10-K

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

þ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended February 3, 2007

or

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: 1-14770

PAYLESS SHOESOURCE, INC.

(Exact name of registrant as specified in its charter)

Delaware	43-1813160
State or other jurisdiction of	(I.R.S. Employer
incorporation or organization	Identification No.)
3231 Southeast Sixth Avenue, Topeka, Kansas	66607-2207
(Address of principal executive offices)	(Zip Code)

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

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

Title of each class	Name of each exchange on which registered
Common Stock, $.01 par value per share	New York Stock Exchange
Preferred stock purchase rights	New York Stock Exchange

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

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    þ Yes     o No

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.    o Yes    þ No

     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 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.    þ Yes    o No

     Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    o

     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.:

Large accelerated filer þ       Accelerated filer o       Non-accelerated filer o

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

The aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $1,608 million based on the closing price of $24.17 as reported on the New York Stock Exchange on July 28, 2006, the last trading day of the registrant’s second fiscal quarter.

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

Common Stock, $.01 par value
65,159,398 shares at March 29, 2007

DOCUMENTS INCORPORATED BY REFERENCE

Document	Parts Into Which Incorporated
Proxy Statement for the Annual Meeting of Stockholders to be held	Part III
on May 24, 2007 (Proxy Statement)

Forward Looking Statements

This report contains forward-looking statements relating to such matters as anticipated financial performance, business prospects, technological developments, products, future store openings and closings, international expansion opportunities, possible strategic initiatives, new business concepts, capital expenditure plans, fashion trends, consumer spending patterns and similar matters. Statements including the words “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” or variations of such words and similar expressions are forward-looking statements. We note that a variety of factors could cause our actual results and experience to differ materially from the anticipated results or expectations expressed in our forward-looking statements. The risks and uncertainties that may affect the operations, performance, development and results of our business include, but are not limited to, the following: changes in consumer spending patterns; changes in consumer preferences and overall economic conditions; the impact of competition and pricing; changes in weather patterns; the financial condition of the suppliers and; changes in existing or potential duties, tariffs or quotas and the application thereof; changes in relationships between the United States and foreign countries; changes in relationships between Canada and foreign countries; economic and political instability in foreign countries, or restrictive actions by the governments of foreign countries in which suppliers and manufacturers from whom we source are located or in which we operate stores or otherwise do business; changes in trade, intellectual property, customs and/or tax laws; fluctuations in currency exchange rates; litigation including intellectual property and employment litigation; availability of suitable store locations on acceptable terms; the ability to terminate leases on acceptable terms; the ability to hire, train and retain associates; performance of other parties in strategic alliances; general economic, business and social conditions in the countries from which we source products, supplies or have or intend to open stores; performance of partners in joint ventures; the ability to comply with local laws in foreign countries; threats or acts of terrorism or war; strikes, work stoppages and/or slowdowns by unions that play a significant role in the manufacture, distribution or sale of product; congestion at major ocean ports; changes in commodity prices such as oil; and changes in the value of the dollar relative to the Chinese Yuan and other currencies. See also “Risk Factors.” All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by these cautionary statements. We do not undertake any obligation to release publicly any revisions to such forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

PAYLESS SHOESOURCE, INC.
FORM 10-K
FOR THE FISCAL YEAR ENDED FEBRUARY 3, 2007
INDEX

		Page
PART I
Item 1.	Business.		1
Item 1A.	Risk Factors.		11
Item 1B.	Unresolved Staff Comments.		16
Item 2.	Properties.		16
Item 3.	Legal Proceedings.		16
Item 4.	Submission of Matters to a Vote of Security Holders.		17
PART II
Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.		18
Item 6.	Selected Financial Data.		21
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations.		22
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk.		36
Item 8.	Financial Statements and Supplementary Data.		36
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.		83
Item 9A.	Controls and Procedures.		83
Item 9B.	Other Information.		83
PART III
Item 10.	Directors, Executive Officers and Corporate Governance.		83
Item 11.	Executive Compensation.		84
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.		84
Item 13.	Certain Relationships and Related Transactions, and Director Independence.		84
Item 14.	Principal Accountant Fees and Services.		85
PART IV
Item 15.	Exhibits and Financial Statement Schedules.		85
Signatures			88
Stock Plan for Non-Management Directors
Supplementary Retirement Plan, as amended
401(k) Profit Sharing Plan, as amended
Stock Ownership Plan, as amended
Form of Restricted Stock Award Agreement
Form of Stock Settled Stock Appreciation Rights Award Agreement
2006 Stock Incentive Plan
Subsidiaries of the Company
Consent of Independent Registered Public Accounting Firm
Certification of Chief Executive Officer and President
Certification of Chief Financial Officer and Treasurer
1350 Certification of Chief Executive Officer and President
1350 Certification of Chief Financial Officer and Treasurer

