subordinated term loan and common stock		—			385
Principal payments on subordinated secured term loan		(1,833,333	)		(2,062,500	)
Net cash provided by financing activities		3,377,560			9,451,403
Net increase (decrease) in cash and cash equivalents		29,862			(17,218	)
Cash and cash equivalents at beginning of period		134,676			154,685
Cash and cash equivalents at end of period	$	164,538		$	137,467
Supplemental disclosures of cash flow information
Cash paid for interest	$	1,475,034		$	1,048,992

See accompanying notes.

6

BAKERS FOOTWEAR GROUP, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS
Unaudited

1. Basis of Presentation

     The accompanying unaudited condensed financial statements contain all adjustments that management believes are necessary to present fairly Bakers Footwear Group, Inc.’s (the Company’s) financial position, results of operations and cash flows for the periods presented. Such adjustments consist of normal recurring accruals. Certain information and disclosures normally included in notes to financial statements have been condensed or omitted in accordance with the rules and regulations of the Securities and Exchange Commission. The Company’s operations are subject to seasonal fluctuations and, consequently, operating results for interim periods are not necessarily indicative of the results that may be expected for other interim periods or for the full year. The condensed financial statements should be read in conjunction with the audited financial statements and the notes thereto contained in our Annual Report on Form 10-K for the fiscal year ended January 30, 2010. The Company has evaluated subsequent events through the date the financial statements were issued and filed with the Securities and Exchange Commission (“SEC”) and has made disclosures of all material subsequent events in the notes to the unaudited condensed interim financial statements.

2. Liquidity

     The Company’s cash requirements are primarily for working capital, principal and interest payments on debt obligations, and capital expenditures. Historically, these cash needs have been met by cash flows from operations, borrowings under the Company’s revolving credit facility and sales of securities. The balance on the revolving credit facility fluctuates throughout the year as a result of seasonal working capital requirements and other uses of cash.

     The Company’s losses in the first thirty-nine weeks of fiscal year 2010 and fiscal years after 2005 have had a significant negative impact on the Company’s financial position and liquidity. As of October 30, 2010, the Company had negative working capital of $15.0 million, unused borrowing capacity under its revolving credit facility of $2.8 million, and shareholders’ deficit of $11.3 million.

     The Company’s business plan for the remainder of fiscal year 2010 is based on mid-single digit increases in comparable store sales for the remainder of the year. Based on the business plan, the Company expects to maintain adequate liquidity for the remainder of fiscal year 2010. The business plan reflects continued focus on inventory management and on timely promotional activity. The plan also includes continued control over selling, general and administrative expenses. The Company continues to work with its landlords and vendors to arrange payment terms that are reflective of its seasonal cash flow patterns in order to manage availability. The business plan for the remainder of fiscal year 2010 reflects continued cash flow management, but does not indicate a return to profitability. The Company’s 2011 business plan, under which the Company expects to maintain adequate levels of liquidity for fiscal year 2011, reflects continued mid-single digit increases in comparable store sales and working with its vendors and landlords to arrange payment terms that are reflective of the Company’s seasonal cash flow patterns in order to manage availability. However, there is no assurance that the Company will achieve the sales, margin or cash flow contemplated in its business plans.

     On May 28, 2010, the Company amended its revolving credit facility. The amendment extended the maturity of the credit facility to May 28, 2013, modified the calculation of the borrowing base, added a new minimum availability or adjusted EBITDA interest coverage ratio covenant, added an obligation for the Company to extend the maturity of its subordinated convertible debentures, and made other changes to the agreement. The Company incurred fees and expenses of approximately $250,000 in connection with this amendment. The minimum availability or adjusted EBITDA interest coverage ratio covenant requires that either the Company maintain unused availability greater than 20% of the calculated borrowing base or maintain a ratio of adjusted EBITDA to interest expense (both as defined in the amendment) of no less than 1.0:1.0. The minimum availability covenant is tested daily and, if not met, then the adjusted EBITDA covenant is tested on a rolling twelve month basis. The adjusted EBITDA calculation is substantially similar to the calculation used previously in the Company’s subordinated secured term loan. The Company did not meet these covenants for the months of June and July 2010; however, this covenant violation was waived by the bank in connection with the Debenture and Stock Purchase Agreement discussed below. During the third quarter of fiscal year 2010, the Company met the bank covenant based on maintaining unused availability greater than 20% on a daily basis. The Company’s business plan for the remainder of 2010 and for 2011 also anticipates meeting the bank covenant on this basis. The Company continues to closely monitor its availability and continues to be constrained by its limited unused borrowing capacity.

7

     On August 26, 2010, the Company entered into a Debenture and Stock Purchase Agreement with Steven Madden, Ltd. In connection with the agreement, the Company sold a subordinated debenture in the principal amount of $5,000,000. Under the subordinated debenture, interest payments are required to be paid quarterly at an interest rate of 11% per annum. The principal amount is required to be paid in four annual installments commencing August 31, 2017, and the subordinated debenture matures on August 31, 2020. The subordinated debenture is generally unsecured and subordinate to the Company’s other indebtedness. As additional consideration, Steven Madden, Ltd. also received 1,844,860 shares of the Company’s common stock, representing a 19.99% interest in the Company on a post-closing basis. In connection with the transaction, the Company received aggregate net proceeds of approximately $4.5 million after transaction and other costs.

     The Company allocated the net proceeds received in connection with the subordinated debenture and the related issuance of common stock based on the relative fair values of the debt and equity components of the transaction. Other expenses incurred by the Company relative to this transaction were allocated either to debt issuance costs or as a reduction of additional paid-in capital based on either specific identification of the particular expenses or on a pro rata basis. The Company is accreting the initial value of the debt to the nominal value of the debt over the term of the loan using the effective interest method and recognizes such accretion as a component of interest expense. Likewise, the Company amortizes the related debt issuance costs using the effective interest method and recognizes this amortization as a component of interest expense.

     In fiscal year 2008, the Company obtained net proceeds of $6.7 million from the entry into a $7.5 million subordinated secured term loan which is now due January 1, 2011. Originally, the term loan agreement contained financial covenants requiring the Company to maintain specified levels of tangible net worth and adjusted EBITDA (as defined in the agreement) measured each fiscal quarter. The Company has amended the loan agreement four times (May 2008, April 2009, September 2009 and March 2010) to modify these covenants in order to remain in compliance. The March 2010 amendment completely eliminated these covenants for the remainder of the term loan.

     Based on the Company’s business plans for fiscal years 2010 and 2011, the Company believes that it will be able to comply with the minimum availability or adjusted EBITDA coverage ratio covenant in the revolving credit facility. However, given the inherent volatility in the Company’s sales performance, there is no assurance that the Company will be able to do so. In addition, in light of the Company’s historical sales volatility and the current state of the economy, the Company believes that there is a reasonable possibility that the Company may not be able to comply with its financial covenants. Failure to comply would be a default under the terms of the Company’s revolving credit facility and could result in the acceleration of all of the Company’s debt obligations. If the Company is unable to comply with its financial covenants, it will be required to seek one or more amendments or waivers from its lenders. The Company believes that it would be able to obtain any required amendments or waivers, but can give no assurance that it would be able to do so on favorable terms, if at all. If the Company is unable to obtain any required amendments or waivers, the Company’s lenders would have the right to exercise remedies specified in the loan agreements, including accelerating the repayment of debt obligations and taking collection action against the Company. If such acceleration occurred, the Company currently has insufficient cash to pay the amounts owed and would be forced to obtain alternative financing.

     The Company continues to face considerable liquidity constraints. Although the Company believes the business plan is achievable, should the Company fail to achieve the sales or gross margin levels anticipated, or if the Company were to incur significant unplanned cash outlays, it would become necessary for the Company to obtain additional sources of liquidity or make further cost cuts to fund its operations. In recognition of existing liquidity constraints, the Company continues to look for additional sources of capital at acceptable terms. However, there is no assurance that the Company would be able to obtain such financing on favorable terms, if at all, or to successfully further reduce costs in such a way that would continue to allow the Company to operate its business.

     The Company’s independent registered public accounting firm’s report issued in the Company’s most recent Annual Report on Form 10-K included an explanatory paragraph describing the existence of conditions that raise substantial doubt about the Company’s ability to continue as a going concern, including recent losses and working capital deficiency. The financial statements do not include any adjustments relating to the recoverability and classification of assets carrying amounts or the amount of and classification of liabilities that may result should the Company be unable to continue as a going concern.

3. Impairment of Long-Lived Assets

8

     The Company reviews long-lived assets to be “held and used” for impairment when events or circumstances exist that indicate the carrying amount of those assets may not be recoverable. The Company regularly analyzes the operating results of its stores and assess the viability of under-performing stores to determine whether they should be closed or whether their associated assets, including furniture, fixtures, equipment, and leasehold improvements, have been impaired. Asset impairment tests are performed at least annually, on a store-by-store basis. After allowing for an appropriate start-up period, unusual nonrecurring events, and favorable trends, fixed assets of stores indicated to be impaired are written down to fair value based on management’s estimates of future store sales and expenses, which are considered Level 3 inputs. During the thirty-nine weeks ended October 30, 2010 and October 31, 2009, the Company recorded $1,415,979 and $2,762,273, respectively, in noncash charges to earnings related to the impairment of long-lived assets.

4. Nasdaq Capital Market Delisting

     On August 17, 2010, the Nasdaq Stock Market filed a Form 25 with the Securities and Exchange Commission to complete the delisting of the common stock of the Company and Nasdaq informed the Company of such filing. Trading of the Company’s common stock was suspended on June 18, 2010 for failure to meet the minimum stockholders’ equity requirement under Nasdaq Listing Rule 5550(b), and has not traded on Nasdaq since that time. The delisting became effective on August 27, 2010, ten days after the filing of the Form 25. The Company’s common stock has traded on the OTC Bulletin Board since June 18, 2010.

5. Revolving Credit Facility

     The Company has a revolving credit agreement with a commercial bank (Bank). This agreement calls for a maximum line of credit of $30,000,000 subject to the calculated borrowing base as defined in the agreement, which is based primarily on the Company’s inventory level. The agreement is secured by substantially all assets of the Company. The credit facility is senior to the subordinated secured term loan, the subordinated convertible debentures and the subordinated debenture . Interest is payable monthly at the bank’s base rate plus 3.5%. An unused line fee of 0.75% per annum is payable monthly based on the difference between the maximum line of credit and the average loan balance. The Company had approximately $3,509,000, $1,900,000 and $2,814,000 (under the terms of the new minimum availability covenant discussed below as applicable) of unused borrowing capacity under the revolving credit agreement based upon the Company’s borrowing base calculation as of October 31, 2009, January 30, 2010, and October 30, 2010, respectively. The agreement has certain restrictive financial and other covenants relating to, among other things, use of funds under the facility in accordance with the Company’s business plan, prohibiting a change of control, including any person or group acquiring beneficial ownership of 40% or more of the Company’s common stock or combined voting power (as defined in the credit facility), maintaining a minimum availability, prohibiting new debt, restricting dividends and the repurchase of the Company’s stock, and restricting certain acquisitions. The revolving credit agreement also provides that the Company can elect to fix the interest rate on a designated portion of the outstanding balance as set forth in the agreement based on the LIBOR (London Interbank Offered Rate) plus 4.0%.

