UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)
[X]Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended July 31,October 30, 2004

[  ]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 1-2191


BROWN SHOE COMPANY, INC.
(Exact name of registrant as specified in its charter)
  
New York
(State or other jurisdiction
of incorporation or organization)
43-0197190
(IRS Employer Identification Number)
  
8300 Maryland Avenue
St. Louis, Missouri
(Address of principal executive offices)
63105
(Zip Code)
 
(314) 854-4000
(Registrant's telephone number, including area code)
 

Indicate by checkmark 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 for 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.     Yes  [X]     No [  ]

Indicate by checkmark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2 of the Exchange Act)12b-2).    Yes  [X]    No [  ]

As of August 28,November 27, 2004, 18,189,16618,196,916 common shares were outstanding.



    Page 1


 
PART I
FINANCIAL INFORMATION

 
ITEM 1
FINANCIAL STATEMENTS

 
BROWN SHOE COMPANY, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
BROWN SHOE COMPANY, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
BROWN SHOE COMPANY, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
   
(Unaudited)
   
($ thousands)
July 31, 2004
August 2, 2003
January 31, 2004
October 30, 2004
November 1, 2003
January 31, 2004

Assets                  
Current Assets                  
Cash and cash equivalents
$
71,478
 
$
50,406
 
$
55,657
 $74,793 $52,750 $55,657 
Receivables 
83,938
  
75,271
  
81,930
  74,850  64,534  81,930 
Inventories 
453,016
  
417,731
  
376,210
  409,961  376,602  376,210 
Prepaid expenses and other current assets 
21,718
  
26,405
  
15,888
 
17,963
24,717
15,888
Total current assets 
630,150
  
569,813
  
529,685
 
577,567
518,603
529,685
Other assets 
85,274
  
83,883
  
83,692
  87,928  84,056  83,692 
Goodwill and intangible assets, net 
20,382
  
18,999
  
20,405
  20,860  20,435  20,405 
Property and equipment 
283,399
  
268,754
  
272,151
  291,684  271,405  272,151 
Allowances for depreciation and amortization 
(196,426
) 
(181,155
) 
(186,603
)
(201,944
)
(186,598
)
(186,603
)
Total property and equipment 
86,973
  
87,599
  
85,548
 
89,740
84,807
85,548
Total assets
$
822,779
 
$
760,294
 
$
719,330
 
$
776,095
$
707,901
$
719,330
Liabilities and Shareholders' EquityLiabilities and Shareholders' Equity        Liabilities and Shareholders' Equity        
Current Liabilities         Current Liabilities         
Notes payable
$
27,500
 
$
19,000
 
$
19,500
  Notes payable$43,500 $16,000 $19,500 
Trade accounts payable 
192,243
  
174,541
  
116,677
  Trade accounts payable 108,617  107,894  116,677 
Accrued expenses 
96,420
  
90,653
  
96,707
  Accrued expenses 92,291  93,613  96,707 
Income taxes 
7,377
  
12,422
  
2,960
  Income taxes 11,811  14,272  2,960 
Current maturities of long-term debt 
-
  
10,000
  
-
  Current maturities of long-term debt
-
3,500
-
Total current liabilities 
323,540
  
306,616
  
235,844
 Total current liabilities
256,219
235,279
235,844
Other Liabilities         Other Liabilities         
Long-term debt and capitalized lease obligations 
100,000
  
103,494
  
100,000
 
Long-term debt Long-term debt 100,000  100,000  100,000 
Other liabilities 
27,373
  
29,411
  
28,358
  Other liabilities
29,550
28,317
28,358
Total other liabilities 
127,373
  
132,905
  
128,358
 Total other liabilities
129,550
128,317
128,358
Shareholders' Equity         Shareholders' Equity         
Common stock 
68,209
  
67,308
  
67,787
  Common stock 68,229  67,640  67,787 
Additional capital 
65,155
  
53,902
  
62,772
  Additional capital 62,977  55,135  62,772 
Unamortized value of restricted stock 
(3,188
) 
(2,896
) 
(3,408
) Unamortized value of restricted stock (2,935) (2,691) (3,408)
Accumulated other comprehensive loss 
(3,974
) 
(7,726
) 
(4,934
) Accumulated other comprehensive loss (607) (5,366) (4,934)
Retained earnings 
245,664
  
210,185
  
232,911
  Retained earnings
262,662
229,587
232,911
Total shareholders' equity 
371,866
  
320,773
  
355,128
 Total shareholders' equity
390,326
344,305
355,128
Total liabilities and shareholders' equity
$
822,779
 
$
760,294
 
$
719,330
 Total liabilities and shareholders' equity
$
776,095
$
707,901
$
719,330
See notes to condensed consolidated financial statements.

Page 2


BROWN SHOE COMPANY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
BROWN SHOE COMPANY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
BROWN SHOE COMPANY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
(Unaudited)
 
(Unaudited)
 
(Unaudited)
 
(Unaudited)
 
Thirteen Weeks Ended
 
Twenty-six Weeks Ended
Thirteen Weeks Ended
Thirty-nine Weeks Ended
($ thousands, except per share amounts)
July 31, 2004
August 2, 2003
July 31, 2004
August 2, 2003
October 30, 2004
November 1, 2003
October 30 , 2004
November 1, 2003
                       
Net sales$
458,657
 $
458,384
 
$
950,489
 
$
904,828
 $514,825 $493,433 $1,465,314 $1,398,261 
Cost of goods sold 
269,411
 
270,519
  
561,879
  
531,836
 
306,782
288,721
868,661
820,557
Gross profit
189,246
187,865
388,610
372,992
208,043204,712596,653577,704
Selling and administrative expenses 
175,968
 
169,249
  
360,415
  
339,039
 
179,762
172,278
540,177
511,317
Operating earnings
13,278
18,616
28,195
33,953
28,28132,43456,47666,387
Interest expense 
2,141
 
2,517
  
4,620
  
5,423
  1,980  2,256  6,600  7,679 
Interest income 
(170
) 
(104
) 
(296
) 
(200
)
(221
)
(118
)
(517
)
(318
)
Earnings before income taxes
11,307
16,203
23,871
28,730
26,52230,29650,39359,026
Income tax provision 
3,493
 
4,647
  
7,490
  
8,171
 
7,702
9,096
15,192
17,267
Net earnings$
7,814
$
11,556
$
16,381
$
20,559
$
18,820
$
21,200
$
35,201
$
41,759
        
Basic net earnings per common share$
0.44
 $
0.66
 
$
0.92
 
$
1.17
 
$
1.05
$
1.19
$
1.97
$
2.37
        
Diluted net earnings per common share$
0.41
 $
0.62
 
$
0.86
 
$
1.11
 
$
1.01
$
1.13
$
1.87
$
2.25
        
Dividends per common share$
0.10
 $
0.10
 
$
0.20
 
$
0.20
 
$
0.10
$
0.10
$
0.30
$
0.30
See notes to condensed consolidated financial statements.

Page 3


BROWN SHOE COMPANY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
BROWN SHOE COMPANY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
BROWN SHOE COMPANY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
(Unaudited)
 
Twenty-six Weeks Ended
Thirty-nine Weeks Ended
 
($ thousands)
July 31, 2004
August 2, 2003
October 30, 2004
November 1, 2003
Operating Activities:            
Net earnings
$
16,381
 
$
20,559
 $35,201 $41,759 
Adjustments to reconcile net earnings to net cash provided by operating activities:            
Depreciation and amortization 
11,787
  
12,470
  18,251  19,053 
Share-based compensation expense 
711
  
1,867
 
Share-based compensation (income) expense (1,480) 3,299 
Tax benefit related to share-based plans 
709
  
-
  913  - 
Loss on disposal of facilities and equipment 
403
  
567
  739  1,599 
Impairment charges for facilities and equipment 
600
  
966
  1,481  2,147 
Provision for (recoveries from) doubtful accounts 
(344
) 
150
  (342) 278 
Changes in operating assets and liabilities:            
Receivables 
(1,664
) 
7,065
  7,422  17,674 
Inventories 
(76,806
) 
(25,147
) (33,751) 15,982 
Prepaid expenses and other current assets 
(5,830
) 
(5,427
) (2,075) (3,739)
Trade accounts payable and accrued expenses 
75,279
  
33,716
  (12,476) (31,198)
Income taxes 
4,417
  
7,070
  8,851  8,920 
Other, net
(645
)
542
1,164
(182
)
Net cash provided by operating activities
24,998
54,398
23,898
75,592
Investing Activities:            
Capital expenditures 
(14,235
) 
(16,146
) (23,880) (21,668)
Other
153
248
153
368
Net cash used for investing activities
(14,082
)
(15,898
)
Net cash used by investing activities
(23,727
)
(21,300
)
Financing Activities:            
Increase (decrease) in short-term notes payable 
8,000
  
(10,000
) 24,000  (13,000)
Principal repayments of long-term debt 
-
  
(10,000
) -  (20,000)
Debt issuance costs 
(1,071
) 
-
  (1,274) - 
Proceeds from stock options exercised 
1,605
  
3,342
  1,687  4,696 
Dividends paid
(3,629
)
(3,557
)
(5,448
)
(5,359
)
Net cash provided by (used for) financing activities
4,905
(20,215
)
Net cash provided (used) by financing activities
18,965
(33,663
)
Increase in cash and cash equivalents
15,821
18,285
19,13620,629
Cash and cash equivalents at beginning of period
55,657
32,121
55,657
32,121
Cash and cash equivalents at end of period
$
71,478
$
50,406
$
74,793
$
52,750
See notes to condensed consolidated financial statements.

Page 4

BROWN SHOE COMPANY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 
Note 1.
Basis of Presentation

The accompanying condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and reflect all adjustments which management believes necessary (which include only normal recurring accruals) to present fairly the Company's financial position, results of operations, and cash flows. These statements, however, do not include all information and footnotes necessary for a complete presentation of the Company's financial position, results of operations and cash flows in conformity with accounting principles generally accepted in the United States.

Certain prior period amounts on the condensed consolidated balance sheets, statements of earnings and statements of cash flows have been reclassified to conform to the current period presentation. These reclassifications did not affect net earnings.

The Company's business is subject to seasonal influences, particularly the back-to-school selling season at Famous Footwear which falls in the Company's third quarter. Interim results may not necessarily be indicative of results which may be expected for any other interim period or for the year as a whole.

For further information, refer to the consolidated financial statements and footnotes included in the Company's Annual Report on Form 10-K for the year ended January 31, 2004.
 