[Page Intentionally Left Blank]

PART I

ITEM 1. BUSINESS

General

We are the largest footwear specialty retailer based upon number of locations in the Western Hemisphere, with 4,572 retail stores in 15 countries and territories as of the fiscal year ended February 3, 2007 (“2006”). Our Payless ShoeSource retail stores in the United States, Canada, the Caribbean, Central America, and South America sold over 177 million pairs of footwear during fiscal 2006. Payless ShoeSource^® stores sell a broad assortment of quality footwear, including athletic, casual and dress shoes, sandals, work and fashion boots, slippers, and accessories such as handbags and hosiery. All references to years are to our fiscal year unless otherwise stated.

Payless ShoeSource stores offer fashionable, quality, private and branded label footwear and accessories for women, men and children at affordable prices in a self-selection shopping format. Our stores feature several designer and mainstream footwear brands including Abaete for Payless, Airwalk^®, American Eagle™, Champion^® and Spalding^®. We seek to compete effectively by getting to market with differentiated, trend-right merchandise before mass-market discounters and at the same time as department and specialty retailers but at a more compelling value. As of fiscal year-end 2006, each Payless ShoeSource store stocked on average approximately 7,200 pairs of footwear.

Our mission is to become the first choice for style and value in footwear and accessories for our target customers. We focus our marketing efforts on women consumers between the ages of 18 and 49 with household incomes of less than $75,000. We believe this group of consumers makes a disproportionately large share of household footwear purchasing decisions. We believe that approximately one-third of these target consumers purchased at least one pair of footwear from our stores last year.

In 2006, we generated net sales from continuing operations of $2.80 billion, as compared with $2.67 billion in 2005.

History

We were founded in Topeka, Kansas in 1956 with a strategy of selling low-cost, high-quality family footwear on a self-service basis. In 1962, we became a public company. In 1979, we were acquired by The May Department Stores Company of St. Louis, Missouri. On May 4, 1996, we became an independent public company as a result of a spin-off from The May Department Stores Company. Our common stock is listed for trading on the New York Stock Exchange (the “NYSE”) under the symbol “PSS.” Our principal executive offices are located at 3231 Southeast Sixth Avenue, Topeka, Kansas 66607-2207, and our telephone number is (785) 233-5171.

Segments and Geographic Areas

We operate our business in two segments, Payless Domestic and Payless International. The Payless Domestic segment includes retail operations in the United States, Guam and Saipan. The Payless International segment includes retail operations in Canada; Puerto Rico; the U.S. Virgin Islands; the South American Region which includes Ecuador; and the Central American Region which includes Costa Rica, Guatemala, El Salvador, the Dominican Republic, Honduras, Nicaragua, Panama and Trinidad and Tobago. Our operations in the Central and South American Regions are operated as joint ventures in which we maintain a 60-percent ownership interest.

For a more detailed discussion of our segments and geographic areas please see the discussion contained in Note 17 “Segment Reporting” in the Notes to Consolidated Financial Statements.

Mission

Our mission is to become the first choice for style and value in footwear and accessories for our target customers. We plan to realize this by focusing on growing our core footwear and accessories businesses, while growing our earnings per share in the mid-teen percentage range over time. To achieve this goal, we must consistently execute tactics embodied in our strategic plan.

1

Positioning Payless ShoeSource^® as the leading Mass Specialty Footwear and Accessories Retailer

Through our customer focused organization and infrastructure, Payless ShoeSource is positioning itself as the leading mass specialty footwear and accessories retailer by consistently delivering on our customer promise and executing against our four strategic themes required to deliver our customer promise.

Our Customer Promise

Establish an emotional connection with target customers by providing on-trend and distinctive product, maintaining key items in-stock, and providing exceptional value. In addition, we strive to deliver a great shopping experience for our customers through delivering compelling brands and product across categories and price-points that are communicated through aspirational messaging and imaging.

Strategic Themes

• Provide product that is on-trend, differentiated, distinctive and inspired by select popular fashion trends and pop culture for all of our target customers, but with a primary focus on expressive women and expressive moms.