     On May 28, 2010, the Company amended its revolving credit agreement. The amendment extended the maturity of the credit facility from January 31, 2011 to May 28, 2013, modified the calculation of the borrowing base, added a new minimum availability or adjusted EBITDA interest coverage ratio covenant, added an obligation for the Company to extend the maturity of its subordinated convertible debentures, and made other changes to the agreement. The Company incurred fees and expenses of approximately $250,000 in connection with this amendment. The minimum availability or adjusted EBITDA interest coverage ratio covenant requires that either the Company maintain unused availability greater than 20% of the calculated borrowing base or maintain the ratio of the Company’s adjusted EBITDA to its interest expense (both as defined in the amendment) of no less than 1.0:1.0. The minimum availability covenant is tested daily and, if not met, then the adjusted EBITDA covenant is tested on a rolling twelve month basis. The adjusted EBITDA calculation is substantially similar to the calculation used previously in the Company’s subordinated secured term loan.

6. Subordinated Debenture

     On August 26, 2010, the Company entered into a Debenture and Stock Purchase Agreement with Steven Madden, Ltd. In connection with the agreement, the Company sold a subordinated debenture in the principal amount of $5,000,000. Under the subordinated debenture, interest payments are required to be paid quarterly at an interest rate of 11% per annum. The principal amount is required to be paid in four annual installments commencing August 31, 2017, through the final maturity date on August 31, 2020. The subordinated debenture is generally unsecured and subordinate to the Company’s other indebtedness. As additional consideration, Steven Madden, Ltd. also received 1,844,860 shares of the Company’s common stock, representing a 19.99% interest in the Company

9

on a post-closing basis. In connection with the transaction, the Company received aggregate net proceeds of approximately $4.5 million after transaction and other costs.

     The Company allocated the net proceeds received in connection with the subordinated debenture and the related issuance of common stock based on the relative fair values of the debt and equity components of the transaction. The fair value of the 1,844,860 shares of common stock issued was estimated based on the actual market value of the Company’s common stock at the time of the transaction net of a blockage discount based on the size of the issuance relative to average trading volume in the Company’s common stock and a discount to reflect that unregistered shares were issued and could not be sold on the open market. The fair value of the $5.0 million principal amount of debt was estimated based on publicly available data regarding the valuation of debt of companies with comparable credit ratings. The relative fair values of the debt and equity components were then pro rated into the net proceeds received by the Company to determine the amounts to be allocated to debt and to equity. Other expenses incurred by the Company relative to this transaction were allocated either to debt issuance costs or as a reduction of additional paid-in capital based on either specific identification of the particular expenses or on a pro rata basis. The Company accretes the initial value of the debt to the nominal value of the debt over the term of the loan using the effective interest method and recognizes such accretion as a component of interest expense. Likewise, the Company amortizes the related debt issuance costs using the effective interest method and recognizes this amortization as a component of interest expense.

7. Subordinated Secured Term Loan

     Effective February 4, 2008, the Company consummated a $7.5 million three-year subordinated secured term loan (the Loan) and issued 350,000 shares of the Company’s common stock as additional consideration. The Loan matures on January 3, 2011, and requires monthly payments of principal and interest at an interest rate of 15% per annum. Net proceeds to the Company after transaction costs were approximately $6.7 million. The Company used the net proceeds to repay amounts owed under its revolving credit facility and for working capital purposes. The Loan is secured by substantially all of the Company’s assets and is subordinate to the Company’s revolving credit facility but has priority over the Company’s subordinated convertible debentures and the subordinated debenture issued subsequent to the end of the second quarter.

     On March 23, 2010, the Company amended the Loan to eliminate the financial covenant for minimum adjusted EBITDA for the period February 1, 2009 to January 30, 2010 in order to maintain compliance with that covenant. The amendment also eliminated the financial covenants relating to the Company’s tangible net worth (as defined in the Loan Agreement) and minimum adjusted EBITDA for the remaining term of the Loan.

     Prior to the amendment described above, the Loan agreement contained financial covenants which required the Company to maintain specified levels of tangible net worth and adjusted EBITDA, both as defined in the loan agreement, each fiscal quarter and annual limits on capital expenditures, as defined in the loan agreement, of no more than $1.0 million each for fiscal years 2009 and 2010. Upon the occurrence of an event of default as defined in the loan agreement, the Lender will be entitled to acceleration of the debt plus all accrued and unpaid interest, subject to the Senior Subordination Agreement, with the interest rate increasing to 17.5% per annum.

     The Company allocated the net proceeds received in connection with this loan and the related issuance of common stock based on the relative fair values of the debt and equity components of the transaction. The fair value of the 350,000 shares of common stock issued was estimated based on the actual market value of the Company’s common stock at the time of the transaction net of a discount to reflect that unregistered shares were issued and could not be sold on the open market until the related required registration statement, covering these shares was declared effective by the SEC, which occurred on May 21, 2008. The fair value of the $7.5 million of debt was estimated based on publicly available data regarding the valuation of debt of companies with comparable credit ratings. The relative fair values of the debt and equity components were then pro rated into the net proceeds received by the Company to determine the amounts to be allocated to debt and to equity. Other expenses incurred by the Company relative to this transaction were allocated either to debt issuance costs or as a reduction of additional paid-in capital based on either specific identification of the particular expenses or on a pro rata basis. Based on this analysis, the Company allocated $6,150,000 to the initial value of the Loan and allocated $715,000 to the value of the 350,000 shares of common stock. The Company accretes the initial value of the debt to the nominal value of the debt over the term of the loan using the effective interest method and recognizes such accretion as a component of interest expense. Likewise, the Company is amortizing the related debt issuance costs using the effective interest method and recognizes this amortization as a component of interest expense.

10

     Scheduled principal payments, net of debt discount applied on the effective interest method are $901,407 for the remainder of fiscal year 2010 subsequent to October 30, 2010. On August 26, 2010, in connection with the issuance of the subordinated debenture, the loan maturity date was changed to January 3, 2011 from February 1, 2011.

8. Subordinated Convertible Debentures

     On June 26, 2007, the Company completed a private placement of $4,000,000 in aggregate principal amount of subordinated convertible debentures. The Company received net proceeds of approximately $3.6 million. The subordinated convertible debentures bear interest at a rate of 9.5% per annum, payable semi-annually. The principal balance of $4,000,000 is payable in full on June 30, 2012. As disclosed in Notes 2 and 5, the amendment to the Company’s revolving credit facility requires that the Company amend the subordinated convertible debentures on or before May 1, 2012, to extend the maturity to a date beyond July 27, 2013; however, the Company has not yet entered into negotiations to obtain such amendment. As a result of the extension of the revolving credit agreement, the issuance of the subordinated debenture, and the Company’s projected ability to comply with its financial debt covenants, all as described in Note 2, the subordinated convertible debentures have been classified as a noncurrent liability as of October 30, 2010. The initial conversion price of the debentures was $9.00 per share. The conversion price is subject to anti-dilution and other adjustments, including a weighted average conversion price adjustment for certain future issuances or deemed issuances of common stock at a lower price, subject to limitations. The Company can redeem the unpaid principal balance of these debentures if the closing price of the Company’s common stock is at least $16.00 per share, subject to the adjustments and conditions in the debentures.

     These debentures contain a weighted average conversion price adjustment that is triggered by issuances or deemed issuances of the Company’s common stock. As a result of the issuance of shares of common stock, effective February 4, 2008, the weighted average conversion price of the debentures decreased from $9.00 to $8.64 and on May 9, 2008, the weighted average conversion price of the debentures decreased from $8.64 to $8.59. As a result of the issuance of shares on April 9, 2009, the weighted average conversion price of the debentures decreased from $8.59 to $8.31. Effective August 26, 2010, the conversion price of the debentures decreased from $8.31 to $6.76 with respect to $1 million in aggregate principal amount of debentures and to $8.10, the minimum conversion price, with respect to $3 million in aggregate principal amount of debentures held by directors and director affiliates as a result of the issuance of the 1,844,860 shares and subordinated debenture discussed in Note 2.

     On February 1, 2009, the Company adopted updated FASB guidance in ASC 815 Derivatives and Hedging related to determining whether an instrument (or embedded feature) is indexed to an entity’s own stock and established a two-step process for making such determination. There was no significant financial impact to the Company as a result of adopting this guidance. Beginning February 1, 2009, the Company accounts separately for the fair value of the conversion feature of the subordinated convertible debentures. As of October 31, 2009, January 30, 2010, and October 30, 2010 the Company determined that the fair value of the conversion feature was de minimis. Significant future increases in the value of the Company’s common stock would result in an increase in the fair value of the conversion feature which would result in expense recognition in future periods.

9. Income Taxes

     In accordance with ASC 740, Income Taxes, the Company regularly assesses available positive and negative evidence to determine whether it is more likely than not that its deferred tax asset balances will be recovered from (a) reversals of deferred tax liabilities, (b) potential utilization of net operating loss carrybacks, (c) tax planning strategies and (d) future taxable income. There are significant restrictions on the consideration of future taxable income in determining the realizability of deferred tax assets in situations where a company has experienced a cumulative loss in recent years. When sufficient negative evidence exists that indicates that full realization of deferred tax assets is no longer more likely than not, a valuation allowance is established as necessary against the deferred tax assets, increasing the Company’s income tax expense in the period that such conclusion is reached. Subsequently, the valuation allowance is adjusted up or down as necessary to maintain coverage against the deferred tax assets. If, in the future, sufficient positive evidence, such as a sustained return to profitability, arises that would indicate that realization of deferred tax assets is once again more likely than not, any existing valuation allowance would be reversed as appropriate, decreasing the Company’s income tax expense in the period that such conclusion is reached.

     The Company has concluded that the realizability of net deferred tax assets is unlikely and therefore maintains a valuation allowance against net deferred tax assets. As of October 30, 2010, the Company increased the valuation allowance to $21,880,603.

11

The Company has scheduled the reversals of its deferred tax assets and deferred tax liabilities and has concluded that based on the anticipated reversals a valuation allowance is necessary only for the excess of deferred tax assets over deferred tax liabilities.

     As of October 30, 2010, the Company has approximately $32.9 million of net operating loss carryforwards that expire through 2022 available to offset future taxable income.