 
Note 2.
Earnings Per Share

The following table sets forth the computation of basic and diluted net earnings per common share for the periods ended July 31,October 30, 2004 and August 2,November 1, 2003:
 

 
Thirteen Weeks Ended
 
Twenty-six Weeks Ended
  
Thirteen Weeks Ended
 
Thirty-nine Weeks Ended
($ thousands, except per share data)
July 31, 2004
August 2, 2003
July 31,  2004
August 2, 2003 
($ thousands, except per share data)
October 30,
2004
November 1,
2003
October 30, 
2004
November 1,
2003 
NUMERATOR   $                    
Net earnings
$
7,814
11,556
$
16,381
$
20,559
$
18,820
$
21,200
$
35,201
$
41,759
DENOMINATOR (thousand shares)                        
Denominator for basic earnings per common share 
17,921
  
17,631
  
17,881
  
17,570
 
Denominator for basic net earnings per common share 
17,943
  
17,761
  
17,902
  
17,634
 
Dilutive effect of unvested restricted stock and stock options
1,066
901
1,072
893
706
937
950
900
Denominator for diluted earnings per common share
18,987
18,532
18,953
18,463
Denominator for diluted net earnings per common share
18,649
18,698
18,852
18,534
Basic earnings per common share
$
0.44
$
0.66
$
0.92
$
1.17
Basic net earnings per common share
$
1.05
$
1.19
$
1.97
$
2.37
Diluted earnings per common share
$
0.41
$
0.62
$
0.86
$
1.11
Diluted net earnings per common share
$
1.01
$
1.13
$
1.87
$
2.25

Options to purchase 231,167387,600 and 15,00034,921 shares of common stock for the thirteen week periods and 233,667284,978 and 15,16737,216 shares of common stock for the twenty-sixthirty-nine week periods ended July 31,October 30, 2004 and August 2,November 1, 2003, respectively, were not included in the denominator for diluted net earnings per common share because their effect would be antidilutive.
 
 
Note 3.
Comprehensive Income

Comprehensive income includes changes in shareholders' equity related to foreign currency translation adjustments and unrealized gains or losses from derivatives used for hedging activities.

Page 5

The following table sets forth the reconciliation from net earnings to comprehensive income for the periods ended July 31,October 30, 2004 and August 2,November 1, 2003:
 

 
Thirteen Weeks Ended
 
Twenty-six Weeks Ended
 
Thirteen Weeks Ended
 
Thirty-nine Weeks Ended
($ Thousands)
July 31,  2004
August 2,  2003
July 31,  2004
August 2,  2003
October 30,
2004
November 1,
2003
October 30,
2004
November 1,
2003
Net earnings $
7,814
 $
11,556
 
$
16,381
 
$
20,559
  $18,820 $21,200 $35,201 $41,759 
Other comprehensive income (loss), net of tax:                       
Foreign currency translation adjustment  
1,218
 
562
 
(92
) 
3,259
   3,580  2,448 3,488  5,707 
Unrealized gains (losses) on derivative instruments  
(214
) 
212
 
(112
) 
(555
)
Net loss reclassified into earnings  
673
 
372
 
1,164
  
717
 
Unrealized losses on derivative instruments  (631) (624) (743) (1,179)
Net loss from derivatives reclassified into earnings
418
536
1,582
1,253
  
1,677
 
1,146
 
960
  
3,421
 
3,367
2,360
4,327
5,781
Comprehensive income
$
9,491
$
12,702
$
17,341
$
23,980
$
22,187
$
23,560
$
39,528
$
47,540

 
Note 4.
Business Segment Information

Applicable business segment information is as follows for the periods ended July 31,October 30, 2004 and August 2,November 1, 2003:
 

($ thousands)
Famous
Footwear
 
Wholesale
Operations
 
Naturalizer
Retail
 
Other
 
Totals
 Famous
Footwear		 Wholesale
Operations		 Naturalizer
Retail		 Other Totals 
Thirteen Weeks Ended July 31, 2004          
Thirteen Weeks Ended October 30, 2004Thirteen Weeks Ended October 30, 2004          
External sales$
269,812
 $
136,886
 $
48,264
 $
3,695
 $
458,657
 $311,685 $148,696 $49,911 $4,533 $514,825 
Intersegment sales 
-
  
36,553
  
-
  
-
  
36,553
  414  46,786  -  -  47,200 
Operating earnings (loss) 
12,631
  
8,963
  
(2,551
) 
(5,765
) 
13,278
  24,802  10,375  (1,491) (5,405) 28,281 
Operating segment assets 
401,577
  
219,564
  
63,888
  
137,750
  
822,779
  359,044  188,362  79,836  148,853  776,095 
Thirteen Weeks Ended August 2, 2003          
Thirteen Weeks Ended November 1, 2003Thirteen Weeks Ended November 1, 2003          
External sales$
268,931
 $
137,903
 $
49,673
 $
1,877
 $
458,384
 $301,588 $140,062 $49,789 $1,994 $493,433 
Intersegment sales 
-
  
32,349
  
-
  
-
  
32,349
  284  35,968  -  -  36,252 
Operating earnings (loss) 
12,904
  
12,594
  
(1,012
) 
(5,870
) 
18,616
  23,427  15,460  (166) (6,287) 32,434 
Operating segment assets 
400,885
  
185,723
  
64,998
  
108,688
  
760,294
  345,000  171,986  70,669  120,246  707,901 
Twenty-six Weeks Ended July 31, 2004             
Thirty-nine Weeks Ended October 30, 2004Thirty-nine Weeks Ended October 30, 2004          
External sales$
541,936
 $
308,430
 $
93,595
 $
6,528
 $
950,489
 $853,620 $457,125 $143,507 $11,062 $1,465,314 
Intersegment sales 
-
  
74,932
  
-
  
-
  
74,932
  1,054  121,718  -  -  122,772 
Operating earnings (loss) 
25,015
  
21,769
  
(4,771
) 
(13,818
) 
28,195
  49,818  32,144  (6,262) (19,224) 56,476 
                              
Twenty-six Weeks Ended August 2, 2003             
Thirty-nine Weeks Ended November 1, 2003Thirty-nine Weeks Ended November 1, 2003          
External sales$
530,046
 $
278,888
 $
92,507
 $
3,387
 $
904,828
 $831,634 $418,950 $142,296 $5,381 $1,398,261 
Intersegment sales 
-
  
64,750
  
-
  
-
  
64,750
  693  100,718  -  -  101,411 
Operating earnings (loss) 
23,487
  
25,562
  
(2,367
) 
(12,729
) 
33,953
  46,914  41,106  (2,534) (19,099) 66,387 

The Other segment includes corporate administrative and other expenses, which are not allocated to the operating units, and the Company's investment in its majority-owned subsidiary, Shoes.com, Inc., a footwear e-commerce company.

Effective February 1, 2004, the Company began accounting for its Irish financing subsidiary, Brown Group Dublin Limited, which holds cash earnedand short term investments relating to offshore earnings other than in Canada, within the Other segment. Brown Group Dublin Limited had previously been accounted for within the Wholesale Operations segment. Prior year

6

amounts have been reclassified to



Page 6

conform to the current year presentation. This reclassification had no effect on operating earnings, but resulted in a transfer of assets of $62.4$68.0 million and $41.3$47.1 million at July 31,October 30, 2004 and August 2,November 1, 2003, respectively, to the Other segment.
 
 
Note 5.5
Restructuring Reserves

Closure of Canadian Manufacturing Facility

In the fourth quarter of fiscal year 2003, the Company announced the closing of its last Canadian footwear manufacturing facility, located in Perth, Ontario, and recorded a pre-tax charge of $4.5 million, the components of which were as follows:

The following is a summary of the activity in the reserve, by category of costs:
 

($ millions)
Employee
Severance
Inventory
Markdowns
Lease
Buyouts
Total
Employee
Severance
Inventory
Markdowns
Lease
Buyouts
Total
Original charge and reserve balance
$
2.3
 
$
1.6
 
$
0.6
 
$
4.5
 
$
2.3
 
$
1.6
 
$
0.6
 
$
4.5
 
Adjustments 
(0.3
) 
0.4
  
(0.1
) 
-
  
(0.3
) 
0.4
  
(0.1
) 
-
 
Expenditures in quarter ending May 1, 2004 
(1.8
) 
(2.0
) 
(0.1
) 
(3.9
) 
(1.8
) 
(2.0
) 
(0.1
) 
(3.9
)
Expenditures in quarter ending July 31, 2004
(0.1
)
-
(0.2
)
(0.3
)
 
(0.1
) 
-
  
(0.2
) 
(0.3
)
Reserve balance July 31, 2004
$
0.1
$
-
$
0.2
$
0.3
Expenditures in quarter ending October 30, 2004
-
-
(0.1
)
(0.1
)
Reserve balance October 30, 2004
$
0.1
$
-
$
0.1
$
0.2

The Company anticipates that the restructuring activities associated with the closure of the Canadian manufacturing facility will be substantially completed by the end of fiscal 2004.
 
 
Note 6.
Goodwill and Other Intangible Assets

Goodwill and intangible assets were attributable to the Company's operating segments as follows:
 

($ thousands)
July 31, 2004
August 2, 2003
January 31, 2004
October 30, 2004
November 1, 2003
January 31, 2004
Famous Footwear
$
3,529
 
$
3,529
 
$
3,529
 
$
3,529
 
$
3,529
 
$
3,529
 
Wholesale Operations 
10,237
  
10,252
  
10,245
  
10,233
  
10,248
  
10,245
 
Naturalizer Retail 
5,281
  
5,018
  
5,296
  
5,763
  
5,323
  
5,296
 
Other
1,335
200
1,335
1,335
1,335
1,335
$
20,382
$
18,999
$
20,405
$
20,860
$
20,435
$
20,405

The change between periods for the Naturalizer Retail segment reflects changes in the Canadian dollar exchange rate. The change in the Other segment from August 2, 2003 to July 31, 2004 of $1.1 million reflects the acquisition of additional shares of Shoes.com Inc. by the Company.
 