• Improve brand marketing effectiveness by implementing a “house of brands” architecture that covers all of our major customer segments and builds distinctiveness and focus in our product assortment.

• Provide a great shopping experience through improved customer engagement, and leveraging our real estate to support new store formats consistent with the repositioning of our brand.

• Maintain efficient operations by building greater speed and flexibility into the supply chain to deliver the right product to the right store at the right time in the appropriate proportions across the approximately 4,600 store network.

On-Trend Targeted Product

We identify fashion trends timely and integrate these insights into on-trend product in our stores. For a more detailed discussion please see the Overview in Item 7.

Brand Marketing

With approximately 4,600 stores, we have strong brand recognition. In 2006, we sold over 177 million pairs of footwear in our Payless ShoeSource stores, making Payless one of the largest family footwear specialty retailers in the Western Hemisphere by unit sales. We average nearly 600 million customer visits per year.

We have three primary marketing objectives which are to (i) effectively position the Payless brand, (ii) increase awareness and drive traffic and transactions into our stores through a planned promotional cadence; and (iii) create market excitement for our brand through select public relations events. This is achieved by our multi-dimensional marketing efforts that include nationally broadcast television, radio, on-line and magazine advertising to strengthen our established brand name, reinforce our broad consumer recognition and support our promotional events. We regularly advertise on television, reaching households across the nation, as well as through free-standing inserts delivered to approximately 25 million homes periodically during the year, in order to support key promotional events. In addition to media support, we utilize in-store promotional materials, including posters, signs and point of sale items, as well as our store associates to convey our message to the customer.

Our new brand essence, “Inspiring fun fashion possibilities for the family ... Payless,” is helping define Payless as the fun fashion source for footwear and accessories for the family. In addition to our in-house marketing team, we collaborate with outside creative and media services.

In June 2006, we officially launched the new Payless logo – the first redesign of the Payless logo in about 20 years – which incorporates key design elements that leverage our rich heritage and communicates a “new and improved” Payless, a brand that is contemporary, fun, friendly, and above all, stylish. The logo amplifies the Payless brand essence.

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Shopping Experience

In 2006, Payless tested and launched two key new store design formats. These formats are called Hot Zones and Fashion Labs.

Hot Zones are a redesign of the front of our store that have experienced mid-to-high single digit percentage lift in same store sales. In Hot Zones, new merchandise is grouped by style on new display tables and low gondolas in the front of the store. This new store design format opens up the front of the store, provides better visibility, and allows for better display of new fashion trends.

The Fashion Lab is a completely new store design that elevates the shopping experience and our status as a specialty store destination. This new store design is more vibrant, engaging, and easier to navigate. Men and women’s footwear is organized by style with easy-to-find sizes nearby. The children’s footwear section is still organized by size since this is how our customers prefer to shop for children’s footwear.

We believe that our real estate strategy provides us with the ability to optimally locate our stores in places that are convenient for large numbers of consumers, as well as the flexibility to react to shifts in consumer demographics. We strategically locate our stores in a variety of retail formats to maximize convenience and accessibility for our broad consumer base, including central business districts, shopping malls, free-standing buildings, strip centers, and leased departments within other retailers. To maintain flexibility, we generally enter into leases with initial terms of five to ten years and either one or two renewal options.

In 2006, it cost us approximately $270,000 in capital expenditures to open a new store. During 2007, we expect the average capital costs for a new store to increase to approximately $330,000. During 2006, we opened 63 new stores. During the same period, we closed 96 stores. In addition, we relocated 106 stores.

Efficient Operations

We review all of the significant operational elements of our business model to maximize financial returns. Recently, we announced a plan to invest approximately $70 million over the next two years in a dual-distribution center model. Investing in our business will remain a top priority. For a more detailed discussion please see the Overview in Item 7.

Experienced Management Team

Our management team is composed of seasoned retail executives. Our 12 most senior executives have an average of 24 years of retail experience. The five executive officers of Payless have been with the Company for an average of more than 15 years.

Our International Business

Since opening our first store in Canada in 1997, our international presence has grown substantially. As of year-end, we had 586 stores in 10 countries, Puerto Rico and the U.S. Virgin Islands. In September 2000, we entered into a joint venture to operate Payless ShoeSource stores in the Central American Region. In November 2001, we entered into a joint venture to operate Payless ShoeSource stores in South America. In 2003, we entered into a joint venture with Nichimen Corporation (which has since become Sojitz Corporation) to try the Payless concept in Japan. Under this arrangement, we opened our first store in Japan in November 2004. However, we ceased retail operations in Japan in 2006. We also wholesale footwear internationally.