     Significant components of the provision for (benefit from) income tax expense are as follows:

	Thirteen			Thirteen			Thirty-nine			Thirty-nine
	Weeks Ended			Weeks Ended			Weeks Ended			Weeks Ended
	October 31, 2009			October 30, 2010			October 31, 2009			October 30, 2010
Current:
Federal	$	(1,896,202	)	$	(1,739,470	)	$	(2,959,723	)	$	(3,085,410	)
State and local		(439,318	)		(399,418	)		(674,481	)		(643,147	)
Total current		(2,335,520	)		(2,138,888	)		(3,634,204	)		(3,728,557	)
Deferred:
Federal		(1,320,839	)		(1,089,568	)		(1,679,324	)		(1,469,185	)
State and local		(240,153	)		(198,103	)		(305,332	)		(267,124	)
Total deferred		(1,560,992	)		(1,287,671	)		(1,984,656	)		(1,736,309	)
Valuation allowance		3,896,512			3,426,559			5,618,860			5,516,570
Total income tax expense	$	—		$	—		$	—		$	51,704

     The differences between income tax expense at the statutory U.S. federal income tax rate of 35% and the amount reported in the statements of operations are as follows:

	Thirteen			Thirteen			Thirty-nine			Thirty-nine
	Weeks Ended			Weeks Ended			Weeks Ended			Weeks Ended
	October 31, 2009			October 30, 2010			October 31, 2009			October 30, 2010
Federal income tax at statutory rate	$	(3,558,443	)	$	(3,127,243	)	$	(5,135,302	)	$	(5,043,233	)
Impact of State NOL carryback refund restrictions		—			—			—			51,704
Impact of graduated Federal rates		101,670			89,350			146,723			144,092
State and local taxes, net of federal income taxes		(449,604	)		(395,118	)		(648,846	)		(637,216	)
Change in valuation allowance		3,896,512			3,426,558			5,618,860			5,516,570
Permanent differences		9,865			6,453			18,565			19,787
Total income tax expense	$	—		$	—		$	—		$	51,704

     Deferred income taxes arise from temporary differences in the recognition of income and expense for income tax purposes. Deferred income taxes were computed using the liability method and reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial statement purposes and the amounts used for income tax purposes.

     Components of the Company’s deferred tax assets and liabilities are as follows:

	October 31, 2009			January 30, 2010			October 30, 2010
Deferred tax assets:
Net operating loss carryforward	$	10,966,852		$	8,894,200		$	12,822,453
Vacation accrual		398,736			396,524			410,565
Inventory		1,386,641			989,396			1,419,073
Stock-based compensation		1,079,577			1,116,518			1,221,810
Accrued rent		3,652,044			3,581,665			3,475,591
Property and equipment		1,185,803			1,496,584			2,664,962
Total deferred tax assets		18,669,653			16,474,887			22,014,454
Deferred tax liabilities:
Prepaid expenses		154,787			111,467			133,851
Total deferred tax liabilities		154,787			111,467			133,851
Valuation allowance		(18,514,866	)		(16,363,420	)		(21,880,603	)
Net deferred tax assets	$	—		$	—		$	—

12

     The Company’s federal income tax returns subsequent to the fiscal year ended January 1, 2005 remain open. As of October 30, 2010, the Company has not recorded any unrecognized tax benefits. The Company’s policy, if it had unrecognized benefits, is to recognize accrued interest and penalties related to unrecognized tax benefits as interest expense and other expense, respectively.

10. Stock-Based Compensation

     During the thirty-nine weeks ended October 30, 2010, the Company issued 227,000 nonqualified stock options with a weighted average exercise price of $2.50. These options are exercisable in equal annual installments of 20% on or after each of the first five years from the date of grant and expire ten years from the date of grant. In June 2009, the executive officers and members of the Company’s Board of Directors surrendered, for no current or future consideration, 224,073 stock options with exercise prices ranging from $7.75 to $20.06. In accordance with ASC 718, the Company recognized $171,966 of non-cash stock-based compensation expense as a result of these surrenders.

     The Company uses the Black-Scholes option pricing model to determine the fair value of stock-based compensation. The number of stock options granted, their grant-date weighted-average fair value, and the significant assumptions used to determine fair-value during the thirty-nine weeks ended October 31, 2009 and October 30, 2010, are as follows:

	Thirty-nine			Thirty-nine
	Weeks Ended			Weeks Ended
	October 31, 2009			October 30, 2010
Options granted		72,000			227,000
Weighted-average fair value of options granted	$	0.33		$	1.96
Assumptions
Dividends		0	%		0	%
Risk-free interest rate		2.2	%		2.8	%
Expected volatility		54	%		97	%
Expected option life	6 years			6 years

     During the thirty-nine weeks ended October 30, 2010, the Company also issued 84,000 shares of restricted common stock and cancelled 7,000 previously issued shares of restricted stock. Shares of restricted stock cliff vest on the five year anniversary of the grant date. The value of the Company’s common stock on the date the restricted shares were issued was $0.32.

11. Earnings (Loss) Per Share

     Basic earnings (loss) per share are computed using the weighted average number of common shares outstanding during the period. Diluted earnings per share are computed using the weighted average number of common shares and potential dilutive securities that were outstanding during the period. Potential dilutive securities consist of outstanding stock options and warrants and shares underlying the subordinated convertible debentures.

     The following table sets forth the components of the computation of basic and diluted earnings (loss) per share for the periods indicated.

	Thirteen			Thirteen			Thirty-nine			Thirty-nine
	Weeks			Weeks			Weeks			Weeks
	Ended			Ended			Ended			Ended
	October 31, 2009			October 30, 2010			October 31, 2009			October 30, 2010
Numerator:
Net loss	$	(10,166,980	)	$	(8,934,981	)	$	(14,672,291	)	$	(14,460,940	)
Numerator for loss per share		(10,166,980	)		(8,934,981	)		(14,672,291	)		(14,460,940	)
Interest expense related to convertible debentures		—			—			—			—
Numerator for diluted loss per share	$	(10,166,980	)	$	(8,934,981	)	$	(14,672,291	)	$	(14,460,940	)
Denominator:
Denominator for basic earnings (loss) per share — weighted average shares		7,382,856			8,701,813			7,309,830			7,822,982
Effect of dilutive securities
Stock purchase warrants		—			—			—			—
Convertible debentures		—			—			—			—
Denominator for diluted earnings (loss) per share — adjusted weighted average shares and assumed conversions		7,382,856			8,701,813			7,309,830			7,822,982

13

     The diluted earnings per share calculation for the thirteen weeks ended October 30, 2010 excludes 28,365 incremental shares related to outstanding stock options and 508,148 incremental shares underlying convertible debentures because they are antidilutive. The diluted earnings per share calculation for the thirty-nine weeks ended October 30, 2010 excludes 34,241 incremental shares related to outstanding stock options and 490,281 incremental shares underlying convertible debentures because they are antidilutive. The diluted earnings per share calculation for the thirteen weeks ended October 31, 2009 excludes 22,241 incremental shares related to outstanding stock options and 481,348 incremental shares underlying convertible debentures because they are antidilutive. The diluted earnings per share calculation for the thirty-nine weeks ended October 31, 2009 excludes 16,750 incremental shares related to outstanding stock options and 477,440 incremental shares underlying convertible debentures because they are antidilutive.

12. Commitments and Contingencies

     The Company has certain contingent liabilities resulting from litigation and claims incident to the ordinary course of business. Management believes the probable resolution of such contingencies will not materially affect the financial position or results of operations of the Company. The Company, in the ordinary course of store construction and remodeling, is subject to mechanic’s liens on the unpaid balances of the individual construction contracts. The Company obtains lien waivers from all contractors and subcontractors prior to or concurrent with making final payments on such projects.

13. Fair Value of Financial Instruments

     Effective with the second quarter of fiscal 2009, the Company adopted the provisions of ASC 825Financial Instrumentsrelated to interim disclosures about fair value of financial instruments. This guidance requires disclosures regarding fair value of financial instruments in interim financial statements, as well as in annual financial statements. The adoption had no impact on the Company’s financial statements other than additional disclosures.

	October 31, 2009
	Carrying
	Amount		Fair Value
Cash and cash equivalents	$	164,538	$	164,538
Revolving credit facility		16,693,755		16,693,755
Subordinated secured term loan		3,375,229		3,369,606
Subordinated convertible debentures		4,000,000		2,466,896

	January 30, 2010
	Carrying
	Amount		Fair Value
Cash and cash equivalents	$	154,685	$	154,685
Revolving credit facility		10,531,687		10,531,687
Subordinated secured term loan		2,785,112		2,811,386
Subordinated convertible debentures		4,000,000		2,578,638

	October 30, 2010
	Carrying
	Amount		Fair Value
Cash and cash equivalents	$	137,467	$	137,467
Revolving credit facility		17,495,501		17,495,501
Subordinated debenture		4,000,000		4,000,000
Subordinated secured term loan		901,407		901,407
Subordinated convertible debentures		4,000,000		3,017,069

     The carrying amount of cash equivalents approximates fair value because of the short maturity of those instruments. The carrying amount of the revolving credit facility approximates fair value because the facility has a floating interest rate. The fair values of the subordinated secured term loan and the subordinated convertible debentures and the subordinated debenture have been estimated based on current rates available to the Company for similar debt of the same maturity.

14

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

The following discussion should be read in conjunction with the Company’s unaudited condensed financial statements and notes thereto provided herein and the Company’s audited financial statements and notes thereto in our annual report on Form 10-K for the fiscal year ended January 30, 2010. The following Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from the results discussed in the forward-looking statements. The factors that might cause such a difference also include, but are not limited to, those discussed in our Annual Report on Form 10-K under “Item 1. Business — Cautionary Note Regarding Forward-Looking Statements and Risk Factors” and under “Item 1. Business — Risk Factors” and those discussed elsewhere in our Annual Report on Form 10-K and related notes thereto and elsewhere in this quarterly report.

Overview

     We are a national, mall-based, specialty retailer of distinctive footwear and accessories targeting young women who demand quality fashion products. We feature private label and national brand dress, casual and sport shoes, boots, sandals and accessories. As of October 30, 2010, we operated 236 stores, including 220 Bakers stores and 16 Wild Pair stores located in 35 states.