 
Note 7.
Share-Based Compensation

As of July 31,October 30, 2004, the Company had four share-based compensation plans, which are described more fully in Note 16 to the consolidated financial statements contained in the Company's Annual Report on Form 10-K for the year ended January 31, 2004. The Company accounts for those plans under the recognition and measurement principles of APB Opinion No. 25, "Accounting for Stock Issued to Employees" and related interpretations. Compensation expense is recognized in net earnings for stock appreciation units, stock performance plans and restricted stock grants. No share-based employee compensation cost is reflected in net earnings for stock options, as all option grants had an exercise price equal to the market value of the

Page 7

underlying common stock on the date of grant. The following table illustrates the effect on net incomeearnings and net earnings per common share as if the Company had applied the fair value recognition provisions of SFAS No. 123, "Accounting for Stock-Based Compensation," to stock options outstanding:
 

 
Thirteen Weeks Ended
 
Twenty-six Weeks Ended
 
Thirteen Weeks Ended
 
Thirty-nine Weeks Ended
 
($ thousands, except per share amounts)
July 31, 2004
August 2, 2003
July 31, 2004
August 2, 2003
October 30,
2004
November 1,
2003
October 30,
2004
November 1,
2003
Net earnings, as reported $
7,814
 $
11,556
 
$
16,381
 
$
20,559
  $18,820 $21,200 $35,201 $41,759 
Add: Total share-based employee compensation
(income) expense included in reported net
earnings, net of related tax effect		  
(451
) 
538
  
462
  
1,213
   (1,425) 931  (962) 2,145 
Deduct: Total share-based employee
compensation expense determined under the
fair value based method for all awards, net of
related tax effect
(359
)
(1,125
)
(2,013
)
(2,397
)
618
(1,479
)
(1,396
)
(3,877
)
Pro forma net earnings
$
7,004
$
10,969
$
14,830
$
19,375
$
18,013
$
20,652
$
32,843
$
40,027
Earnings per share:
Net earnings per common share:
Basic - as reported $
0.44
 $
0.66
 
$
0.92
 
$
1.17
  $1.05 $1.19 $1.97 $2.37 
Basic - pro forma  
0.39
  
0.62
  
0.83
  
1.10
   1.00  1.16  1.83  2.27 
Diluted - as reported  
0.41
  
0.62
  
0.86
  
1.11
   1.01  1.13  1.87  2.25 
Diluted - pro forma  
0.37
  
0.59
  
0.78
  
1.05
   0.97  1.10  1.74  2.16 

The Company issued 55,3875,250 and 150,34788,654 shares of common stock for the thirteen week periods, and 112,577117,827 and 266,153354,807 shares of common stock for the twenty-sixthirty-nine week periods, ended July 31,October 30, 2004 and August 2,November 1, 2003, respectively, for stock options exercised and restricted stock grants. The Company recognized $0.5 million of share-based compensation income during the thirteen weeks ended July 31, 2004 as

As a result of the decline in the Company's net earnings and stock price during that period.
the period and the corresponding change in estimated payouts under stock-based and other incentive plans, the Company's third quarter and year to date 2004 results reflect reduced compensation expense as compared to the same periods in 2003. The Company recognized income of $3.2 million ($2.0 million on an after tax basis, or $0.11 per diluted share) during the thirteen weeks ended October 30, 2004 related to these plans, compared to expense of $5.4 million ($3.3 million on an after tax basis) during the thirteen weeks ended November 1, 2003. For the year to date period, the Company recognized $4.2 million of expense ($2.6 million on an after tax basis, or $0.14 per diluted share) related to these plans during the thirty-nine weeks ended October 30, 2004 as compared to $13.9 million of expense ($8.6 million on an after tax basis) during the thirty-nine weeks ended November 1, 2003.
 
Note 8.
Retirement and Other Benefit Plans

The following table sets forth the components of net periodic benefit cost or income for the Company, including all domestic and Canadian plans:
 

Pension Benefits
 
Other Postretirement Benefits
Pension Benefits
 
Other Postretirement Benefits
 
Thirteen Weeks Ended
 
Thirteen Weeks Ended
Thirteen Weeks Ended
 
Thirteen Weeks Ended
 
($ thousands)
July 31, 2004
August 2, 2003
July 31,2004
August 2, 2003
October 30,
2004
November 1, 
2003
October 30,
2004
November 1, 
2003
Service cost
$
1,699
 
$
1,349
 
$
-
 
$
-
 $1,543 $1,318 $- $- 
Interest cost 
2,228
  
2,016
 
67
  
61
  2,169  2,001 65  68 
Expected return on assets 
(4,042
) 
(3,798
) 
-
  
-
  (3,831) (3,705) -  - 
Amortization of:                      
Actuarial (gain) loss 
81
  
109
 
(20
) 
(48
)
Actuarial loss (gain) 104  96 (35) (48)
Prior service costs 
81
  
81
    
(27
) 78  78 -  (26)
Net transition assets
(42
)
(42
)
-
-
-
(42
)
-
-
Total net periodic benefit cost (income)
$
5
$
(285
)
$
47
$
(14
)
$
63
(254
)
$
30
$
(6
)

Page 8


Pension Benefits
 
Other Postretirement Benefits
Pension Benefits
 
Other Postretirement Benefits
 
Twenty-six Weeks Ended
 
Twenty-six Weeks Ended
Thirty-nine Weeks Ended
 
Thirty-nine Weeks Ended
 
($ thousands)
July 31, 2004
August 2, 2003
July 31,2004
August 2, 2003
October 30,
2004
November 1,
2003
October 30,
2004
November 1,
2003
Service cost
$
3,082
 
$
2,632
 
$
-
 
$
-
 $4,625 $3,950 $- $- 
Interest cost 
4,331
  
3,994
 
130
  
136
  6,500  5,995 195  204 
Expected return on assets 
(7,650
) 
(7,399
) 
-
  
-
  (11,481) (11,104) -  - 
Amortization of:                      
Actuarial (gain) loss 
159
  
187
 
(70
) 
(98
)
Actuarial loss (gain) 263  283 (105) (146)
Prior service costs 
156
  
156
 
-
  
(52
) 234  234 -  (78)
Net transition assets
(85
)
(81
)
-
-
(85
)
(123
)
-
-
Total net periodic benefit cost (income)
$
(7
)
$
(511
)
$
60
$
(14
)
$
56
$
(765
)
$
90
$
(20
)

 
Note 9.
Amended and Restated Credit Agreement

The Company entered into an Amended and Restated Credit Agreement (the "Agreement") effective July 21, 2004, which amended and restated its existing $350 million revolving bank credit agreement. The Agreement provides for a maximum line of credit of $350 million, subject to the calculated borrowing base restrictions. In addition to extending the credit term, the Agreement also provides other benefits to the Company, including expanding the definition of eligible inventory in certain circumstances and reducing the interest rate spread paid on outstanding borrowings. Borrowing availability under the Agreement is based upon the sum of eligible accounts receivable and inventory, less outstanding borrowings, letters of credit and applicable reserves. The Agreement matures on July 21, 2009 and the Company's obligations are secured by the Company's accounts receivable and inventory. Borrowings under the Agreement bear interest at a variable rate determined based upon the level of availability under the Agreement. If availability falls below specified levels, the Company would then be subject to certain financial covenants. In addition, if availability falls below $25 million and the fixed charge coverage ratio is less than 1.0 to 1, the Company would be in default. The Agreement also contains certain other covenants and restrictions.

In connection with the Agreement, the Company incurred $1.1approximately $1.3 million of issuance costs, in the second quarter, which, together with remaining unamortized debt issuance costs of approximately $2.7 million associated with the existingoriginal bank credit agreement, will be amortized over the five-year term of the Agreement.
 
 
Note 10.
Commitments and Contingencies

Environmental Remediation
The Company is involved in environmental remediation and ongoing compliance activities at several sites. The Company is remediating, under the oversight of Colorado authorities, the groundwater and indoor air at its owned facility in Colorado (also known as the Redfield site) and residential neighborhoods adjacent to and near the property that have been affected by solvents previously used at the facility. The anticipated future cost of remediation activities at July 31,October 30, 2004 is $7.1$6.5 million and is accrued within accrued expenses and other liabilities on the condensed consolidated balance sheet, but the ultimate cost may vary. The cumulative costs incurred through July 31,October 30, 2004 are $13.8$14.2 million.

The Company assesses future recoveries from insurance companies related to remediation costs by estimating a range of probable recoveries and recording the low end of the range. Recoveries from other responsible parties are recorded when a contractual agreement is reached. As of July 31,October 30, 2004, recorded recoveries totaled $3.8 million and are recorded in other noncurrent assets on the condensed consolidated balance sheet. $3.6$3.3 million of the recorded recoveries are expected from certain insurance companies as indemnification for amounts spent for remediation associated with the Redfield site. The insurance companies are contesting their indemnity obligations, and the Company has sued its insurers seeking recovery of defense costs, indemnity and other damages related to the former operations and the remediation at the site. The Company believes insurance coverage in place entitles it to reimbursement for more than the recovery recorded. The Company believes the recorded recovery is supported by the fact the limits of the insurance policies at issue exceed the amount of the recorded

9

recovery, and certain insurers have offered to settle these claims. The Company is unable to estimate the ultimate recovery from the insurance carriers, but is pursuing resolution of its claims.



Page 9

The Company has completed its remediation efforts at its closed New York tannery and two associated landfills. In 1995, state environmental authorities reclassified the status of these sites as being properly closed and requiring only continued maintenance and monitoring over the next 20 years. In addition, various federal and state authorities have identified the Company as a potentially responsible party for remediation at certain other landfills.

Based on information currently available, the Company had an accrued liability of $9.1$8.5 million as of July 31,October 30, 2004 to complete the cleanup, maintenance and monitoring at all sites. Of the $9.1$8.5 million liability, $6.8$1.7 million is included in accrued expenses and $2.3$6.8 million is included in other liabilities on the condensed consolidated balance sheet. The ultimate costs may vary, and it is possible costs may exceed the recorded amounts.

While the Company currently does not operate manufacturing facilities, prior operations included numerous manufacturing and other facilities for which the Company may have responsibility under various environmental laws for the remediation of conditions that may be identified in the future.

Litigation
In March 2000, a class action lawsuit was filed in Colorado State Court (District Court for the City and County of Denver) related to the Redfield site described above. Plaintiffs alleged claims for trespass, nuisance, strict liability, unjust enrichment, negligence and exemplary damages arising from the alleged release of solvents contaminating the groundwater and indoor air in the areas adjacent to and near the site. In December 2003, the jury hearing the claims returned a verdict finding one of the Company's subsidiaries negligent and awarded the class plaintiffs $1.0 million in damages. The Company has recorded this award along with pre-trial interest on the award and estimated costs related to sanctions imposed by the court related to a pre-trial discovery dispute between the parties. The total pre-tax charge recorded for these matters in the fourth quarter of fiscal 2003 was $3.1 million ($2.0 million after tax). The Company recorded an additional $0.6 million in expense in the first quarter of 2004, related to pre-trial interest, to reflect the trial court's ruling extending the time period for which pre-judgment interest applied. In April 2004, the plaintiffs filed a motion for a new trial; the court has denied that motion. Several other post-trial motions are still pending before the trial court. The plaintiffs have appealed the judgment to the Colorado Court of Appeals and have asked for a retrial. The Company has cross-appealed the trial court's ruling as to the amount of pre-judgment interest, and has conditionally appealed a number of the trial court's rulings in the event of a retrial. The ultimate outcome and cost to the Company may vary.