3

Stores

As of February 3, 2007, we operated a total of 4,572 stores in a single retail format, Payless ShoeSource. The domestic and international segments are represented in the tables below.

Domestic Segment

Alaska	8	Louisiana	62	Oklahoma	46
Alabama	35	Massachusetts	97	Oregon	50
Arkansas	41	Maryland	72	Pennsylvania	162
Arizona	85	Maine	12	Rhode Island	14
California	543	Michigan	134	South Carolina	38
Colorado	55	Minnesota	49	South Dakota	16
Connecticut	47	Missouri	77	Tennessee	49
District of Columbia	8	Mississippi	48	Texas	393
Delaware	9	Montana	14	Utah	52
Florida	284	North Carolina	65	Virginia	81
Georgia	97	North Dakota	7	Vermont	7
Hawaii	17	Nebraska	34	Washington	87
Iowa	34	New Hampshire	18	Wisconsin	78
Idaho	30	New Jersey	128	West Virginia	14
Illinois	192	New Mexico	28	Wyoming	5
Indiana	61	Nevada	34
Kansas	35	New York	257	Guam*	2
Kentucky	33	Ohio	141	Saipan*	1
Total Domestic Segment Store Count				3,986

* Guam and Saipan reflected as U.S. Territories

4

International Segment

Canada
Ontario	140
All Other	175
Total Canada	315
Central America
Costa Rica	22
Dominican Republic	16
El Salvador	22
Guatemala	35
Honduras	16
Nicaragua	12
Panama	18
Trinidad/Tobago	11
Total Central America	152
South America
Ecuador	31
Puerto Rico	83
U.S. Virgin Islands	5
Total International Segment Store Count	586

Payless ShoeSource^® Stores

The average size of our Payless ShoeSource stores in the United States and Canada is approximately 3,200 square feet. The average Payless ShoeSource store in the United States and Canada has between four and six associates, including a store manager. During 2006, each Payless store in the United States and Canada carried on average approximately 7,200 pairs of shoes. Payless ShoeSource stores operate in a variety of real estate formats, including shopping malls, central business districts, free-standing buildings, strip centers, and leased departments in ShopKo stores. At year-end, 465 locations incorporated a “Payless Kids” area which has approximately 974 additional square feet of selling space devoted to an expanded assortment of children’s shoes.

In 1999, we entered into a 10-year strategic alliance with ShopKo Stores, Inc., a discount retailer with stores primarily in the Midwest, Western Mountain, and Pacific Northwest regions, through which we operate Payless ShoeSource shoe departments within ShopKo^® stores. This alliance provides an additional distribution channel for our products. As of year-end, there were 132 of these locations.

Our Central American and South American Regions operate in a variety of real estate formats, including shopping malls, central business districts, free-standing buildings and strip centers. The average size of our Payless ShoeSource stores in the Central American Region is approximately 2,500 square feet. The average size of our Payless ShoeSource stores in the South American Region is approximately 2,900 square feet. At year-end, the average Payless ShoeSource store in the Central American Region and South American Region typically has between five and six associates, including a store manager, respectively.

Dyelights^(SM)

We also operate a shoe dyeing facility through our Dyelights^(SM) business. Currently, Dyelights shoes are exclusively offered through our Payless ShoeSource stores. Customers select the color they would like their shoes to be dyed from a color book. The shoes are dyed to the Customer’s specifications and are available for pickup in approximately ten days at the Payless

5

ShoeSource store where ordered. Customers may also elect to pay a shipping cost and have the shoes delivered to their home address.

Employees

As of February 3, 2007, we had approximately 27,100 employees, including approximately 11,350 U.S. and 1,100 Canadian full-time associates and 12,900 U.S. and 1,000 Canadian part-time associates, as well as approximately 540 primarily full-time associates in the Central American and South American Regions and approximately 200 in Asia. Approximately 475 of our distribution center general warehouse associates and 140 of our other associates are covered by collective bargaining agreements.

Store Management and Systems

All of our stores are equipped with electronic point of sale registers and a back office computer except the ShopKo locations which are equipped only with a back office computer. The store computer can provide price look-up, daily communications with our corporate headquarters and other functions. Store associates receive frequent communications through the back office computer from our corporate headquarters describing promotional events, price changes, and time-sensitive operational updates.