     During the first thirty-nine weeks of 2010, our net sales decreased 0.3% compared to the first thirty-nine weeks of 2009, reflecting unfavorable response to our sandal assortment in the Spring, partially offset by a 3.9% increase in net sales in the third quarter resulting from strength in dress and boot sales in the fall. Comparable store sales in the first thirty-nine weeks of 2010 increased 1.3%, compared to an increase of 0.2% in the first thirty-nine weeks of last year. Gross profit percentage decreased to 22.8% of sales in the first thirty-nine weeks of 2010 compared to 25.4% in the first thirty-nine weeks of 2009 due to increased markdown activity during the year. We ended the first thirty-nine weeks of 2010 with inventory up 17.8% from a year ago in connection with the launch of H by Halston ™ and Wild Pair ™ lines. Our selling expenses decreased 2.2% and our general and administrative expenses decreased 6.1%. We recognized noncash impairment expense of $1.4 million compared to $2.8 million last year. Our net loss was $14.5 million for the first thirty nine weeks of 2010, compared to a net loss of $14.7 million in the first thirty nine weeks of 2009. Comparable store sales for the fourth quarter of 2010, through December 4, have increased 6.6%.

     We incurred net losses of $9.1 million and $15.0 million in fiscal years 2009 and 2008. These losses have had a significant negative impact on our financial position and liquidity. As of October 30, 2010, we had negative working capital of $15.0 million, unused borrowing capacity under our revolving credit facility of $2.8 million, and a shareholders’ deficit of $11.3 million.

     Our business plan for fiscal year 2010 is based on mid-single digit increases in comparable store sales for the remainder of the year. Fourth quarter comparable store sales through December 4, 2010 are up 6.6%. Based on our business plan, we expect to maintain adequate liquidity for the remainder of fiscal year 2010. The business plan reflects continued focus on inventory management and on timely promotional activity. The plan also includes continued control over selling, general and administrative expenses. We continue to work with our landlords and vendors to arrange payment terms that are reflective of our seasonal cash flow patterns in order to manage availability. The business plan for fiscal year 2010 reflects continued management of cash flow, but does not indicate a return to profitability. Our 2011 business plan, under which we expect to maintain adequate levels of liquidity for fiscal year 2011, reflects continued mid-single digit increases in comparable store sales and working with our vendors and landlords to maintain payment terms that are reflective of our seasonal cash flow patterns in order to manage availability. However, there is no assurance that we will achieve the sales, margin or cash flow contemplated in our business plan.

Debt Agreements

On May 28, 2010, we amended our revolving credit facility. The amendment extended the maturity of the credit facility to May 28, 2013, modified the calculation of the borrowing base, added a new minimum availability or adjusted EBITDA interest coverage ratio covenant, added an obligation for us to extend the maturity of our subordinated convertible debentures, and made other changes to the agreement. We incurred fees and expenses of approximately $250,000 in connection with this amendment. The minimum availability or adjusted EBITDA interest coverage ratio covenant requires that either we maintain unused availability greater than 20% of the calculated borrowing base or maintain the ratio of our adjusted EBITDA to our interest expense (both as defined in the amendment) of no less than 1.0:1.0. The minimum availability covenant is tested daily and, if not met, then the adjusted EBITDA covenant is tested

15

on a rolling twelve month basis. The adjusted EBITDA calculation is substantially similar to the calculation used previously in our subordinated secured term loan. We did not meet these covenants for the months of June and July 2010; however, this covenant violation was waived by the bank in connection with the August 2010 debt and equity issuance discussed below. During the third quarter of fiscal year 2010, we met the bank covenant based on maintaining unused availability greater than 20% on a daily basis. Our business plan for the remainder of 2010 and for 2011 also anticipates meeting the bank covenant on this basis. We continue to closely monitor our availability and continue to be constrained by our limited unused borrowing capacity. As of December 4, 2010, the balance on our revolving line of credit was $18.8 million and our unused borrowing capacity in excess of the covenant minimum was $1.5 million.

     On August 26, 2010, we issued debt and equity to Steven Madden, Ltd., as investor. In connection with that arrangement, we sold to the investor a subordinated debenture in the principal amount of $5,000,000. Under the subordinated debenture, interest payments are required to be paid quarterly at an interest rate of 11% per annum. The principal amount is required to be paid in four annual installments commencing on August 31, 2017, through the final maturity date of August 31, 2020. The subordinated debenture is generally unsecured and subordinate to our other indebtedness. As additional consideration, Steve Madden, Ltd. also received 1,844,860 shares of our common stock, representing a 19.99% interest in our common stock on a post-closing basis. In connection with the transaction, we received aggregate net proceeds of $4.5 million after transaction and other costs. We are using the net proceeds for working capital purposes. We received consents from all of our other debt holders to enter into the transaction.

     Based on our business plan for fiscal years 2010 and 2011, we believe that we will be able to comply with the minimum availability or adjusted EBITDA coverage ratio covenant in our revolving credit facility. However, given the inherent volatility in our sales performance, there is no assurance that we will be able to do so. In addition, in light of our historical sales volatility and the current state of the economy, we believe that there is a reasonable possibility that we may not be able to comply with the financial covenants. Failure to comply would be a default under the terms of the revolving credit facility and could result in the acceleration of all of our debt obligations. If we are unable to comply with our financial covenants, we will be required to seek one or more additional amendments or waivers from our lenders. We believe that we would be able to obtain any required amendments or waivers, but can give no assurance that we would be able to do so on favorable terms, if at all. If we are unable to obtain any required amendments or waivers, our lenders would have the right to exercise remedies specified in the loan agreements, including accelerating the repayment of debt obligations and taking collection action against us. If such acceleration occurred, we currently have insufficient cash to pay the amounts owed and would be forced to obtain alternative financing.

     We continue to face considerable liquidity constraints. Although we believe our business plan is achievable, should we fail to achieve the sales or gross margin levels we anticipate, or if we were to incur significant unplanned cash outlays, it would become necessary for us to obtain additional sources of liquidity or make further cost cuts to fund our operations. In recognition of existing liquidity constraints, we continue to look for additional sources of capital at acceptable terms. However, there is no assurance that we would be able to obtain such financing on favorable terms, if at all, or to successfully further reduce costs in such a way that would continue to allow us to operate our business.

     For comparison purposes, we classify our stores as comparable or non-comparable. A new store’s sales are not included in comparable store sales until the thirteenth month of operation. Sales from remodeled stores are excluded from comparable store sales during the period of remodeling. We include our Internet and call center sales (“Multi-Channel Sales”) as one store in calculating our comparable store sales.

Critical Accounting Policies

     Our financial statements are prepared in accordance with U.S. generally accepted accounting principles, which require us to make estimates and assumptions about future events and their impact on amounts reported in our Financial Statements and related Notes. Since future events and their impact cannot be determined with certainty, the actual results will inevitably differ from our estimates. These differences could be material to the financial statements.

     We believe that our application of accounting policies, and the estimates that are inherently required by these policies, are reasonable. We believe that the following significant accounting policies may involve a higher degree of judgment and complexity.

Merchandise inventories

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     Merchandise inventories are valued at the lower of cost or market. Cost is determined using the first-in, first-out retail inventory method. Consideration received from vendors relating to inventory purchases is recorded as a reduction of cost of merchandise sold, occupancy, and buying expenses after an agreement with the vendor is executed and when the related inventory is sold. We physically count all merchandise inventory on hand annually, generally during the month of January, and adjust the recorded balance to reflect the results of the physical count. We record estimated shrinkage between physical inventory counts based on historical results. Inventory shrinkage is included as a component of cost of merchandise sold, occupancy, and buying costs. Permanent markdowns are recorded to reflect expected adjustments to retail prices in accordance with the retail inventory method. In determining permanent markdowns, we consider current and recently recorded sales prices, the length of time product is held in inventory, and quantities of various product styles contained in inventory, among other factors. The process of determining our expected adjustments to retail prices requires significant judgment by management. The ultimate amount realized from the sale of inventories could differ materially from our estimates. If market conditions are less favorable than those projected, additional inventory markdowns may be required.

Store closing and impairment charges

     Long-lived assets to be “held and used” are reviewed for impairment when events or circumstances exist that indicate the carrying amount of those assets may not be recoverable. We regularly analyze the operating results of our stores and assess the viability of under-performing stores to determine whether they should be closed or whether their associated assets, including furniture, fixtures, equipment, and leasehold improvements, have been impaired. Asset impairment tests are performed at least annually, on a store-by-store basis. After allowing for an appropriate start-up period, unusual nonrecurring events, and favorable trends, fixed assets of stores indicated to be impaired are written down to fair value.

     During the thirty-nine weeks ended October 30, 2010, we recorded $1.4 million in noncash charges to earnings related to the impairment of furniture, fixtures, and equipment, leasehold improvements, and other assets at certain underperforming stores. We recognized impairment expense of $2.8 million during the thirty-nine weeks ended October 31, 2009.

Stock-based compensation expense

     We compensate certain employees with various forms of share-based payment awards and recognize compensation expense for stock-based compensation based on the grant date fair value. Stock-based compensation expense is then recognized ratably over the service period related to each grant. We determine the fair value of stock-based compensation using the Black-Scholes option pricing model, which requires us to make assumptions regarding future dividends, expected volatility of our stock, and the expected lives of the options. We also make assumptions regarding the number of options and the number of shares of restricted stock and performance shares that will ultimately vest. The assumptions and calculations are complex and require a high degree of judgment. Assumptions regarding the vesting of grants are accounting estimates that must be updated as necessary with any resulting change recognized as an increase or decrease in compensation expense at the time the estimate is changed. Excess tax benefits related to stock option exercises are reflected as financing cash inflows and operating cash outflows.

Deferred income taxes

     We calculate income taxes using the asset and liability method. Under this method, deferred tax assets and liabilities are recognized based on the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and income tax reporting purposes. Deferred tax assets and liabilities are measured using the tax rates in effect in the years when those temporary differences are expected to reverse. Inherent in the measurement of deferred taxes are certain judgments and interpretations of existing tax law and other published guidance as applied to our operations.

     We regularly assess available positive and negative evidence to determine whether it is more likely than not that our deferred tax asset balances will be recovered from (a) reversals of deferred tax liabilities, (b) potential utilization of net operating loss carrybacks, (c) tax planning strategies and (d) future taxable income. Accounting standards place significant restrictions on the consideration of future taxable income in determining the realizability of deferred tax assets in situations where a company has experienced a cumulative loss in recent years. When sufficient negative evidence exists that indicates that full realization of deferred tax assets is no longer more likely than not, a valuation allowance is established as necessary against the deferred tax assets, increasing our income tax expense in the period that such conclusion is reached. Subsequently, the valuation allowance is adjusted up or down as necessary to maintain coverage against the deferred tax assets. If, in the future, sufficient positive evidence, such as a sustained return to

17

profitability, arises that would indicate that realization of deferred tax assets is once again more likely than not, any existing valuation allowance would be reversed as appropriate, decreasing our income tax expense in the period that such conclusion is reached.

     We have concluded that the realizability of net deferred tax assets is unlikely, and maintain a full valuation allowance against our net deferred tax assets. We have scheduled the reversals of our deferred tax assets and deferred tax liabilities and have concluded that based on the anticipated reversals, a valuation allowance is necessary only for the excess of deferred tax assets over deferred tax liabilities.