As described above in "Environmental Remediation," the Company has filed suit against its insurance carriers and is seeking recovery of certain defense costs, indemnity for the costs incurred for remediation related to the Redfield site and for the damages awarded in the class action, and other related damages.

The Company also is involved in legal proceedings and litigation arising in the ordinary course of business. In the opinion of management, the outcome of such ordinary course of business proceedings and litigation currently pending will not have a material adverse effect on the Company's results of operations or financial position.

Other
The Company is a guarantor of an Industrial Development Bond financing of $3.5 million for a manufacturing and warehouse facility in Bedford County, Pennsylvania. The outstanding principal on this Industrial Development Bond is $3.0 million. These facilities and the business that operated them were sold to another party in 1985, which assumed this obligation. This financing is scheduled to be paid annually beginning in 20042005 through 2009. During October 2004, the current owner of the manufacturing and warehouse facility filed for bankruptcy protection and is seeking liquidation of its assets. Management believes the maximum amount of potential future payments under this guarantee, including interest due through maturity, is $3.5 million. While the ultimate outcome is uncertain, management believes that the fair market value of the facility is sufficient to cover the payments due under the Industrial Development Bond. Accordingly, the Company has not recorded any charge related to this guarantee.

The Company is contingently liable for lease commitments of approximately $10 million in the aggregate, which primarily relate to the Cloth World and Meis specialty retailing chains, which were sold in prior years.

In order for the Company to incur any liability related to these guarantees and lease commitments, the current owners would have to default. At this time, the Company does not believe this is reasonably likely to occur.

Page 10





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

 
OVERVIEW

Overall, the secondCompany's third quarter was a difficult one for the Companyresults were disappointing as net earnings declined from the secondthird quarter last year despite a slightin spite of an increase in net sales. Consolidated net sales rose 0.1%4.3% to $458.7$514.8 million for the secondthird quarter of fiscal 2004, as compared to $458.4$493.4 million for the secondthird quarter of the prior year. Net earnings were $7.8$18.8 million, or $0.41$1.01 per diluted share, for the secondthird quarter compared to $0.62$21.2 million, or $1.13 per diluted share, for the secondthird quarter of last year. Each of our operating segments reported lower operating earnings than in last year's second quarter.

FollowingThe following is a summary of the more significant factors affecting our results in the secondthird quarter of fiscal 2004:

Page


11


CONSOLIDATED RESULTS

Thirteen Weeks Ended
 
Twenty-six Weeks Ended
Thirteen Weeks Ended
 
Thirty-nine Weeks Ended
July 31, 2004
August 2, 2003
July 31, 2004
August 2, 2003
October 30, 2004
November 1, 2003
October 30, 2004
November 1, 2003
($ millions)
% of
Net
Sales
% of
Net 
Sales
% of 
Net
Sales
% of 
Net
Sales
% of
Net
Sales
% of
Net 
Sales
% of 
Net
Sales
% of 
Net
Sales
Net sales$
458.7
 
100.0%
 
$
458.4
 
100.0%
 $
950.5
 
100.0%
 
$
904.8
 
100.0%
$
514.8
 
100.0%
 
$
493.4
 
100.0%
 $
1,465.3
 
100.0%
 
$
1,398.3
 
100.0%
Cost of goods sold
269.4
58.7%
270.5
59.0%
561.9
59.1%
531.8
58.8%
306.8
59.6%
288.7
58.5%
868.6
59.3%
820.6
58.7%
Gross profit 
189.3
 
41.3%
 
187.9
 
41.0%
 
388.6
 
40.9%
 
373.0
 
41.2%
 
208.0
 
40.4%
 
204.7
 
41.5%
 
596.7
 
40.7%
 
577.7
 
41.3%
Selling and
administrative expenses
176.0
38.4%
169.3
36.9%
360.4
37.9%
339.0
37.5%
179.7
34.9%
172.3
34.9%
540.2
36.8%
511.3
36.6%
Operating earnings 
13.3
 
2.9%
 
18.6
 
4.1%
 
28.2
 
3.0%
 
34.0
 
3.7%
 
28.3
 
5.5%
 
32.4
 
6.6%
 
56.5
 
3.9%
 
66.4
 
4.7%
Interest expense 
2.2
 
0.4%
 
2.5
 
0.6%
 
4.6
 
0.5%
 
5.5
 
0.5%
 
2.0
 
0.3%
 
2.2
 
0.5%
 
6.6
 
0.5%
 
7.7
 
0.5%
Interest income
(0.2
)
0.0%
(0.1
)
0.0%
(0.3
)
0.0%
(0.2
)
0.0%
(0.2
)
0.0%
(0.1
)
0.0%
(0.5
)
0.0%
(0.3
)
0.0%
Earnings before
income taxes		 
11.3
 
2.5%
 
16.2
 
3.5%
 
23.9
 
2.5%
 
28.7
 
3.2%
 
26.5
 
5.2%
 
30.3
 
6.1%
 
50.4
 
3.4%
 
59.0
 
4.2%
Income tax provision
(3.5
)
(0.8)%
(4.6
)
(1.0)%
(7.5
)
(0.8)%
(8.1
)
(0.9)%
(7.7
)
(1.5)%
(9.1
)
(1.8)%
(15.2
)
(1.0)%
(17.2
)
(1.2)%
Net earnings
$
7.8
1.7%
$
11.6
2.5%
$
16.4
1.7%
$
20.6
2.3%
$
18.8
3.7%
$
21.2
4.3%
$
35.2
2.4%
$
41.8
3.0%

Net Sales
Net sales increased $0.3$21.4 million, or 0.1%4.3%, to $458.7$514.8 million in the secondthird quarter of 2004 as compared to $458.4$493.4 million in the secondthird quarter of the prior year. This increase is primarily attributable to a $10.1 million increase at Famous Footwear and the acquisition of the Bass footwear license at the beginning of fiscal 2004, which contributed $9.1 million of net sales during the second quarter. Offsetting the impact of the Bass sales increase was weakness in both the children's and women's private label wholesale divisions as well as a decline in sales at the Naturalizer Retail stores.2004.

Net sales increased $45.7$67.0 million, or 5.0%4.8%, to $950.5$1,465.3 million in the first halfnine months of 2004 as compared to $904.8$1,398.3 million in the first halfnine months of the prior year. The increase is primarily attributable to the acquisition of the Bass footwear license at the beginning of 2004, which contributed $24.4 million in net sales during the firstover one half of 2004.the increase. In addition, the net sales improvement was driven by first quarter sales gains within our private label, Dr. Scholl'sSantana and LifeStride lines and from new Famous Footwear stores.

Gross Profit
Gross profit increased $1.4$3.3 million, or 0.7%1.6%, to $189.3$208.0 million for the secondthird quarter of 2004 as compared to $187.9$204.7 million in the secondthird quarter of the prior year. As a percent of net sales, our gross margin percentage increasedprofit rate decreased to 41.3%40.4% in the secondthird quarter from 41.0%41.5% in the secondthird quarter of the prior year as a result of higher gross profit ratesmore aggressive promotions and pricing at Famous Footwear due to capture more sales during the fresher product mixcritical back-to-school period, higher provisions for allowances to our department store customers, and lower markdowns.higher inventory markdowns in our wholesale operations.

Gross profit increased $15.6$19.0 million, or 4.2%3.3%, to $388.6$596.7 million in the first halfnine months of 2004 as compared to $373.0$577.7 million in the first halfnine months of the prior year. The overall increase in gross profit is primarily driven by the $45.7$67.0 million increase in net sales. As a percent of net sales, our gross profit rate decreased to 40.9%40.7% in the first halfnine months of 2004 as compared to 41.2%41.3% in the first halfnine months of the prior year. The decline in the gross profit rate reflects a greater mix of wholesale sales, which carry a lower gross margin rate than our overall retail sales, more aggressive back-to-school pricing at Famous Footwear, a higher provision for allowances to our department store customers, and a lower gross profit ratehigher inventory markdowns in our Wholesale Operations segment.wholesale operations.

Selling and Administrative Expenses
Selling and administrative expenses increased $6.7$7.4 million, or 4.0%4.3%, to $176.0$179.7 million for the secondthird quarter as compared to $169.3$172.3 million in the secondthird quarter of the prior year. This increase is attributable to both transitionincreased selling and assimilationadministrative costs related toassociated with the Bass footwear line, of approximately $1.5 millionincreased costs related to new store openings at Famous Footwear and to our ongoing investments in talent, systems, and infrastructure intended to position the Company for future growth. Offsetting these factors were benefits from reduced compensation costs associated with stock-based and incentive compensation plans of $2.4$8.6 million compared to last year.

Selling and administrative expenses increased $21.4$28.9 million, or 6.3%,5.6% to $360.4$540.2 million in the first halfnine months of 2004 as compared to $339.0$511.3 million in the first halfnine months of the prior year. This increase is due to bothincreased wholesale selling costs and warehousing costs, increased costs related to new store openings at Famous Footwear and transition and assimilation

12

costs related to the Bass footwear line of approximately $4.8$5.1 million, increased selling and administrative costs associated with the Bass footwear line, and our ongoing investments in talent, systems and infrastructure intended to position the Company for future growth.

Page 12

Offsetting these factors were benefits from reduced compensation costs associated with stock-based and incentive compensation plans of $9.7 million compared to last year.

Interest Expense
Interest expense decreased $0.3$0.2 million, or 14.9%12.2%, to $2.0 million in the third quarter as compared to $2.2 million in the second quarter as compared to $2.5 million in the secondthird quarter of the prior year. The decrease in interest expense is due to a decline in the average daily borrowings. In addition, onlower interest rates. On July 21, 2004, the Company amended and restated its credit agreement, which resulted in more favorable interest rates nearduring the end of the secondthird quarter.

Interest expense decreased $0.9$1.1 million, or 14.8%14.1%, to $4.6$6.6 million in the first halfnine months of 2004 as compared to $5.5$7.7 million in the first halfnine months of the prior year due to a decline in the average daily borrowings.more favorable interest rates.

Income Tax Provision
Our consolidated effective tax rate was 30.9%29.0% in the secondthird quarter of 2004 as compared to 28.7%30.0% in the secondthird quarter of the prior year, reflecting a lower projected annual effective tax rate.

For the first nine months of 2004, our consolidated effective income tax rate was 30.1% as compared to 29.3% for the first nine months of the prior year, reflecting a greater projected annual mix of domestic income. We do not provide deferred taxes on unremitted foreign earnings, as it is our intention to reinvest those earnings indefinitely or to repatriate the earnings only when it is tax-advantageous to do so.

For the first half of 2004, our consolidated effective income tax rate was 31.4% as compared to 28.4% for the first half of the prior year, reflecting a greater projected annual mix of domestic income.