In general, each retail location is managed by a Store Manager and is assigned to a district. Store Managers report to District Managers who, in turn, report to Directors of Retail Operations who have full responsibility for the stores in their region. Human Resources, loss prevention, inventory control functions, accounting, logistics support, information technology, and other more general support services are generally coordinated from our Topeka, Kansas corporate headquarters. In addition, we have accounting offices in Costa Rica, Guatemala, El Salvador, Honduras, Nicaragua, Ecuador, Panama, and the Dominican Republic that support the Central and South American Regions.

Competition

The retail footwear and accessories market is highly competitive. The retail footwear and accessories industry can be divided into three segments: high, moderate and value-priced. The high-priced segment is comprised principally of department and specialty stores. The moderate-priced segment, which includes specialty shoe chains, mass-merchandisers and mid-tier department stores, has no single dominant competitor. The value-priced segment includes Payless and other large national discount merchandisers.

With our breadth of assortment, we face a variety of competitive challenges from domestic and international footwear retailers, including traditional shoe stores, department stores, branded discount stores, sporting goods retailers, direct retailers, and mass-market discount retailers. In addition, many retailers who have not traditionally carried footwear have added various footwear and accessories including seasonal, specialty and general footwear in their merchandise assortment.

The primary competitive levers to establish a point of differentiation in our industry are merchandise selection, flow and timing, pricing, fashion, product quality and aesthetics, convenience and in-store experience. We seek to compete effectively by getting to market with differentiated, trend-right merchandise before mass-market discounters such as Wal-Mart and Target and at the same time as department and specialty retailers such as Sears, Kohl’s, J.C. Penney, Nine West and Foot Locker, but at a more compelling value.

Seasonality

The domestic retail footwear market is characterized by four high volume seasons: Easter, early summer, back-to-school, and winter. During each of these periods, we increase our inventory levels to support the increased demand for our products, as well as offer styles particularly suited for the relevant season, such as sandals in the early summer season and boots during the fall season. The retail footwear market in Central and South America is also seasonal and is characterized by stronger sales in December and the back-to-school season.

6

Customer Service

Our stores offer customers a broad assortment of quality footwear in a convenient self-selection format. Our self-selection shopping format allows customers to select their own shoes or to seek help from one of our trained associates. Sales associates are trained to use a device to measure feet, and to check key areas, such as the toe box, for proper fit. Our stores also offer one of the broadest customer satisfaction guarantees in the industry: if a customer is not completely satisfied with a purchase, he or she can return it, generally even if the item is worn. We believe our sales associates provide a level of customer service that is generally not available in mass-market discount stores. Sales associates are trained to sell footwear and complementary accessories, and to provide customers with the assistance needed to guide the purchase decision, support customer satisfaction and to encourage return visits to our stores.

We continue to train all of our store associates on engaging customers in order to drive higher conversion rates. In 2006, we converted more of our customer traffic into sales versus in the previous year. Our customer satisfaction metrics also trended more favorably in 2006 than the previous year. Data on these metrics are gathered through company and third party survey techniques.

Purchasing and Distribution

Purchasing

We procure products in two different ways. First, about half of our product is sourced through our direct distribution network. And secondly, we engage third party agents to procure products which we cannot or do not want to procure ourselves.

Our direct distribution network is made up of development, sourcing, and transitional centers. These centers perform many functions including: executing product direction from Topeka; generating samples; quality control; production management and follow-up; and more. Our centers are closely aligned with large factories, which we rely on heavily, which serve as our vendors. We typically give these factories specifications and performance standards and bid jobs out to multiple factories. Approximately 15 core factories account for 70% of our footwear purchases. If any one of them were to be unable to supply our needs consistent with prior performance, we might experience disruptions in shoe deliveries. However, we have about 100 factories with whom we do run-over and special approval business, and we believe these factories can fill production voids if necessary. We believe our relationships with our factory base are good. Factories in the People’s Republic of China are a direct source of approximately 96% of our footwear based on cost.

Products are manufactured to meet our specifications and standards. We do not purchase “seconds” or “overruns.” Our direct distribution network is made up of facilities in the United States, Brazil, China, Hong Kong, Taiwan, and Vietnam.