     We anticipate that until we re-establish a pattern of continuing profitability, in accordance with the applicable accounting guidance, we will not recognize any material income tax expense or benefit in our statement of operations for future periods, as pretax profits or losses generally will generate tax effects that will be offset by decreases or increases in the valuation allowance with no net effect on the statement of operations. If a pattern of continuing profitability is re-established and we conclude that it is more likely than not that deferred income tax assets are realizable, we will reverse any remaining valuation allowance which will result in the recognition of an income tax benefit in the period that it occurs.

     We regularly analyze filing positions in all of the federal and state jurisdictions where required to file income tax returns, as well as all open tax years in these jurisdictions. Our federal income tax returns subsequent to the fiscal year ended January 1, 2005 remain open. As of October 30, 2010, we have not record any unrecognized tax benefits. Our policy, if we had unrecognized benefits, is to recognize accrued interest and penalties related to unrecognized tax benefits as interest expense and other expense, respectively.

Results of Operations

     The following table sets forth our operating results, expressed as a percentage of sales, for the periods indicated.

	Thirteen			Thirteen			Thirty-			Thirty-
	Weeks			Weeks			nine Weeks			nine Weeks
	Ended			Ended			Ended			Ended
	October 31,			October 30,			October 31,			October 30,
	2009			2010			2009			2010
Net sales		100.0	%		100.0	%		100.0	%		100.0	%
Cost of merchandise sold, occupancy and buying expense		82.7			84.4			74.6			77.2
Gross profit		17.3			15.6			25.4			22.8
Selling expense		24.7			23.6			23.2			22.8
General and administrative expense		9.9			9.4			9.6			9.0
Loss on disposal of property and equipment		—			—			0.2			0.1
Impairment of long-lived assets		7.1			3.5			2.1			1.1
Operating loss		(24.4	)		(20.9	)		(9.9	)		(10.2	)
Other income, net		0.1			0.2			0.1			0.1
Interest expense		(1.7	)		(1.3	)		(1.7	)		(1.2	)
Loss before income taxes		(26.0	)		(22.0	)		(11.5	)		(11.3	)
Provision for income taxes		—			—			—			—
Net loss		(26.0	)%		(22.0	)%		(11.5	)%		(11.3	)%

     The following table sets forth our number of stores at the beginning and end of each period indicated and the number of stores opened and closed during each period indicated.

	Thirteen		Thirteen			Thirty-			Thirty-
	Weeks		Weeks			nine Weeks			nine Weeks
	Ended		Ended			Ended			Ended
	October 31,		October 30,			October 31,			October 30,
	2009		2010			2009			2010
Number of stores at beginning of period		240		237			239			238
Stores opened during period		1		2			4			4
Stores closed during period		—		(3	)		(2	)		(6	)
Number of stores at end of period		241		236			241			236

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Thirteen Weeks Ended October 30, 2010 Compared to Thirteen Weeks Ended October31, 2009

     Net sales.Net sales increased to $40.6 million for the thirteen weeks ended October 30, 2010 (third quarter 2010) from $39.0 million for the thirteen weeks ended October 31, 2009 (third quarter 2009), an increase of $1.6 million or 3.9%. This increase reflected strong demand for dress shoes and casual boots. Our comparable store sales for the third quarter of 2010 increased by 5.9% compared to a 5.1% decrease in comparable store sales in the third quarter of 2009. Average unit selling prices increased 9.3% while unit sales decreased 4.1% compared to the third quarter of 2009. Our multi-channel sales increased 19.5% to $2.6 million.

     Gross profit.Gross profit decreased to $6.4 million in the third quarter of 2010 from $6.8 million in the third quarter of 2009, a decrease of $0.4 million or 6.2%. As a percentage of sales, gross profit decreased to 15.7% in the third quarter of 2010 from 17.3% in the third quarter of 2009. The decrease in gross profit percentage results from higher costs and higher inventory levels in connection with the launch of H by Halston ™ and Wild Pair ™ lines. We attribute the decrease in gross profit dollars to the following components: a decrease of $0.6 million from reduced gross margin percentage, a decrease of $0.1 million from net store closures, partially offset by comparable store sales increase of $0.3 million. Total markdown costs increased to $9.1 million in the third quarter of 2010 from $8.0 million in the third quarter of 2009.

     Selling expense.Selling expense decreased to $9.6 million in the third quarter of 2010 from $9.7 million in the third quarter of 2009, a decrease of $0.1 million or 0.9%, and decreased as a percentage of sales to 23.6% from 24.7%.

     General and administrative expense.General and administrative expense decreased to $3.8 million in the third quarter of 2010 from $3.9 million in the third quarter of 2009, a decrease of $0.1 million or 1.1%, and decreased as a percentage of sales to 9.4% from 9.9%.

     Impairment of long-lived assets. Based on the criteria in ASC 360, long-lived assets to be “held and used” are reviewed for impairment when events or circumstances exist that indicate the carrying amount of those assets may not be recoverable. During the third quarter of 2010, we recognized $1.4 million in noncash charges related to the impairment of fixed assets and other assets at specific underperforming stores compared to $2.8 million in the third quarter of 2009.

     Interest expense.Interest expense decreased to $0.5 million in the third quarter of 2010 from $0.7 million in the third quarter of 2009.

     Net loss. Net loss decreased to $8.9 million in the third quarter of 2010 compared to a net loss of $10.2 million in the third quarter of 2009.

Thirty-nine Weeks Ended October 30, 2010 Compared to Thirty-nine Weeks Ended October 31, 2009

     Net sales.Net sales decreased to $127.4 million for the thirty-nine weeks ended October 30, 2010 from $127.7 million for the thirty-nine weeks ended October 31, 2009, a decrease of $0.3 million or 0.3%, reflecting unfavorable response to our sandal assortment in the Spring, partially offset by a 3.9% increase in net sales in the third quarter resulting from strength in dress and boot sales in the fall. Our comparable store sales for the first thirty-nine weeks of 2010 increased by 1.3% compared to a 0.2% decrease in comparable store sales in the first thirty-nine weeks of 2009. Average unit selling prices increased 2.8% and unit sales decreased 2.1% compared to the first thirty-nine weeks of 2009. Our multi-channel sales increased 9.3% to $7.6 million for the first three quarters of 2010.

     Gross profit.Gross profit decreased to $29.0 million in 2010 from $32.4 million in 2009, a decrease of $3.4 million or 10.4%. As a percentage of sales, gross profit decreased to 22.8% in 2010 from 25.4% in 2009. The decrease in gross profit is primarily attributable to weak demand for our spring offerings and higher inventory levels, collectively resulting in higher markdown activity. We attribute the decrease in gross profit dollars to the following components: a decrease $3.1 million from reduced gross margin percentage, a decrease of $0.5 million from net store closures, partially offset by a $0.2 million increase in margins from our comparable store sales increase. Total markdown costs increased to $21.2 million in the first thirty-nine weeks of 2010 from $19.1 million in the first thirty-nine weeks of 2009.

     Selling expense.Selling expense decreased to $29.0 million in 2010 from $29.6 million in 2009, a decrease of $0.6 million or 2.2%, and decreased as a percentage of sales to 22.8% from 23.2%. This decrease primarily reflects a $0.5 million in lower store

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depreciation, $0.2 million decrease in store payroll expenses, $0.1 million decrease in repairs and maintenance due to a reduction in store count, partially offset by $0.2 million increase in store supplies.

     General and administrative expense.General and administrative expense decreased to $11.5 million in 2010 from $12.3 million in 2009, a decrease of $0.8 million or 6.1% and decreased as a percentage of sales to 9.0% from 9.6%. This decrease primarily reflects $0.3 million of lower group health insurance costs, $0.3 million decrease in professional fees and $0.2 million in lower depreciation.

     Impairment of long-lived assets. During the first three quarters of 2010, we recognized $1.4 million in noncash charges related to the impairment of fixed assets and other assets at specific underperforming stores. We recognized $2.8 million of impairment expense in the first three quarters of 2009.

     Interest expense.Interest expense decreased to $1.5 million in 2010 from $2.2 million in 2009.

     Net loss. We had a net loss of $14.5 million in the first three quarters of 2010 compared to a net loss of $14.7 million in the first three quarters of 2009.

Seasonality and Quarterly Fluctuations

     Our operating results are subject to significant seasonal variations. Our quarterly results of operations have fluctuated, and are expected to continue to fluctuate in the future, as a result of these seasonal variances, in particular our principal selling seasons. We have five principal selling seasons: transition (post-holiday), Easter, back-to-school, fall and holiday. Sales and operating results in our third quarter are typically much weaker than in our other quarters. Quarterly comparisons may also be affected by the timing of sales promotions and costs associated with remodeling stores, opening new stores, or acquiring stores.

Liquidity and Capital Resources

     Our cash requirements are primarily for working capital, principal and interest payments on our debt obligations and capital expenditures. Historically, these cash needs have been met by cash flows from operations, borrowings under our revolving credit facility and sales of securities. As discussed below in “Financing Activities” the balance on our revolving credit facility fluctuates throughout the year as a result of our seasonal working capital requirements and our other uses of cash.

     Our losses in the first three quarters of fiscal year 2010 and recent years have had a significant negative impact on our financial position and liquidity. As of October 30, 2010, we had negative working capital of $15.0 million, unused borrowing capacity under our revolving credit facility of $2.8 million, and shareholders’ deficit of $11.3 million.

     Our business plan for the remainder fiscal year 2010 is based on mid-single digit increases in comparable store sales for the remainder of the year. Fourth quarter comparable store sales through December 4, 2010 are up 6.6%. Based on our business plan, we expect to maintain adequate liquidity for the remainder of fiscal year 2010. The business plan reflects continued focus on inventory management and on timely promotional activity. The plan also includes continued control over selling, general and administrative expenses. We continue to work with our landlords and vendors to arrange payment terms that are reflective of our seasonal cash flow patterns in order to manage availability. The business plan for fiscal year 2010 reflects continued management of cash flow, but does not indicate a return to profitability. Our 2011 business plan, under which we expect to maintain adequate levels of liquidity for fiscal year 2011, reflects continued mid-single digit increases in comparable store sales and working with our vendors and landlords to maintain payment terms that are reflective of our seasonal cash flow patterns in order to manage availability. However, there is no assurance that we will achieve the sales, margin or cash flow contemplated in our business plans.

     As of December 4, 2010, the balance on our subordinated secured term loan was $0.5 million, with a final principal and interest payment due January 3, 2011. We have amended the loan agreement four times (May 2008, April 2009, September 2009 and March 2010) to modify certain financial covenants, including a minimum adjusted EBITDA covenant, in order to remain in compliance. The March 2010 amendment completely eliminated these covenants for the remainder of the term loan.