 
FAMOUS FOOTWEAR

Thirteen Weeks Ended
 
Twenty-six Weeks Ended
Thirteen Weeks Ended
 
Thirty-nine Weeks Ended
July 31, 2004
August 2, 2003
July 31, 2004
August 2, 2003
October 30, 2004
November 1, 2003
October 30, 2004
November 1, 2004
($ millions)
% of
Net
Sales
% of
Net 
Sales
% of 
Net
Sales
% of 
Net
Sales
($ millions, except per square foot)
% of
Net
Sales
% of
Net 
Sales
% of 
Net
Sales
% of 
Net
Sales
Operating Results                                
Net sales
$
269.8
 
100.0%
 
$
268.9
 
100.0%
 
$
541.9
 
100.0%
 
$
530.0
 
100.0%
$
311.7
 
100.0%
 
$
301.6
 
100.0%
 
$
853.6
 
100.0%
 
$
831.6
 
100.0%
Cost of goods sold
148.0
54.9%
149.9
55.7%
299.1
55.2%
295.0
55.7%
174.6
56.0%
167.5
55.6%
473.7
55.5%
462.5
55.6%
Gross profit 
121.8
 
45.1%
 
119.0
 
44.3%
 
242.8
 
44.8%
 
235.0
 
44.3%
 
137.1
 
44.0%
 
134.1
 
44.4%
 
379.9
 
44.5%
 
369.1
 
44.4%
Selling and
administrative expenses
109.2
40.4%
106.1
39.5%
217.8
40.2%
211.5
39.9%
112.3
36.0%
110.7
36.6%
330.1
38.7%
322.2
38.8%
Operating earnings
$
12.6
4.7%
$
12.9
4.8%
$
25.0
4.6%
$
23.5
4.4%
$
24.8
8.0%
$
23.4
7.8%
$
49.8
5.8%
$
46.9
5.6%
                                
Key Metrics                                
Same-store sales % change 
(2.5)%
   
(2.9)%
   
0.0%
   
(4.1)%
   
(0.4)%
   
0.7%
   
(0.2)%
   
(2.5)%
  
Same-store sales $ change 
$(6.5)
   
$(7.4)
   
$   -
   
$(21.0)
   
$(1.2)
   
$1.9
   
$(1.3)
   
$(19.2)
  
Sales change from new and

closed stores, net

 
$7.4
   
$5.6
   
$11.9
   
$12.7
   
$11.3
   
$5.2
   
$23.3
   
$17.9
  
                                
Sales per square foot 
$43
   
$43
   
$86
   
$85
   
$49
   
$48
   
$135
   
$134
  
Square footage
(thousand sq. ft.)		 
6,384
   
6,224
   
6,384
   
6,224
   
6,394
   
6,274
   
6,394
   
6,274
  
                                
Stores opened 
26
   
12
   
38
   
32
   
16
   
19
   
54
   
51
  
Stores closed 
8
   
16
   
16
   
41
   
17
   
20
   
33
   
61
  
Ending stores 
915
   
909
   
915
   
909
   
914
   
908
   
914
   
908
  

Net Sales
Net sales increased $0.9$10.1 million, or 0.3%3.3%, to $269.8$311.7 million in the secondthird quarter of 2004 as compared to $268.9$301.6 million in the secondthird quarter of the prior year. This increase is primarily attributable to higher sales growth from net new stores.stores, offset by a modest same-store sales decline of 0.4% reflecting lower traffic counts. During the secondthird quarter of 2004, we opened 2616 new stores and closed 8,

13

17, resulting in 915914 stores at the end of the secondthird quarter as compared to 909908 at the end of the secondthird quarter of the prior year. Sales per square foot were $43, even with$49, up slightly from $48 in the year ago period. Same-store sales were down 2.5% during the second quarter due to lower traffic counts, a later start to the back-to-school season and a shift in tax-free days between the second and third quarters. In addition, we experienced some weakness in our women's casual business, sandals and our junior category.

Page 13

Net sales increased $11.9$22.0 million, or 2.2%2.6%, to $541.9$853.6 million in the first halfnine months of 2004 as compared to $530.0$831.6 million in the first halfnine months of the prior year. While same-store sales for the first halfnine months of 2004 were flatdown 0.2% compared to the first halfnine months of the prior year, sales from net new stores totaled $11.9$23.3 million. We opened 3854 new stores and closed 1633 during the first halfnine months of 2004, resulting in 915914 stores at the end of the secondthird quarter.

Same-store sales changes are calculated by comparing the sales in stores that have been open at least 13 months. This method avoids the distorting effect that grand opening sales have in the first month of operation. Relocated stores are treated as new stores. Closed stores are excluded from the calculation. Sales change from new and closed stores, net reflects the change in net sales due to stores that have been opened or closed during the period and are thereby excluded from the same-store sales calculation.

Gross Profit
Gross profit increased $2.8$3.0 million, or 2.3%, to $121.8$137.1 million in the secondthird quarter of 2004 as compared to $119.0$134.1 million in the secondthird quarter of the prior year. As a percentage of net sales, we achievedthere was a slight improvementdecrease in the gross profit rate to 45.1%44.0% in the secondthird quarter of 2004 from 44.3%44.4% in the secondthird quarter of the prior year. This improvementdecline was driven by our fresher product mix and lower markdowns.due to more aggressive promotions used to drive sales during the critical back-to-school period.

Gross profit increased $7.8$10.8 million, or 3.3%2.9%, to $242.8$379.9 million in the first halfnine months of 2004 as compared to $235.0$369.1 million in the first halfnine months of the prior year. The gross profit increase of 3.3%2.9% is primarily attributed to the 2.2%2.6% increase in net sales. As a percent of net sales, our gross profit rate increased slightly to 44.8%44.5% in the first halfnine months of 2004 as compared to 44.3%44.4% in the first halfnine months of the prior year, reflecting reduced shrinkage costs and a fresher product mix.year.

Selling and Administrative Expenses
Selling and administrative expenses increased $3.1$1.6 million, or 2.8%1.5%, to $109.2$112.3 million for the secondthird quarter of 2004 as compared to $106.1$110.7 million in the secondthird quarter of the prior year. This increase is primarily attributable to increased marketing costs, partially offset by reduced compensation costs associated with stock-based and higher selling salaries, due in part to the large number of store openings during the second quarter.incentive compensation plans. As a percentage of net sales, theseselling and administrative costs increaseddecreased to 40.4%36.0% from 39.5%36.6% last year.year as the division tightly controlled expenses.

Selling and administrative expenses increased $6.3$7.9 million, or 2.9%2.5%, to $217.8$330.1 million in the first halfnine months of 2004 as compared to $211.5$322.2 million in the first halfnine months of the prior year due to increased marketing costs and higher selling salaries, due in part to store openings during the first halfnine months of 2004. Reduced compensation costs associated with stock-based and incentive compensation plans partially offset the increase in selling and administrative expenses. As a percent of net sales, selling and administrative costs decreased slightly to 38.7% from 38.8% last year.

Operating Earnings
Operating earnings decreased $0.3increased $1.4 million, or 2.1%5.9%, to $12.6$24.8 million for the secondthird quarter of 2004 as compared to $12.9$23.4 million in the secondthird quarter of the prior year. This decrease was driven by increases in selling and administrative expenses, partially offset by the improvement in the gross profit rate.

Operating earnings increased $1.5 million, or 6.5%, to $25.0 million in the first half of 2004 as compared to $23.5 million in the first half of the prior year. This increase was driven by boththe $10.1 million increase in net sales, partially offset by the decline in the gross profit rate.

Operating earnings increased $2.9 million, or 6.2%, to $49.8 million in the first nine months of 2004 as compared to $46.9 million in the first nine months of the prior year. This increase was driven by the increase in net sales and, to a lesser extent, the improvement in the gross profit rate partially offset byas a percent of net sales and the increasereduction in selling and administrative expenses.expenses as a percent of net sales.

Page 14


NATURALIZER RETAIL

Thirteen Weeks Ended
 
Twenty-six Weeks Ended
Thirteen Weeks Ended
 
Thirty-nine Weeks Ended
July 31, 2004
August 2, 2003
July 31, 2004
August 2, 2003
October 30, 2004
November 1, 2003
October 30, 2004
November 1, 2003
($ millions)
% of
Net
Sales
% of
Net 
Sales
% of 
Net
Sales
% of 
Net
Sales
($ millions, except per square foot)
% of
Net
Sales
% of
Net 
Sales
% of 
Net
Sales
% of 
Net
Sales
Operating Results                                
Net sales
$
48.3
 
100.0%
 $
49.7
 
100.0%
 $
93.6
 
100.0%
 
$
92.5
 
100.0%
$
49.9
 
100.0%
 $
49.8
 
100.0%
 $
143.5
 
100.0%
 
$
142.3
 
100.0%
Cost of goods sold
27.0
55.9%
27.5
55.2%
49.9
53.3%
48.8
52.8%
26.0
52.1%
25.6
51.4%
75.9
52.9%
74.4
52.3%
Gross profit 
21.3
 
44.1%
 
22.2
 
44.8%
 
43.7
 
46.7%
 
43.7
 
47.2%
 
23.9
 
47.9%
 
24.2
 
48.6%
 
67.6
 
47.1%
 
67.9
 
47.7%
Selling and
administrative expenses
23.9
49.4%
23.2
46.8%
48.5
51.8%
46.1
49.8%
25.4
50.9%
24.4
48.9%
73.9
51.5%
70.4
49.5%
Operating earnings
$
(2.6
)
(5.3)%
$
(1.0
)
(2.0)%
$
(4.8
)
(5.1)%
$
(2.4
)
(2.6)%
Operating loss
$
(1.5
)
(3.0)%
$
(0.2
)
(0.3)%
$
(6.3
)
(4.4)%
$
(2.5
)
(1.8)%
                                
Key Metrics                                
Same-store sales % change 
(3.9)%
   
2.3%
   
(1.0)%
   
(0.9)%
   
(2.8)%
   
(0.9)%
   
(1.6)%
   
(0.9)%
  
Same-store sales $ change 
$(1.8)
   
$1.1
   
$(0.8)
   
$(0.7)
   
$(1.4)
   
$(0.3)
   
$(2.3)
   
$(1.1)
  
Sales change from new and
closed stores, net		 
$0.2
   
$(3.7)
   
$0.3
   
$(9.3)
   
$0.5
   
$(2.1)
   
$0.8
   
$(11.3)
  
Impact of changes in
Canadian exchange
rate on sales		 
$0.2
   
$2.1
   
$1.6
   
$3.1
   
$1.0
   
$2.3
   
$2.7
   
$5.3
  
                                
Sales per square foot 
$80
   
$83
   
$154
   
$153
   
$81
   
$85
   
$236
   
$238
  
Square footage
(thousand sq. ft.)		 
588
   
580
   
588
   
580
   
586
   
575
   
586
   
575
  
                                
Stores opened 
4
   
2
   
9
   
3
   
4
   
1
   
13
   
4
  
Stores transferred, net 
-
   
-
   
4
   
-
   
-
   
-
   
4
   
-
  
Stores closed 
3
   
3
   
11
   
6
   
3
   
4
   
14
   
10
  
Ending stores 
380
   
386
   
380
   
386
   
381
   
383
   
381
   
383
  

Net Sales
Net sales decreased $1.4increased $0.1 million, or 2.8%0.2%, to $48.3$49.9 million in the secondthird quarter of 2004 as compared to $49.7$49.8 million in the secondthird quarter of the prior year. This decrease is attributable to a decrease in same-store sales of 3.9%. However, theThe favorable impact of the Canadian exchange rate improved net sales by $0.2 million.$1.0 million, but was offset by a same-store sales decline of 2.8%. For our Canadian stores, same-store sales increased 2.4%, while domestic stores experienced a same-store decline of 5.7%. During the secondthird quarter of 2004, we opened 4 new stores and closed 3 resulting in 380381 stores at the end of the secondthird quarter of 2004 as compared to 386383 at the end of the secondthird quarter of the prior year. Sales per square foot declined to $80$81 from $83$85 in the year ago period. Our net sales decline is partly attributable to our emphasis on sandals and casual footwear, while the market was favoring dressy looks, leading to a poor performance in Canada and in our U.S. outlet stores. We are focused on providing better-fashion, higher-grade imported product in our Canadian stores and providing trend-right merchandise in our U.S. outlet stores, both priced to deliver better margins.