Production Management and Quality Assurance

The production management organization manages an ongoing process to qualify and approve new factories, while continually assessing existing factory service and quality of performance. New factories must meet specified quality and safety standards for shoe production and minimum capacity requirements. They must also agree to our production control processes and certify that neither they nor their suppliers use forced or child labor. Factory performance is regularly monitored. If a factory does not continue to meet or exceed our requirements, the factory risks being removed from our list of approved factories. The production management organization utilizes a unique, internally developed production control process by which we are electronically linked to the factories and agents. This process is designed to ensure on-time deliveries of merchandise with minimum lead time and at reduced costs.

Our quality assurance organization also provides technical design support for our direct purchasing function. It is responsible for review and approval of agent and factory technical design, for worldwide laboratory testing of materials and components, and for performing in-factory product inspections to ensure that materials and factory production techniques are consistent with our specifications. We locate our field inspection personnel close to the factories and freight consolidation facilities we use throughout the world.

7

Merchandise Distribution

We base our decisions on how to stock our stores using several criteria. We consider the customer profile of our store locations based on demographics, shopping behavior and appetite for fashion. Also, we consider seasonality and climate by geography which impacts the timing of our flow. In addition, we consider our stores’ sales volume, selling history, and the categories of products they tend to sell when deciding how to stock our stores.

Our merchandise distribution system allows us to track shoes by pair from order placement through sale to the customer by the use of perpetual inventory, product planning and sourcing systems. These systems are maintained by experienced information systems personnel and are enhanced regularly to improve the product distribution process. Stores generally receive new merchandise on average twice a week in an effort to maintain a constant flow of fresh and replenished merchandise.

We currently operate a single distribution center (including office space) and dyeing facility in Topeka, Kansas totaling approximately 850,000 square feet. The distribution center sources our stores in the United States, Canada, Puerto Rico, Guam and Saipan. It is capable of replenishing domestic in-store product levels by style, color and size. Our Topeka distribution center handles substantially all of our replenishments and operates seven days a week, 12 to 24 hours per day. Our remaining domestic distribution needs are handled by a third-party facility in Los Angeles, California. We utilize third-party carriers to ship all products to and from our distribution centers. We also use a third-party distribution facility in Panama to service our stores in the Central and South American Regions.

We are currently building a new distribution center model to better service our stores and customers which tend to cluster on the borders and coasts of the U.S. We plan to operate one new distribution center in Redlands, California beginning in the summer of 2007. In addition, we plan to operate a new distribution center east of the Mississippi river (in a location to be determined) which will begin operation around June 2008. In 2008, when both new facilities are open and running to our satisfaction, we will close the Topeka distribution center.

Intellectual Property

Through our wholly-owned subsidiaries, we own certain copyrights, trademarks, patents and domain names which we use in our business and regard as valuable assets. The trademarks and service marks used in our business include Payless^®, Payless ShoeSource^®, Payless Kids^®, Dyelights^(SM), and various logos used on our Payless ShoeSource store signs and in advertising, including our traditional yellow and orange signage and our new orange and blue circle “P” logos. The domain names include Payless.com^®, as well as derivatives of Payless ShoeSource. On May 18, 2006, we acquired from Jimlar Corporation the rights to the trademarks American Eagle™ and AE™ for use on footwear and certain accessories, and related domain names.

In March, 2007, Payless ShoeSource announced its acquisition of privately held Collective International, LP (“Collective”), a brand development, management and licensing company with a strong youth lifestyle and board sport-inspired brand portfolio including Airwalk^®, Vision Street Wear^®, Lamar^®, Sims^®, LTD^®, genetic^™, Dukes^®, Rage^®, Ultra-Wheels^®, and Skate Attack^®.

Collective’s focus is on the growing active sport lifestyle market driven predominantly by the skate- and snowboard-inspired trends. The company is strongly positioned with its authentic brand portfolio that has consistently proven its ability to reach both the younger consumer with strong ties to board sports, as well as appeal to the broad range of consumers drawn to this established lifestyle and fashion.

The acquisition provides immediate brand leverage for Payless’ core footwear and accessories product lines in the youth lifestyle, athletics and outdoor categories. It also facilitates building broad corporate intellectual property management and brand development capabilities to create a diversified portfolio of brands serving discrete consumer segments across a range of price points, categories, and sales channels. As well, with this acquisition, Payless is establishing a licensing business that will provide growth opportunities across multiple product categories in domestic and international markets to create new revenue streams from wholesaling or licensing to other retailers and third parties.