     On May 28, 2010, we amended our revolving credit facility. The amendment extended the maturity of the credit facility to May 28, 2013, modified the calculation of the borrowing base, added a new minimum availability or adjusted EBITDA interest coverage ratio covenant, added an obligation for us to extend the maturity of its subordinated convertible debentures, and made other changes to

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the agreement. We incurred fees and expenses of approximately $250,000 in connection with this amendment. The minimum availability or adjusted EBITDA interest coverage ratio covenant requires that either we maintain unused availability greater than 20% of the calculated borrowing base or maintain the ratio of our adjusted EBITDA to our interest expense (both as defined in the amendment) of no less than 1.0:1.0. The minimum availability covenant is tested daily, and if not met, then the adjusted EBITDA covenant is tested monthly on a rolling twelve month basis. The adjusted EBITDA calculation is substantially similar to the calculation used previously in our subordinated secured term loan. We did not meet these covenants for the months of June and July 2010; however, this covenant violation was waived by the bank in connection with the August 2010 debt and equity issuance discussed below. During the third quarter of fiscal year 2010, we met the bank covenant based on maintaining unused availability greater than 20% on a daily basis. Our business plan for the remainder of 2010 and for 2011 also anticipates meeting the bank covenant on this basis. We continue to closely monitor our availability and continue to be constrained by our limited unused borrowing capacity. As of December 4, 2010, the balance on our revolving line of credit was $18.8 million and our unused borrowing capacity was $1.5 million or 25.2% of the calculated borrowing base.

     On August 26, 2010, we issued debt and equity to Steven Madden, Ltd. In connection with that arrangement, we sold to the investor a debenture in the principal amount of $5,000,000. Under the subordinated debenture, interest payments are required to be paid quarterly at an interest rate of 11% per annum. The principal amount is required to be repaid in four annual installments commencing on August 31, 2017, through the final maturity date on August 31, 2020. The subordinated debenture is generally unsecured and subordinate to our other indebtedness. As additional consideration, Steven Madden, Ltd. also received 1,844,860 shares of our common stock, representing a 19.99% interest in our Company on a post-closing basis. In connection with the transaction, we received aggregate net proceeds of $4.6 million after transaction and other costs. We are using the net proceeds for working capital purposes. We received consents from all of our other debt holders to enter into the transaction.

     Based on our business plan for fiscal years 2010 and 2011, we believe that we will be able to comply with the minimum availability or adjusted EBITDA coverage ratio covenant. However, given the inherent volatility in our sales performance, there is no assurance that we will be able to do so. In addition, in light of our historical sales volatility and the current state of the economy, we believe that there is a reasonable possibility that we may not be able to comply with the financial covenants. Failure to comply would be a default under the terms of our revolving credit facility and could result in the acceleration of all of our debt obligations. If we are unable to comply with our financial covenants, we will be required to seek one or more additional amendments or waivers from our lenders. We believe that we would be able to obtain any required amendments or waivers, but can give no assurance that we would be able to do so on favorable terms, if at all. If we are unable to obtain any required amendments or waivers, our lenders would have the right to exercise remedies specified in the loan agreements, including accelerating the repayment of debt obligations and taking collection action against us. If such acceleration occurred, we currently have insufficient cash to pay the amounts owed and would be forced to obtain alternative financing. Please see “Part II — Item 1A. — Risk Factors — The terms of our revolving credit facility contain certain financial covenants with respect to our performance and other covenants that restrict our activities. If we are unable to comply with these covenants, we would have to negotiate an amendment to the loan agreement or the lender could accelerate the repayment of our indebtedness” in our Quarterly Report on Form 10-Q for the period ended May 1, 2010.

     We continue to face considerable liquidity constraints. Although we believe our business plan is achievable, should we fail to achieve the sales or gross margin levels we anticipate, or if we were to incur significant unplanned cash outlays, it would become necessary for us to obtain additional sources of liquidity or make further cost cuts to fund our operations. In recognition of existing liquidity constraints, we continue to look for additional sources of capital at acceptable terms. However, there is no assurance that we would be able to obtain such financing on favorable terms, if at all, or to successfully further reduce costs in such a way that would continue to allow us to operate our business.

     As described in Note 4 to the financial statements, our common stock has been delisted from the Nasdaq Stock Market. Our common stock has traded on the OTC Bulletin Board since June 18, 2010. Delisting could limit our ability to raise capital from the sale of securities. See “Part II — Item 1A. — Risk Factors — We were recently delisted from the Nasdaq Stock Market. Our common stock is not quoted on a national exchange, and there is relatively limited trading in our common stock, which limits the ability of our shareholders or potential shareholders to purchase or sell shares of our common stock and limits our ability to obtain financing” in our Quarterly Report on Form 10-Q for the period ended July 31, 2010.

     Our independent registered public accounting firm’s report issued in our most recent Annual Report on Form 10-K included an explanatory paragraph describing the existence of conditions that raise substantial doubt about our ability to continue as a going concern, including our recent losses and working capital deficiency. See Note 2 to our financial statements. Our financial statements

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do not include any adjustments relating to the recoverability and classification of assets carrying amounts or the amount of and classification of liabilities that may result should we be unable to continue as a going concern. We have taken several steps that we believe will be sufficient to allow us to continue as a going concern and to improve our liquidity, operating results and financial condition. See “Item 1. Business — Risk Factors — The report issued by our independent registered public accounting firm on our fiscal year 2009 financial statements contains language expressing substantial doubt about our ability to continue as a going concern” in our Annual Report on Form 10-K for the fiscal year ended January 30, 2010.

     The following table summarizes certain key liquidity measurements as of the dates indicated:

	October 31, 2009			January 30, 2010			October 30, 2010
Cash	$	164,538		$	154,685		$	137,467
Inventories		23,335,432			20,233,207			27,477,487
Total current assets		26,058,815			23,010,037			30,483,470
Property and equipment, net		26,183,851			24,757,395			19,586,088
Total assets		53,177,366			48,618,467			51,168,350
Revolving credit facility		16,693,755			10,531,687			17,495,501
Subordinated convertible debentures		4,000,000			4,000,000			4,000,000
Subordinated debenture		—			—			4,000,000
Subordinated secured term loan		3,375,229			2,785,112			901,407
Total current liabilities		47,357,912			37,294,558			45,507,000
Total shareholders’ equity (deficit)		(3,544,763	)		2,140,153			(11,250,421	)
Net working capital (deficit)		(21,299,097	)		(14,284,521	)		(15,023,530	)
Unused borrowing capacity*		3,508,600			1,928,913			2,813,626

* as calculated under the terms of our revolving credit facility

Operating activities

     Cash used in operating activities was $8.6 million in the first three quarters of 2010 compared to cash used in operating activities of $3.0 million in the first three quarters of 2009. Other than our net loss of $14.5 million, the most significant use of cash in operating activities in the first three quarters of 2010 relates to a $7.2 million increase in inventory partially offset by significant noncash expenses ($4.4 million of depreciation, $1.4 million of impairment expense, $0.3 million of stock-based compensation expense and $0.2 million of accretion of debt discount) and a $6.9 million increase of accounts payables, accrued expenses and accrued liabilities, as we have been working with our vendors and landlords to maintain terms that are reflective of our seasonal cash flow patterns.

     Besides our net loss of $14.7 million in the first three quarters of 2009, the most significant use of cash in operating activities in the first three quarters of 2009 relates to a $2.4 million increase in inventory partially offset by significant noncash expenses ($5.0 million of depreciation, $2.8 million of impairment expense, $0.5 million of stock-based compensation expense and $0.4 million of accretion of debt discount) and a $4.9 million increase of accounts payables, accrued expenses and accrued liabilities, as we have been working with our vendors and landlords to maintain terms that are reflective of our seasonal cash flow patterns.

     Inventories at October 30, 2010 increased $4.1 million, or 17.8%, over inventories at October 31, 2009. The increased inventory levels reflect the fall launch of our H by Halston ™ and our Wild Pair ™ lines, acceleration of merchandise receipts, and incremental inventory to support our increased comparative store sales. Although we believe that at October 30, 2010, inventory levels and valuations are appropriate given current and anticipated sales trends, there is always the possibility that fashion trends could change suddenly. We monitor our inventory levels closely and will take appropriate actions, including taking additional markdowns, as necessary, to maintain the freshness of our inventory.

Investing activities

     Cash used in investing activities was $0.8 million in the first three quarters of 2010 compared to $0.3 million for the first three quarters of 2009. During each period, cash used in investing activities substantially consisted of capital expenditures for furniture, fixtures and leasehold improvements for both new and remodeled stores.

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     Our future capital expenditures will depend primarily on the number of new stores we open, the number of existing stores we remodel and the timing of these expenditures. We continuously evaluate our future capital expenditure plans and adjust planned expenditures, as necessary, based on business conditions. As of December 4, 2010, we have opened four new stores and closed six stores in fiscal year 2010. We currently anticipate that our capital expenditures in fiscal year 2010, primarily related to new stores, store remodelings, distribution and general corporate activities, will be approximately $1.0 million.

Financing activities

     Cash provided by financing activities was $9.5 million in the first three quarters of 2010 compared to $3.4 million for the first three quarters of 2009. The principal source of cash from financing activities in the first three quarters of 2010 were the net draws of $7.0 million on our revolving line of credit, $4.5 million aggregate net proceeds from the issuance of common stock and the subordinated debenture, partially offset by $2.1 million of principal payments on the subordinated secured term loan. The principal sources of cash from financing activities in the first three quarters of 2009 were the net draws of $5.2 million on our revolving line of credit offset by $1.8 million of principal payments on the subordinated secured term loan.

Revolving Credit Facility

     We have a $30 million senior secured revolving credit facility with Bank of America, N.A. On May 28, 2010, we amended our revolving credit agreement to extend the maturity of the credit facility from 2010 to May 28, 2013, modify the calculation of the borrowing base, add a new minimum availability or adjusted EBITDA interest coverage ratio covenant, add an obligation for the Company to extend the maturity of its subordinated convertible debentures by May 2012, add an early termination fee, and make other changes to the agreement. The minimum availability or adjusted EBITDA interest coverage ratio covenant requires that either the Company maintain unused availability greater than 20% of the calculated borrowing base or maintain the ratio of our adjusted EBITDA to our interest expense (both as defined in the amendment) of no less than 1.0:1.0. The minimum availability covenant is tested daily, and if not met the adjusted EBITDA covenant is tested monthly on a rolling twelve month basis. The adjusted EBITDA calculation is substantially similar to the calculation used previously in our subordinated secured term loan. We did not meet these covenants for the months of June and July 2010; however, this covenant violation was waived by the bank in connection with the issuance of the subordinated debenture issued in August 2010 discussed below.