Net sales increased $1.1$1.2 million, or 1.2%0.9%, to $93.6$143.5 million in the first halfnine months of 2004 as compared to $92.5$142.3 million in the first halfnine months of the prior year. However, same-store sales for the first halfnine months of 2004 declined 0.8%1.6%, led by weakness in our domestic stores. For our Canadian stores.stores, same-store sales declined 1.6%, while domestic stores experienced a same-store decline of 1.7%. The increase in net sales is attributable to the impact of changes in the Canadian exchange rate, which improved net sales by $1.6$2.7 million during the first halfnine months of 2004. Sales per square foot increaseddecreased slightly to $154$236 for the first halfnine months of 2004 from $153$238 for the first halfnine months of the prior year.year due to lower customer traffic.

Gross Profit
Gross profit decreased $0.9$0.3 million, or 4.3%1.2%, to $21.3$23.9 million in the secondthird quarter of 2004 as compared to $22.2$24.2 million in the secondthird quarter of the prior year. As a percentage of net sales, our gross profit rate declined to 44.1%47.9% in the secondthird quarter from 44.8%48.6% in the year ago quarter. This decline was driven by higher markdowns in our Canadian stores to clear domestically- produced footwear as we transition to higher-grade imported product.

Page 15

lower initial markups resulting from more promotional pricing.

Gross profit remained flat at $43.7decreased $0.3 million, or 0.4%, to $67.6 million in the first halfnine months of 2004 as compared to $67.9 million in the first halfnine months of the prior year. As a percent of sales, our gross profit rate decreased to 46.7%47.1% in the first halfnine months of 2004 as compared to 47.2%47.7% in the first halfnine months of the prior year, due primarily to lower initial markups resulting from

15

more promotional pricing, and the transition in the Canadian stores from domestically produced footwear to higher-grade imported product.

Selling and Administrative Expenses
Selling and administrative expenses increased $0.7$1.0 million, or 2.5%4.3%, to $23.9$25.4 million for the secondthird quarter of 2004 as compared to $23.2$24.4 million in the secondthird quarter of the prior year. Approximately $0.1$0.5 million of the increase is due to changes in the Canadian exchange rate. The remaining $0.6$0.5 million relates to a combination of noncash asset impairment charges and increased consulting fees, and increased employee benefit costs.offset by reduced compensation costs associated with incentive compensation plans.

Selling and administrative expenses increased $2.4$3.5 million, or 5.3%4.9%, to $48.5$73.9 million in the first halfnine months of 2004 as compared to $46.1$70.4 million in the first halfnine months of the prior year. Approximately $0.6$1.3 million of the increase is due to changes in the Canadian exchange rate. The remaining increase is due to a combination of increased retail facilities costs, noncash asset impairment charges and increased consulting fees, and increased employee benefit costs.offset by reduced compensation costs associated with incentive compensation plans.

Operating Earnings
Naturalizer Retail's operating loss increased to $2.6$1.5 million in the secondthird quarter of 2004 as compared to a loss of $1.0$0.2 million in the secondthird quarter of the prior year. The current period loss was due to the same-store sales decline, lower gross profit rates and higher markdowns in Canada.selling and administrative expenses.

The operating loss of $4.8$6.3 million in the first halfnine months of 2004 increased from an operating loss of $2.4$2.5 million in the first halfnine months of the prior year, due principally to the same-store sales decline, lower gross profit rates and the increase in selling and administrative expenses.
 
 
WHOLESALE OPERATIONS

Thirteen Weeks Ended
 
Twenty-six Weeks Ended
Thirteen Weeks Ended
 
Thirty-nine Weeks Ended
July 31, 2004
August 2, 2003
July 31, 2004
August 2, 2003
October 30, 2004
November 1, 2003
October 30, 2004
November 1, 2003
($ millions)
% of
Net
Sales
% of
Net 
Sales
% of 
Net
Sales
% of 
Net
Sales
% of
Net
Sales
% of
Net 
Sales
% of 
Net
Sales
% of 
Net
Sales
Operating Results                                
Net sales$
136.9
 
100.0%
 $
137.9
 
100.0%
 $
308.4
 
100.0%
 
$
278.9
 
100.0%
$
148.7
 
100.0%
 $
140.1
 
100.0%
 $
457.1
 
100.0%
 
$
419.0
 
100.0%
Cost of goods sold
92.3
67.4%
92.3
66.9%
209.5
67.9%
186.5
66.9%
103.9
69.9%
94.7
67.6%
313.4
68.6%
281.2
67.1%
Gross profit 
44.6
 
32.6%
 
45.6
 
33.1%
 
98.9
 
32.1%
 
92.4
 
33.1%
 
44.8
 
30.1%
 
45.4
 
32.4%
 
143.7
 
31.4%
 
137.8
 
32.9%
Selling and
administrative
expenses
35.6
26.1%
33.0
23.9%
77.1
25.0%
66.8
23.9%
34.4
23.1%
29.9
21.4%
111.6
24.4%
96.7
23.1%
Operating earnings
$
9.0
6.5%
$
12.6
9.2%
$
21.8
7.1%
$
25.6
9.2%
$
10.4
7.0%
$
15.5
11.0%
$
32.1
7.0%
$
41.1
9.8%
                                
Key Metrics                                
Unfilled order position at
End of period		Unfilled order position at
End of period		 
$175.6
   
$155.2
        Unfilled order position at
End of period		 
$199.2
   
$187.9
        

Net Sales
Net sales decreased $1.0increased $8.6 million, or 0.7%6.2%, to $136.9$148.7 million in the secondthird quarter of 2004 as compared to $137.9$140.1 million in the secondthird quarter of the prior year. Although net sales for the Bass footwear line contributed $9.1 million in the quarter, weakness in children's and women's private label markets more than offset the increase from netyear, due primarily to sales of Bass footwear. A shortageThe division also experienced an increase of trucks20.6% in its Mens & Athletics business and an increase of 19.4% in its Lifestride business as compared to the year ago quarter. These increases were offset by continued weakness in the MidwestChildren's division, which declined 19.0%, and delays at the West Coast ports atNaturalizer business, which declined 9.8%, as compared to the end of the second quarter also negatively impacted net sales for that period.year ago quarter.

Net sales increased $29.5$38.1 million, or 10.6%9.1%, to $308.4$457.1 million in the first halfnine months of 2004 as compared to $278.9$419.0 million in the first halfnine months of the prior year. This increase was primarily due to approximately $24.4 millionsales of sales for the Bass footwear line.footwear. In addition, althoughwe have experienced solid sales gains in our Dr. Scholl'sLifestride and Santana businesses haveMens & Athletics businesses. Our Lifestride business has increased by 11.1% and our Men's and Athletics' business has posted wholesalea 4.6% sales gains,gain. Offsetting these increases were weakness in our children's division has partially offset those gains.

Page 16

Children's business, which experienced a 22.5% sales decline and our Naturalizer business, which experienced a 4.6% sales decline.

Gross Profit
Gross profit decreased $1.0$0.6 million, or 2.1%1.2%, to $44.6$44.8 million in the secondthird quarter of 2004 as compared to $45.6$45.4 million in the secondthird quarter of the prior year. As a percentage of net sales, our gross profit rate declined to 32.6%30.1% in the secondthird quarter from 33.1%32.4% in the secondthird quarter of the prior year. This decline is primarily due to higher allowances granted to our department store customers within our Naturalizer, Bass and Dr. Scholl's wholesale divisions.divisions, higher markdowns and provisions for minimum royalty guarantees on license agreements.

Gross profit increased $6.5$5.9 million, or 7.0%4.3%, to $98.9$143.7 million in the first halfnine months of 2004 as compared to $92.4$137.8 million in the first halfnine months of the prior year. As a percent of net sales, our gross profit rate decreased to 32.1%31.4% in the first halfnine months of 2004 as compared to 33.1%32.9% in the first halfnine months of the prior year. The decline in our gross profit rate is principally due to higher allowances relatedgranted to the disposal of Bass closeout footwear acquired under an asset purchase agreement.our department store customers.

Selling and Administrative Expenses
Selling and administrative expenses increased $2.6$4.5 million, or 8.2%15.1%, to $35.6$34.4 million for the secondthird quarter of 2004 as compared to $33.0$29.9 million in the secondthird quarter of the prior year. Selling and administrative costs include $1.5 millionyear, due primarily to transition the Bass business to our headquarters and distribution centers. In addition, the acquisition of the Bass footwear license resulted in an additional $2.8 million of typicalincreased selling and administrative costs duringassociated with the Bass footwear line. Excluding costs associated with Bass marketing, marketing costs increased $2.0 million compared to the third quarter including selling costs, warehousing and distribution, marketing, sourcing, etc. Offsettinglast year. Partially offsetting these factorsincreases were benefits from reduced compensation costs associated with stock-based and incentive compensation plans.

Selling and administrative expenses increased $10.3$14.9 million, or 15.5%15.4%, to $77.1$111.6 million in the first halfnine months of 2004 as compared to $66.8$96.7 million in the first halfnine months of the prior year. This increase is due to transition and assimilation costs related to the Bass footwear line of approximately $4.8$5.1 million and an additional $5.8 million of typicalincreased selling and administrative costs associated with the Bass footwear including sellingline. Partially offsetting these factors were benefits from reduced compensation costs warehousingassociated with stock-based and distribution, marketing, sourcing, etc.incentive compensation plans.