Payless has been a licensee of the Airwalk brand since 2003 and features the brand on a wide range of footwear and accessories. Payless has helped drive Airwalk to be the number two skate footwear brand in America.

8

As of February 3, 2007, in the United States, we have approximately 200 pending registrations and applications for our trademarks and service marks, as well as several common law marks, under which we market private label merchandise in our Payless ShoeSource stores. We also have approximately 1,300 pending registrations and applications for our trademarks in foreign countries. In addition, we have registrations or pending applications for the Payless ShoeSource mark in over 70 foreign registries.

Currently, we have agreements in place regarding the following brands: Champion^®, which expires on June 30, 2015; Airwalk^®, which expires on January 31, 2015; Spalding^®, which expires on June 1, 2008; and American Ballet Theatre ™, which expires on January 31, 2010. In 2006, we entered into agreements with Disney Enterprises, Inc. for use of various Disney properties and characters which expires on December 31, 2010, and Exeter Brands Group, LLC, a subsidiary of Nike USA, Inc., for use of the Tailwind^® brand on footwear and accessories, which expires on November 19, 2011. We have agreements with Laura Poretzky, Lela Rose and Patricia Field for development, licensing, marketing and distribution of Laura Poretzky’s Abaeté for Payless line, which expires on May 31, 2009; Lela Rose for Payless line, which expires on January 31, 2008, and the Patricia Field for Payless and/or Red Carpet Collection by Patricia Field lines, which expires on January 31, 2008. We also currently have the exclusive right to use the Dunkman^® brand. We, through agents, also utilize various character marks from time-to-time.

Environment

Compliance with federal, state and local statutes, rules, ordinances, laws and other provisions which have been enacted or adopted regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, have not had, and are not expected to have, a material effect on capital expenditures, earnings or our competitive position.

Payless Direct

In the fall of 1999, we launched payless.com to make Payless ShoeSource more accessible to our existing and new customers. In addition to eCommerce sales and on-line marketing, payless.com provides a multi-channel service to our stores by allowing stores to order product from payless.com in the event that shoe is not available in a given store. Our eCommerce strategy is evolving with the overall Payless strategy and brand positioning.

Available Information

We file or furnish our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, and amendments to those reports pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 with the SEC electronically. Copies of any of these documents will be provided in print to any shareholder who submits a request in writing to Payless ShoeSource, Inc., ATTN Investor Relations, 3231 Southeast Sixth Avenue, Topeka KS 66607 or calls our Investor Relations Department at (785) 559-6966. The public may read or copy any materials we file with the SEC at the SEC’s Office of Investor Education and Assistance at 100 F Street N.E., Washington, D.C. 20549-0313. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains a website that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. The address of that site is http://www.sec.gov.

We maintain an investor relations website at www.paylessinfo.com. On our investor relations website, you can access free of charge our reports that are filed with the SEC, the Guidelines for our Board of Directors, and the charters for the Board of Directors, the Audit and Finance Committee and the Compensation, Nominating and Governance Committee. In addition, we maintain a website at www.payless.com where our customers can shop at their convenience. This website also provides a link to our investor relations website. No portion of our Web site or the information contained in or connected to the Web site is a part of, or incorporated into, this Annual Report on Form 10-K.

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Directors of the Company

Listed below are the names and present principal occupations or, if retired, most recent occupations of the Company’s Directors:

Name	Principal Occupation
Management Director
Matthew E. Rubel(1*)	Chief Executive Officer and President of the Company
Independent Directors
Howard R. Fricke(1)(2)(3)	Retired Chairman of the Board of the Security Benefit Group of Companies
Daniel Boggan Jr.(3)	Retired Senior Vice President of the National Collegiate Athletic Association
Judith K. Hofer (4)	Retail Consultant
Mylle H. Mangum(1)(4*)	Chief Executive Officer of IBT Enterprises, LLC
John F. McGovern(1) (3*)	Founder and Partner of Aurora Capital LLC and former Executive Vice President/Chief Financial Officer of Georgia-Pacific Corporation
Robert F. Moran(3)	President and Chief Operating Officer of PetSmart, Inc.
Michael E. Murphy(3)	Retired Vice Chairman and Chief Administrative Officer of Sara Lee Corporation
David Scott Olivet(3)	Chief Executive Officer and Director of Oakley, Inc.
Michael A. Weiss(4)	Retired President and Chief Executive Officer of Express, a subsidiary of Limited Brands, Inc. and non-executive Chairman of Chicos FAS, Inc.
Robert C. Wheeler(4)	Chairman and Chief Executive Officer of Hill’s Pet Nutrition, Inc.