     Amounts borrowed under the facility bear interest at a rate equal to the base rate (as defined in the agreement) plus a margin amount between 3.0% and 3.5%. The base rate equals the greater of the bank’s prime rate, the federal funds rate plus 0.50% or the Libor rate plus 1.0% (all as defined in the agreement).

     The revolving credit facility also allows us to apply an interest rate based on Libor (as defined in the agreement) plus a margin amount to a designated portion of the outstanding balance as set forth in the agreement. The Libor margin (as defined in the agreement) ranges from 3.5% to 4.0%. Following the occurrence of any event of default, the bank may increase the rate by an additional two percentage points.

     The unused line fee is 0.75% per annum. The unused line fee is payable monthly based on the difference between the revolving credit ceiling and the average loan balance under the agreement. The aggregate amount that we may borrow under the agreement at any time is further limited by a formula, which is based substantially on our inventory level but cannot be greater than the revolving credit ceiling of $30 million.

     Amounts borrowed under the credit facility are secured by substantially all of our assets. If contingencies related to early termination of the revolving credit facility were to occur, or if we request and receive an accommodation from the lender in connection with the facility, we may be required to pay additional fees. We may be required to pay an early termination fee of up to $150,000 in the event we terminate the facility before May 2012.

     The credit facility includes financial, reporting and other covenants relating to, among other things, use of funds under the facility in accordance with the our business plan, prohibiting a change of control, including any person or group acquiring beneficial ownership of 40% or more of our common stock or combined voting power (as defined in the credit facility), maintaining a minimum availability, prohibiting new debt, restricting dividends and the repurchase of our stock, and restricting certain acquisitions. In the event that we violate any of these covenants, including the minimum availability or adjusted EBITDA interest coverage financial covenant or the obligation to extend the maturity of our subordinated convertible debentures (both as described above), or if other

23

indebtedness in excess of $1.0 million could be accelerated, or in the event that 10% or more of our leases could be terminated (other than solely as a result of certain sales of our common stock), the bank would have the right to accelerate repayment of all amounts outstanding under the agreement, or to commence foreclosure proceedings on our assets.

     We had balances under our revolving credit facility of $17.5 million, $10.5 million and $16.7 million as of October 30, 2010, January 30, 2010 and October 31, 2009, respectively. We had approximately $2.8 million, $1.9 million and $3.5 million in unused borrowing capacity calculated under the provisions of our revolving credit facility as of October 30, 2010, January 30, 2010, and October 31, 2009, respectively. During the first thirty-nine weeks of fiscal years 2010 and 2009, the highest outstanding balances on our revolving credit facility were $17.5 million and $16.9 million, respectively. We primarily have used the borrowings on our revolving credit facility for working capital purposes and capital expenditures.

Subordinated Secured Term Loan

     We have a subordinated secured term loan with Private Equity Management Group, Inc. (PEM) as arranger and administrative agent on behalf of the lender, and an affiliate of PEM, as the lender, pursuant to a Second Lien Credit Agreement dated February 4, 2008. The loan now matures on January 3, 2011. The loan is secured by substantially all of our assets. The loan is subordinate to our senior secured revolving credit facility with Bank of America, N.A., our senior lender, but it is senior to our $4 million in aggregate principal amount of subordinated convertible debentures due 2012 and our subordinated debenture issued in August 2010.

     Originally, the loan agreement contained financial covenants requiring us to maintain specified levels of tangible net worth and adjusted EBITDA (as defined in the agreement) each fiscal quarter. We have amended the loan agreement four times (May 2008, April 2009, September 2009 and March 2010) to modify these covenants in order to remain in compliance. The March 2010 amendment completely eliminated these covenants for the remainder of the term loan. As consideration for the initial loan and the May 2008 amendment thereto, PEM received 400,000 shares of our common stock, an advisory fee of $300,000 and PEM’s costs and expenses. As consideration for the April 2009 and September 2009 amendments, we paid fees totaling $265,000 and issued an additional 250,000 shares of our common stock. We did not pay any fees in connection with the March 2010 amendment.

     We entered into the loan in February 2008. At that time, we received aggregate gross proceeds of $7.5 million and net proceeds of approximately $6.7 million from the term loan. We used the net proceeds initially to repay amounts owed under our senior credit facility and for working capital purposes. We also have broad obligations to indemnify, and pay the fees and expenses of PEM and the Lender in connection with, among other things, the enforcement, performance and administration of the loan agreement and the other loan documents.

     The loan agreement still contains a financial covenant which sets an annual limit of $1 million for capital expenditures. The loan agreement also contains certain other restrictive covenants, including covenants that restrict our ability to incur additional indebtedness, to pre-pay other indebtedness, to dispose of assets, to effect certain corporate transactions, including specified mergers and sales of all or substantially all of our assets, to change the nature of our business, to pay dividends (other than in the form of common stock dividends), as well as covenants that limit transactions with affiliates and prohibit a change of control. For this purpose, a change of control is generally defined as, among other things, a person or entity acquiring beneficial ownership of more than 50% of our common stock, specified changes to our Board of Directors, sale of all or substantially all of our assets or certain recapitalizations. The loan agreement also contains customary representations and warranties and affirmative covenants, including provisions relating to providing reports, inspections and appraisal, and maintenance of property and collateral.

     Upon the occurrence of an event of default under the loan agreement, the Lender will be entitled to acceleration of the debt plus all accrued and unpaid interest, subject to the senior subordination agreement, with the interest rate increasing to 17.5% per annum. The loan agreement generally provides for customary events of default, including default in the payment of principal or interest or other required payments, failure to observe or perform covenants or agreements contained in the transaction documents (excluding the registration rights agreement), materially breaching our credit facility with our senior lender or the terms of our subordinated convertible debentures, generally failure to pay when due debt obligations (broadly defined, subject to certain exceptions) in excess of $1 million, specified events of bankruptcy or specified judgments against us.

     We have granted certain registration rights to PEM with respect to the initial 400,000 shares described above, including the potential payments of liquidated damages in certain circumstances in relating to the timing and effectiveness of the registration statement. As required, we filed the registration statement at our expense and the SEC declared the registration statement effective

24

within the required time periods, and our potential liability for liquidated damages ended on February 1, 2010. We also have certain other ongoing obligations, including providing PEM specified notices and certain information, indemnifying PEM for certain liabilities and using reasonable best efforts to timely file all required filings with the SEC and make and keep current public information about us. We did not grant PEM any registration rights with respect to the 250,000 additional shares issued in connection with the April 2009 amendment to the term loan.

     On August 26, 2010, in connection with the issuance of the subordinated debentures, we entered into an amendment to the loan that adjusted the maturity date from February 1, 2011 to January 3, 2011.

Subordinated Convertible Debentures

     On June 26, 2007, we issued $4 million in aggregate principal amount of subordinated convertible debentures to seven accredited investors in a private placement generating net proceeds of approximately $3.6 million, which were used to repay amounts owed under our revolving credit facility. The subordinated convertible debentures are nonamortizing, bear interest at a rate of 9.5% per annum, payable semi-annually on each June 30 and December 31, and mature on June 30, 2012. Investors included corporate directors Andrew N. Baur and Scott C. Schnuck, an entity affiliated with Mr. Baur, and advisory directors Bernard A. Edison and Julian Edison.

     The subordinated convertible debentures are convertible into shares of common stock at any time. The initial conversion price was $9.00 per share. The conversion price, and thus the number of shares into which the debentures are convertible, is subject to anti-dilution and other adjustments. If we distribute any assets (other than ordinary cash dividends), then generally each holder is entitled to receive a like amount of such distributed property. In the event of a merger, consolidation, sale of substantially all of our assets, or reclassification or compulsory share exchange, then upon any subsequent conversion each holder will have the right to either the same property as it would have otherwise been entitled or cash in an amount equal to 100% principal amount of the debenture, plus interest and any other amounts owed. The subordinated convertible debentures also contain a weighted average conversion price adjustment generally for future issuances, at prices less than the then current conversion price, of common stock or securities convertible into, or options to purchase, shares of common stock, excluding generally currently outstanding options, warrants or performance shares and any future issuances or deemed issuances pursuant to any properly authorized equity compensation plans. The subordinated convertible debentures contain limitations on the number of shares issuable pursuant to the subordinated convertible debentures regardless of how low the conversion price may be, including limitations generally requiring that the conversion price not be less than $8.10 per share for subordinated convertible debentures issued to advisory directors, corporate directors or the entity affiliated with Mr. Baur, that we do not issue common stock amounting to more than 19.99% of our common stock in the transaction or such that following conversion, the total number of shares beneficially owned by each holder does not exceed 19.999% of our common stock. These limitations may be removed with shareholder approval.

     As a result of the issuance of the 1,844,860 shares of our common stock in August 2010, the weighted average conversion price of the subordinated convertible debentures decreased from $8.31 to $6.76 with respect to $1 million in aggregate principal amount of debentures and to $8.10, the minimum conversion price, with respect to $3 million in aggregate principal amount of debentures held by directors and director affiliates. The debentures are now convertible into a total of 518,299 shares of the Company’s common stock.

     The subordinated convertible debentures generally provide for customary events of default, which could result in acceleration of all amounts owed, including default in required payments, failure to pay when due, or the acceleration of other monetary obligations for indebtedness (broadly defined) in excess of $1 million (subject to certain exceptions), failure to observe or perform covenants or agreements contained in the transaction documents, including covenants relating to using the net proceeds, maintaining legal existence, prohibiting the sale of material assets outside of the ordinary course, prohibiting cash dividends and distributions, share repurchases, and certain payments to our officers and directors. We generally have the right, but not the obligation, to redeem the unpaid principal balance of the subordinated convertible debentures at any time prior to conversion if the closing price of our common stock (as adjusted for stock dividends, subdivisions or combinations) is equal to or above $16.00 per share for each of 20 consecutive trading days and certain other conditions are met. We have also agreed to provide certain piggyback and demand registration rights, until two years after the subordinated convertible debentures cease to be outstanding, to the holders under the Securities Act of 1933 relating to the shares of common stock issuable upon conversion of the subordinated convertible debentures. In April 2010, the debenture documents were amended to remove our de-listing from the Nasdaq Stock Market as an event of default.

Subordinated Debenture

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     On August 26, 2010, we entered into a Debenture and Stock Purchase Agreement with Steven Madden, Ltd. In connection with the Purchase Agreement, we sold to Steven Madden, Ltd. a debenture in the principal amount of $5,000,000 (the “subordinated debenture”). Under the subordinated debenture, interest payments are required to be paid quarterly at an interest rate of 11% per annum. The principal amount is required to be repaid in four annual installments commencing on August 31, 2017, through the final maturity on August 31, 2020. As additional consideration, Steven Madden, Ltd. also received 1,844,860 shares of the our common stock which are subject to a voting agreement in favor of Peter Edison, representing a 19.99% interest in the Company on a post-closing basis. In connection with the transaction, we received aggregate net proceeds of $4.6 million after transaction and other costs.