Operating Earnings
Operating earnings decreased $3.6$5.1 million, or 29.1%32.9%, to $9.0$10.4 million for the secondthird quarter of 2004 as compared to $12.6$15.5 million in the secondthird quarter of the prior year. This decrease is due to weakness in our children'sChildren's and women's private label markets,Naturalizer products, lower gross profit rates and $1.5 million in expenses related to transition and assimilation ofthe operating loss within the Bass business incurred during the second quarter of 2004.division.

Operating earnings decreased $3.8$9.0 million, or 15.1%21.8%, to $21.8$32.1 million in the first halfnine months of 2004 as compared to $25.6$41.1 million in the first halfnine months of the prior year. This decrease is due to weakness in our children's business as well asChildren's and Naturalizer businesses, Bass transition and assimilation costs of $4.8 million.and the operating loss within the Bass division.
 
 
OTHER SEGMENT

The Other segment includes our majority-owned subsidiary, Shoes.com, Inc., a footwear e-commerce company, and unallocated corporate administrative and other costs.

Net Sales
Net sales of Shoes.com increased $1.8$2.5 million or 96.9%, to $3.7$4.5 million in the secondthird quarter of 2004 as compared to $1.9$2.0 million in the secondthird quarter of the prior year. Net sales increased $3.1$5.7 million or 92.7%, to $6.5$11.1 million in the first halfnine months of 2004 as compared to $3.4$5.4 million in the first halfnine months of the prior year. This increase reflects continuing strong sales growth due to increased Web site traffic and improved conversion rates.

Operating Earnings
The Shoes.com business generated operating earnings of $0.1 million in the second quarter of 2004 as compared to an operating loss of $0.2 million in the secondthird quarter of 2004, even with the third quarter of the prior year. For the first nine months of 2004, the Shoes.com business generated an operating loss of $0.3 million compared to an operating loss of $0.5 million for the prior year. The earnings improvement is due to a favorable settlement to discontinue operation of a former affiliate's Web site of $0.5 million received in the second quarter of 2004, to discontinue operation of a former affiliate's Web site.

For the first half of 2004, the Shoes.com business generated an operating loss of $0.1 million compared to an operating loss of $0.3 million for the prior year. The earnings improvement is due to the $0.5 million settlement received in the second quarter, offset by increased warehouse expenses to move facilities to accommodate the Bass acquisition.and distribution expenses.

Page 17

Other Corporate Expenses
Unallocated corporate administrative and other costs were $5.9$5.3 million in the secondthird quarter of 2004 as compared to $5.7$6.1 million in the secondthird quarter of the prior year. Corporate expenses increaseddecreased due to lower compensation costs of $3.7 million associated with stock-based and incentive compensation plans, partially offset by higher consulting costs related to Project ExCEL, - our supply chain management improvement initiative, partially offset by lower compensation costs of $1.3 million associated with stock-based and incentive compensation plans.initiative.

For the first halfnine months of 2004, unallocated corporate administrative and other costs were $13.7$18.9 million as compared to $12.4$18.6 million in the first halfnine months of the prior year. The increase is attributable to both increased consulting costs associated with Project ExCEL and a charge of $0.6 million recorded in the first quarter related to pre-trial interest awarded in connection with the Redfield litigation.litigation offset by lower compensation costs of $4.3 million associated with stock-based and incentive compensation plans. For further information on the Redfield litigation, see Part II - - Item 1 - Legal Proceedings.
 
 
LIQUIDITY AND CAPITAL RESOURCES

Borrowings

($ millions)
July 31, 2004
August 2, 2003
Increase/
(Decrease)
($ millions)
October 30, 
2004
November 1,
2003
Increase/
(Decrease)
Notes payable
$
27.5
 
$
19.0
 
$
8.5
 $43.5 $16.0 $27.5 
Long-term debt, including current maturities
100.0
113.5
(13.5
)
 100.0  103.5  (3.5)
Total short- and long-term debt
$
127.5
$
132.5
$
(5.0
)
$
143.5
$
119.5
$
24.0

Total debt obligations have declinedincreased by $5.0$24.0 million, or 3.8%20.1%, to $127.5$143.5 million at July 31,October 30, 2004 as compared to $132.5$119.5 million at August 2,November 1, 2003. Interest expense decreased $0.3 million, or 14.9%12.2%, to $2.2$2.0 million in the secondthird quarter of 2004 as compared to $2.5$2.3 million in the secondthird quarter of the prior year. The reduction in interest expense was due to lower average daily borrowings compared with the second quarter of the prior year.interest rates.

The Company entered into an Amended and Restated Credit Agreement (the "Agreement") effective July 21, 2004, which amended and restated its existing $350 million revolving bank credit agreement. The Agreement provides for a maximum line of credit of $350 million, subject to the calculated borrowing base restrictions. In addition to extending the credit term, the Agreement also provides other benefits to the Company, including expanding the definition of eligible inventory in certain circumstances and reducing the interest rate spread paid on outstanding borrowings. Borrowing availability under the Agreement is based upon the sum of eligible accounts receivable and inventory, less outstanding borrowings, letters of credit and applicable reserves. The Agreement matures on July 21, 2009 and the Company's obligations are secured by the Company's accounts receivable and inventory. Borrowings under the Agreement bear interest at a variable rate determined based upon the level of availability under the Agreement. If availability falls below specified levels, the Company would then be subject to certain financial covenants. In addition, if availability falls below $25 million and the fixed charge coverage ratio is less than 1.0 to 1, the Company would be in default. The Agreement also contains certain other covenants and restrictions.

At July 31,October 30, 2004, the Company had $127.5$143.5 million of borrowings outstanding and $21.0$12.5 million in letters of credit outstanding under the Amended and Restated Credit Agreement. Total additional borrowing availability was approximately $194.5$165.5 million at July 31,October 30, 2004.

18

Working Capital and Cash Flow


($ millions)
July 31, 2004
August 2, 2003
Increase/
(Decrease)
          
Net cash provided by (used for) operating activities
$
25.0
 
$
54.4
 
$
(29.4
)
Net cash provided by (used for) investing activities 
(14.1
) 
(15.9
) 
1.8
 
Net cash provided by (used for) financing activities
4.9
(20.2
)
25.1
Increase in cash and cash equivalents
$
15.8
$
18.3
$
(2.5
)

Page 18

($ millions)
October 30, 2004
November 1, 2003
Increase/
(Decrease)
          
Net cash provided (used) by operating activities$23.9 $75.6 $(51.7)
Net cash provided (used) by investing activities (23.7) (21.3) (2.4)
Net cash provided (used) by financing activities 18.9  (33.7) 52.6 
Increase in cash and cash equivalents
$
19.1
$
20.6
$
(1.5
)

A summary of key financial data and ratios at the dates indicated is as follows:

July 31, 2004
August 2, 2003
January 31, 2004
October 31, 2004
November 1, 2003
January 31, 2004
Working capital ($ millions)
$306.6
 
$263.2
 
$293.8
$ 321.3 $ 283.3 $ 293.8
Current ratio
1.9:1
1.9:1
2.2:1
2.3:12.2:12.2:1
Total debt as a percentage of total capitalization
25.5%
29.2%
25.2%
26.9%
25.8%
25.2%

Working capital at July 31,October 30, 2004 was $306.6$321.3 million, which was $12.8$27.5 million higher than at January 31, 2004 and $43.4$38.0 million higher than at August 2,November 1, 2003. The improvement in our working capital is attributable to continued growth in cash and cash equivalents as a result of our positive financial results over the past twelve monthsand inventories as well as effective management of our outstanding debt obligations and other current liabilities. Our current ratio, the relationship of current assets to current liabilities, decreasedincreased to 1.92.3 to 1 at July 31,October 30, 2004 from 2.2 to 1 at January 31, 2004 and remained flat compared to August 2, 2003. The current ratio is generally lower at the endNovember 1, 2003 as a result of the second quarter as compared to the year-end ratio due to the seasonality of inventory purchases in preparation for the back-to-school selling season that occurs during the third quarter.working capital increase.

At July 31,October 30, 2004, the Company had $71.5$74.8 million of cash and cash equivalents, substantially all of which represents cash and cash equivalents of our Canadian and other foreign subsidiaries. Our intention is to maintain this cash within our foreign operations indefinitely or to repatriate it only when it is tax-effective to do so. On October 22, 2004, the American Jobs Creation Act of 2004 (the "Act") was signed into law. The Act provides for a special one-time tax reduction for certain foreign earnings that are repatriated to the United States if certain conditions are met. Based on initial estimates, the Company may be able to repatriate approximately $50 - $60 million, which would generate tax expense of approximately $9 - - $10 million. However, at this time, we are evaluating the terms of the Act, but have made no decisions regarding repatriation, and accordingly, have not provided deferred taxes on unremitted foreign earnings.

Cash provided by operating activities was $25.0$23.9 million in the first halfnine months of 2004 as compared to $54.4$75.6 million last year, a difference of $29.4$51.7 million. This difference primarily reflects the investment of approximately $13.4$10.8 million in Bass inventory and approximately $5.9 million of accounts receivable from sales of Bass footwear.

Cash used for investing activities was $14.1$23.7 million in the first halfnine months of 2004 as compared to $15.9$21.3 million last year. Investing activities primarily include capital expenditures. Our capital expenditures are relatively consistent with the prior year and are in line with our planned levels. The majority of our capital expenditures in the secondthird quarter were used to both retrofit existing stores and open new stores in our retail divisions.

Cash provided by financing activities was $4.9$18.9 million in the first halfnine months of 2004 as compared to cash used for financing activities of $20.2$33.7 million last year, a difference of $25.1$52.6 million. This difference represents an increase in our short-term notes payable of $8.0$24.0 million since the beginning of the year as compared to debt reductions totaling $20.0$33.0 million in the first halfnine months of last year. The increase in short-term notes payable was used to fund operations, including the Bass inventory and accounts receivable as well as the related transition and assimilation costs. In connection with its Amended and Restated Credit Agreement, the Company incurred $1.1$1.3 million in debt issuance costs, in the second quarter, which are being deferred and amortized to expense over the five-year term of the agreement.

In May 2000, we announced a stock repurchase program authorizing the repurchase of up to 2 million shares of our outstanding common stock. Since the inception of this program, we have purchased a total of 928,900 shares for $11.3 million. No shares were purchased under the plan in either the first halfnine months of 2004 or during any of fiscal 2003.

19

The Company paid dividends of $0.10 per share in the secondthird quarter of 2004 and the secondthird quarter of the prior year.
 