     The transaction documents contain standstill provisions which generally prohibit Steven Madden, Ltd. from owning more than 19.999% of our outstanding shares of common stock or from engaging in certain transactions in our common stock for ten years, subject to certain conditions. Until the earlier of August 26, 2012 or the termination or departure of Peter A. Edison as our Chief Executive Officer, Steven Madden, Ltd. is generally prohibited from transferring the shares issued or the subordinated debenture.

     The subordinated debenture is subordinate to our other indebtedness, and is generally unsecured. We are required to offer to redeem the subordinated debenture at 101% of the outstanding principal amount in certain circumstances, including a change of control of the Company (as defined in the subordinated debenture), including the termination or departure of Peter A. Edison as our Chief Executive Officer for any reason.

     The subordinated debenture generally provides for customary events of default, including default in the payment of principal or interest or other required payments in favor of Steven Madden, Ltd., breach of representations, and specified events of bankruptcy or specified judgments against us. Upon the occurrence of an event of default under the subordinated debenture, Steven Madden, Ltd. would be entitled to acceleration of the debt (at between 102% and 100% of principal depending on when a default occurred) plus all accrued and unpaid interest, with the interest rate increasing to 13.0% per annum. We may prepay the debenture at any time, subject to prepayment penalties of between 1% and 2% of the principal amount over the first two years. We also granted certain demand and piggy-back registration rights in respect of the shares covering a period of ten years.

Off-Balance Sheet Arrangements

     At October 30, 2010, January 30, 2010, and October 31, 2009, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities or variable interest entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. We are, therefore, not materially exposed to any financing, liquidity, market or credit risk that could otherwise have arisen if we had engaged in such relationships.

Contractual Obligations

     The following table summarizes our contractual obligations as of October 30, 2010:

	Payments due by Period
			Less than
Contractual Obligations	Total		1 Year		1 - 3 Years		3 -5 Years		More than 5 Years
Long-term debt obligations (1)	$	15,395,744	$	1,930,244	$	5,486,333	$	1,100,000	$	6,879,167
Operating lease obligations (2)		118,297,309		24,027,652		42,399,809		31,963,379		19,906,469
Purchase obligations (3)		13,972,194		9,097,194		3,000,000		1,875,000		—
Total	$	147,665,247	$	35,055,090	$	50,886,142	$	34,938,379	$	26,785,636

(1)	Includes principal and interest payments on our subordinated convertible debentures, subordinated debenture, and our subordinated secured term loan.
(2)	Includes minimum payment obligations related to our store leases.
(3)	Includes merchandise on order, minimum royalty payments and payment obligations relating to store construction and miscellaneous service contracts.

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Recent Accounting Pronouncements

     None.

Impact of Inflation

     Overall, we do not believe that inflation has had a material adverse impact on our business or operating results during the periods presented. We cannot give assurance, however, that our business will not be affected by inflation in the future.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     Not required.

ITEM 4. CONTROLS AND PROCEDURES

     Disclosure Controls and Procedures. The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)), as of the end of the period covered by this report. Any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. Based on such evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Company’s disclosure controls and procedures provided reasonable assurance that the disclosure controls and procedures were effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act and in accumulating and communicating such information to management, including the Company’s Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

     Internal Control Over Financial Reporting. The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the Company’s internal control over financial reporting to determine whether any changes occurred during the Company’s third fiscal quarter ended October 30, 2010 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. Based on that evaluation, there has been no such change during the Company’s third quarter of fiscal year 2010.

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PART II — OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

     We are involved from time to time in various lawsuits and claims arising in the ordinary course of business. Although the outcomes of these lawsuits and claims are uncertain, we do not believe any of them will have a material adverse effect on our business, financial condition or results of operations.

ITEM 1A. RISK FACTORS

     There are no material changes to the risk factors disclosed in our Annual Report on Form 10-K for fiscal year 2009 and in our Quarterly Reports on Form 10-Q for the quarters ended May 1, 2010 and July 31, 2010.

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ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Purchase of Equity Securities by the Issuer and Affiliated Purchasers

     The Company does not have any programs to repurchase shares of its common stock and no such repurchases were made during the thirteen weeks ended October 30, 2010.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

     None.

ITEM 4. [Removed and Reserved]

ITEM 5. OTHER INFORMATION

     None.

ITEM 6. EXHIBITS

     See Exhibit Index herein

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this Quarterly Report on Form 10-Q to be signed, on its behalf by the undersigned thereunto duly authorized.

Date: December 14, 2010

BAKERS FOOTWEAR GROUP, INC. (Registrant)
By:	/s/ Peter A. Edison
	Peter A. Edison
	Chairman of the Board, Chief Executive Officer and President (Principal Executive Officer) Bakers Footwear Group, Inc. (On behalf of the Registrant)
By:	/s/ Charles R. Daniel, III
	Charles R. Daniel, III
	Executive Vice President and Chief Financial Officer, Controller, Treasurer, and Secretary (Principal Financial Officer and Principal Accounting Officer)

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EXHIBIT INDEX

Exhibit No.	Description
3.1	Restated Articles of Incorporation of the Company (incorporated by reference to Exhibit 3.1 to the Company’s Annual Report on Form 10-K for the fiscal year ended January 3, 2004 filed on April 2, 2004 (File No. 000-50563)).
3.2	Restated Bylaws of the Company (incorporated by reference to Exhibit 3.2 to the Company’s Annual Report on Form 10-K for the fiscal year ended January 3, 2004 filed on April 2, 2004 (File No. 000-50563)).
4.1	Debenture and Stock Purchase Agreement dated August 26, 2010 by and among the Company and Steven Madden, Ltd. (incorporated by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K filed on August 27, 2010 (File No. 000-50563)).
4.2	Debenture issued by the Company to Steven Madden, Ltd. on August 26, 2010 (incorporated by reference to Exhibit 4.2 to the Company’s Current Report on Form 8-K filed on August 27, 2010 (File No. 000-50563)).
4.3	Voting Agreement dated August 26, 2010 by and among the Company, Peter A. Edison, and Steven Madden, Ltd. (incorporated by reference to Exhibit 4.3 to the Company’s Current Report on Form 8-K filed on August 27, 2010 (File No. 000-50563)).
4.4	Registration Rights Agreement dated August 26, 2010 by and among the Company and Steven Madden, Ltd. (incorporated by reference to Exhibit 4.4 to the Company’s Current Report on Form 8-K filed on August 27, 2010 (File No. 000-50563)).
4.5	Subordination Agreement dated August 26, 2010 by and among the Company, Bank of America, N.A., and Steven Madden, Ltd. (incorporated by reference to Exhibit 4.5 to the Company’s Current Report on Form 8-K filed on August 27, 2010 (File No. 000-50563)).
4.6	Subordination Agreement dated August 26, 2010 by and among the Company, Private Equity Management Group, Inc., in its capacity as administrative agent for GVECR II 2007 E Trust dated December 17, 2007, and Steven Madden, Ltd. (incorporated by reference to Exhibit 4.6 to the Company’s Current Report on Form 8-K filed on August 27, 2010 (File No. 000-50563)).
4.7	Subordination Agreement dated August 26, 2010 by and among the Company, the holders of $4 million aggregate principal amount of the Company’s 9.5% Subordinated Convertible Debentures due June 30, 2012, and Steven Madden, Ltd. (incorporated by reference to Exhibit 4.7 to the Company’s Current Report on Form 8-K filed on August 27, 2010 (File No. 000-50563)).
4.8	Amendment Number 5 to Loan Documents dated August 26, 2010 by and among the Company, Private Equity Management Group, Inc. and the Lender named therein. (incorporated by reference to Exhibit 4.8 to the Company’s Quarterly Report on Form 10-Q filed on September 14, 2010 (File No. 000-50563)).
10.1	Second Amended and Restated Loan and Security Agreement dated as of August 31, 2006 by and between Bank of America, N.A. and the Company (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on September 7, 2006 (File No. 000-50563)).
10.2	Amended and Restated Revolving Credit Note dated as of August 31, 2006 by and between Bank of America, N.A. and the Company (incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on September 7, 2006 (File No. 000-50563)).
10.3	Waiver and consent agreement dated as of April 18, 2007 by and between Bank of America, N.A. and the Company (incorporated by reference to Exhibit 10.14.2 to the Company’s Annual Report on Form 10-K for the fiscal year ended February 3, 2007 filed on April 24, 2007 (File No. 000-50563)).
10.4	First Amendment to Second Amended and Restated Loan and Security Agreement dated as of May 17, 2007 by and between the Company and Bank of America, N.A. (incorporated by reference to Exhibit 10.4 to the Company’s Current Report on Form 8-K filed on May 18, 2007 (File No. 000-50563)).

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Exhibit No.	Description
10.5	Extension Agreement dated June 26, 2007 between the Company and Bank of America, N.A. (incorporated by reference to Exhibit 4.4 to the Company’s Current Report on Form 8-K filed on July 2, 2007 (File No. 000-50563)).
10.6	Second Amendment to Second Amended and Restated Loan and Security Agreement dated February 1, 2008 by and among the Company and Bank of America, N.A. (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on February 4, 2008 (File No. 000-50563)).
10.7	Third Amendment to Second Amended and Restated Loan and Security Agreement dated April 9, 2009 by and among the Company and Bank of America, N.A. (incorporated by reference to Exhibit 10.7 to the Company’s Current Report on Form 8-K filed on April 15, 2009 (File No. 000-50563)).
10.8	Fourth Amendment to Second Amended and Restated Loan and Security Agreement dated September 8, 2009 by and among the Company and Bank of America, N.A. (incorporated by reference to Exhibit 10.8 to the Company’s Quarterly Report on Form 10-Q filed on September 10, 2009 (File No. 000-50563)).
10.9	Fifth Amendment to Second Amended and Restated Loan and Security Agreement dated May 28, 2010 by and among the Company and Bank of America, N.A. (incorporated by reference to Exhibit 10.9 to the Company’s Current Report on Form 8-K filed on May 28, 2010 (File No. 000-50563)).
10.10	Waiver of Bank of America, N.A., dated August 26, 2010 (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on August 27, 2010 (File No. 000-50563)).
10.11	Consent of Bank of America, N.A., dated August 26, 2010 (incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on August 27, 2010 (File No. 000-50563)).
11.1	Statement regarding computation of per share earnings (incorporated by reference from Note 11 to the unaudited interim financial statements included herein).
31.1	Rule 13a-14(a)/15d-14(a) Certification (pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, executed by Chief Executive Officer).
31.2	Rule 13a-14(a)/15d-14(a) Certification (pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, executed by Chief Financial Officer).
32.1	Section 1350 Certifications (pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, executed by Chief Executive Officer and the Chief Financial Officer).

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