 
CRITICAL ACCOUNTING POLICIES AND ESTIMATES

No material changes have occurred related to critical accounting policies and estimates since the end of the most recent fiscal year. For further information, see Item 7 of the Company's Annual Report on Form 10-K for the year ended January 31, 2004.
 
 
FORWARD-LOOKING STATEMENTS

This Form 10-Q contains forward-looking statements. Such statements are subject to various risks and uncertainties that could cause actual results to differ materially. These include (i) general economic conditions and the consumer's preferences

Page 19

and purchasing patterns, which may be influenced by consumers' disposable income; (ii) the uncertainties of currently pending litigation; (iii) intense competition within the footwear industry; and (iv) political and economic conditions or other threats to continued and uninterrupted flow of inventory from Brazil and China, where the Company relies heavily on third-party manufacturing facilities for a significant amount of its inventory. In Item 1 of the Company's Annual Report on Form 10-K for the year ended January 31, 2004, detailed risk factors that could cause variations in results to occur are listed and further described. Such description is incorporated herein by reference.
 
 
ITEM 3
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

No material changes have taken place in the quantitative and qualitative information about market risk since the end of the most recent fiscal year. For further information, see Item 7A of the Company's Annual Report on Form 10-K for the year ended January 31, 2004.
 
 
ITEM 4
CONTROLS AND PROCEDURES

It is the Chief Executive Officer's and Chief Financial Officer's ultimate responsibility to ensure the Company maintains disclosure controls and procedures designed to provide reasonable assurance that material information, both financial and non-financial, and other information required under the securities laws to be disclosed is identified and communicated to senior management on a timely basis. The Company's disclosure controls and procedures include mandatory communication of material events, automated accounting processing and reporting, management review of monthly, quarterly and annual results, an established system of internal controls and internal control reviews by the Company's internal auditors.

As of July 31,October 30, 2004, management of the Company, including the Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of the design and operation of the Company's disclosure controls and procedures with respect to the information generated for use in this Quarterly Report. Based upon and as of the date of that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded the Company's disclosure controls were effective to provide reasonable assurance that information required to be disclosed in the reports that the Company files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Commission's rules and forms. There have been no changes in the Company's internal control over financial reporting during the quarter ended July 31,October 30, 2004, that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.

It should be noted that while the Company's management, including the Chief Executive Officer and Chief Financial Officer, believes the Company's disclosure controls and procedures provide a reasonable level of assurance, they do not expect that the Company's disclosure controls and procedures or internal control over financial reporting will prevent all errors and all fraud. A control system, no matter how well conceived or operated, can provide only reasonable, not absolute, assurance the objectives of the control system are met. Further, the design of a control system must reflect the fact there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and

20

breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to errors or fraud may occur and not be detected.

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PART II
OTHER INFORMATION

 
ITEM 1PART II
OTHER INFORMATION
ITEM 1
LEGAL PROCEEDINGS

We are involved in legal proceedings and litigation arising in the ordinary course of business. In the opinion of management, the outcome of such ordinary course of business proceedings and litigation currently pending will not have a material adverse effect on our results of operations or financial position.

We are involved in environmental remediation and ongoing compliance activities at several sites. We are remediating, under the oversight of Colorado authorities, contamination at and beneath our owned facility in Colorado (also known as the "Redfield" site) and groundwater and indoor air in residential neighborhoods adjacent to and near the property, which have been affected by solvents previously used at the site and surrounding facilities.

In March 2000, a class action lawsuit was filed in Colorado State Court (District Court for the City and County of Denver) related to the Redfield site described above against one of our subsidiaries, a prior operator at the site and two individuals (the Antolovich class action). Plaintiffs, certain current and former residents living in an area adjacent to the Redfield site, alleged claims for trespass, nuisance, strict liability, unjust enrichment, negligence and exemplary damages arising from the alleged release of solvents that are contaminating the groundwater and indoor air in certain areas adjacent to the site. In December 2003, a jury returned a verdict finding one of our subsidiaries negligent and awarding the class plaintiffs $1.0 million in damages. We have recorded this award along with the cost of associated pre-trial interest and the estimated costs of sanctions imposed on us by the court resulting from pre-trial discovery disputes between the parties. We have recorded total pre-tax charges of $3.7 million for these matters. In April 2004, the plaintiffs filed a motion for a new trial; the court has denied that motion. The plaintiffs have appealed the judgment to the Colorado Court of Appeals and have asked for a retrial. The Company has cross-appealed the trial court's ruling as to the amount of pre-judgment interest, and has conditionally appealed a number of the trial court's rulings in the event of a retrial. Several other post-trial motions are still pending before the trial court, and theThe ultimate outcome and cost to us may vary.

We have also filed suit in Federal District Court in Denver against a number of former owners/operators of the Redfield site as well as surrounding businesses seeking recovery of amounts spent responding to the contamination at and around the Redfield site. We have consummated settlements with severalall but two of thesethe defendants. A settlement agreement with one of the remaining defendants has been submitted to the court for approval, and we have reached agreementsan agreement in principle to settle with the other remaining defendants anddefendant. We currently do not anticipate the case will be tried. We have also filed a contribution action in Colorado State Court against the Colorado Department of Transportation, which owns and operates a facility adjacent to the Redfield site. That case is not yet set for trial.

We have also filed suit against our insurance carriers seeking recovery of the costs incurred for investigation and remediation of the Redfield site, the damages awarded in the Antolovich class action and other relief. In prior years, we recorded an anticipated recovery of $4.5 million for remediation costs, of which approximately $3.6$3.8 million is outstanding at July 31,October 30, 2004. We believe insurance coverage in place entitles us to reimbursement for more than the recorded recovery. While the insurance companies are contesting their indemnity obligations, we believe the recorded recovery is supported by the fact that the limits of the insurance policies at issue exceed the amount of the recorded recovery, and certain insurance companies have made offers to settle the claim. We are unable to estimate the ultimate recovery from our insurers, but are pursuing resolution of our claims.

We have completed our remediation efforts at our closed New York tannery and two associated landfills. In 1995, state environmental authorities reclassified the status of these sites as being properly closed and requiring only continued maintenance and monitoring over the next 20 years. In addition, various federal and state authorities have identified the Company as a potentially responsible party for remediation at certain other landfills.

21

While we currently do not operate manufacturing facilities, prior operations included numerous manufacturing and other facilities for which we may have responsibility under various environmental laws to address conditions that may be identified in the future.

The Company is a guarantor of an Industrial Development Bond financing of $3.5 million for a manufacturing and warehouse facility in Bedford County, Pennsylvania. The outstanding principal on this Industrial Development Bond is $3.0 million. These facilities and the business that operated them were sold to another party in 1985, which assumed this obligation. This financing is scheduled to be paid annually in 2005 through 2009. During October 2004, the current owner of the manufacturing and warehouse facility filed for bankruptcy protection and is seeking liquidation of its assets. Management believes the maximum amount of potential future payments under this guarantee, including interest due through maturity, is $3.5 million. While the ultimate outcome is uncertain, management believes that the fair market value of the facility is sufficient to cover the payments due under the Industrial Development Bond. Accordingly, the Company has not recorded any charge related to this guarantee.

There have been no material developments during the quarter ended July 31,October 30, 2004 in any other legal proceedings described in the Company's Annual Report on Form 10-K for the year ended January 31, 2004.

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ITEM 2
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

The following table provides information relating toDuring the Company'sthird quarter of 2004, the Company did not repurchase any shares of common stock during the second quarter of 2004.
 
Fiscal Period
Total Number
of Shares
Purchased
Average
Price Paid
per Share
Total Number
of Shares Purchased
as Part of Publicly
Announced Program
Maximum Number
of Shares that
May Yet Be
Purchased Under
the Program
(1) (2)
 
May 2, 2004 - May 29, 2004 
-
 
$ 
-
 
-
  
1,071,000
 
            
May 30, 2004 - July 3, 2004 
18,237
(2) 
40.81
(2)
-
(2) 
1,071,000
 
            
July 4, 2004 - July 31, 2004
-
-
-
1,071,000
Total
18,237
$
40.81
-
1,071,000

  1. stock.

    In May 2000, the Board of Directors authorized a stock repurchase program authorizing the repurchase of up to 2 million shares of our outstanding common stock. The Company can utilize the repurchase program to repurchase shares on the open market or in private transactions from time to time, depending on market conditions. The repurchase program does not have an expiration date. Under this plan, 928,900 shares have been repurchased and the remaining availability is 1,071,100 shares as of the end of the quarter.

  2. This represents shares that were tendered by employees upon the exercise of stock options. The shares were tendered in satisfaction of the exercise price of such options. Accordingly, this share purchase is not considered a part of our publicly announced stock repurchase program.

ITEM 3
DEFAULTS UPON SENIOR SECURITIES

None
 
 
ITEM 43
DEFAULTS UPON SENIOR SECURITIES

None

ITEM 4
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None
 
 
ITEM 5
OTHER INFORMATION

None



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ITEM 6
EXHIBITS
 (3)(i)Certificate of Incorporation of the Company incorporated herein by reference from Exhibit 3 (a) to the Company's Quarterly Report on Form 10-Q for the quarter ended May 4, 2002.
  (ii)Bylaws of the Company as amended through February 5, 2004, incorporated herein by reference from Exhibit 3 (b) to the Company's Annual Report on Form 10-K for the year ended January 31, 2004.
 (10.1)(31.1) Amended and Restated Credit Agreement, dated as of July 21, 2004, among Brown Shoe Company, Inc., as lead borrower, Bank of America, N.A., as lead issuing bank, lead arranger, administrative agent, and collateral agent, LaSalle Bank, National Association, as syndication agent, Wells Fargo Foothill, LLC as documentation agent and the other financial institutions party thereto, as lenders, incorporated herein by reference to the Company's Form 8-K dated July 21, 2004.
 (10.2)Form of Performance Share Award Agreement, filed herewith, to be issued under the Incentive and Stock Compensation Plan of 2002.
 (10.3)Form of Non-Qualified Stock Option Plan Award Agreement, filed herewith, to be issued under the Incentive and Stock Compensation Plan of 2002.
 (10.4)Form of Incentive Stock Option Agreement, filed herewith, to be issued under the Incentive and Stock Compensation Plan of 2002.
 (10.5)Form of Restricted Stock Agreement, filed herewith, to be issued under the Incentive and Stock Compensation Plan of 2002.
(31.1)Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 (31.2) Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 (32.1) Certification of the Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
  

 
 
SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
  
BROWN SHOE COMPANY, INC.
   
Date: SeptemberDecember 8, 2004 
/s/ Andrew M. Rosen
  
Senior Vice President and
Chief Financial Officer and Treasurer
On Behalf of the Corporation and as the 
Principal Financial Officer

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