(1)	Executive Committee member
(2)	Non-Executive Chairman of the Board
(3)	Audit and Finance Committee member
(4)	Compensation, Nominating and Governance Committee member
*	Chairman

Executive Officers of the Company

Listed below are the names and ages of the executive officers of the Company as of April 3, 2007 and offices held by them with the Company.

Name	Age		Position and title
Matthew E. Rubel		49	Chief Executive Officer and President
Jay A. Lentz		63	Senior Vice President
Michael J. Massey		42	Senior Vice President, General Counsel and Secretary
Darrel J. Pavelka		51	Senior Vice President
Ullrich E. Porzig		61	Senior Vice President, Chief Financial Officer and Treasurer

Matthew E. Rubel is 49 years old and has served as Chief Executive Officer and President of Payless since July 18, 2005. Prior to joining Payless, Mr. Rubel was Chairman and Chief Executive Officer for Cole Haan from 1999 to July 2005. He served as Executive Vice President, J. Crew Group and Chief Executive Officer of Popular Club Plan from 1994 to 1999, and in November 1998, led the sale of Popular from J. Crew to Fingerhut. While at J. Crew Group, Mr. Rubel was responsible for all licensing and international activities, as well as brand marketing and served on its Group Executive Committee. Mr. Rubel has also served as President and Chief Executive Officer of Pepe Jeans USA, and President of the Specialty Division of Revlon. Mr. Rubel has served as a Director of Payless since July 2005.

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Jay A. Lentz is 63 years old and has served as Senior Vice President — Human Resources since May 2001. Prior to that he was Vice President of Organization Development from 1992 to 2001; and 1985 to 1990. From 1990 to 1992 he served as Senior Vice President of Human Resources for Payless Cashways Inc. He previously worked for Pizza Hut Inc., a division of PepsiCo, Inc., as Senior Director of Management Development, Arthur Young Co. as Manager, Organization Development Consulting, and The University of Missouri as a consulting psychologist.

Michael J. Massey is 42 years old and has served as Senior Vice President — General Counsel and Secretary since March 2004. Prior to that he served as Vice President of International Development during 2001, Vice President of Contract Manufacturing during 2000, Vice President, Group Counsel Intellectual Property from 1998 to 2000, and Senior Counsel from 1996 to 1998. Prior to joining Payless, Mr. Massey was an attorney for The May Department Stores Company from 1990 to 1996.

Darrel J. Pavelka is 51 years old and has served as Senior Vice President — Merchandise Distribution, Planning and Supply Chain since September 2004. Prior to that he was Senior Vice President — International Operations from March 2003 to September 2004. He also served as Senior Vice President — Merchandise Distribution from 1999 to 2003, Vice President of Retail Operations for Division R from 1997 to 1999, Vice President of Stores Merchandising from 1995 to 1997, Director of Stores Merchandising from 1990 to 1995, Director of Distribution for Women’s from 1987 to 1990, Manager of Stores Merchandising for Division R from 1983 to 1987, and Manager of the Northeast store expansion from 1980 to 1983.

Ullrich E. Porzig is 61 years old and has served as Senior Vice President — Chief Financial Officer and Treasurer since February, 1996 and from 1986 to 1988. Between 1993 and 1996, Mr. Porzig was Senior Vice President-Chief Financial Officer and Treasurer of Petro Stopping Centers L.P. From 1982 to 1993 he was employed by The May Department Stores Company in various capacities including Senior Vice President-Finance and Chief Financial Officer of Foley’s from 1988 to 1993.

ITEM 1A. RISK FACTORS

We May be Unable to Compete Effectively in the Competitive Worldwide Footwear Retailing Industry

We face a variety of competitive challenges from other domestic and international footwear retailers, including a number of competitors that have substantially greater financial and marketing resources than we do. These competitors include mass-market discount retailers such as Wal-Mart Stores, Inc., and Target Corp.; department stores such as Sears, Kohl’s Corp. and J.C. Penney Company, Inc.; specialty retailers such as Nine West and Foot Locker; and branded discount stores such as DSW and Shoe Pavilion. We compete with these footwear retailers on the basis of:

• developing fashionable, high-quality merchandise in an assortment of sizes, colors and styles that appeals to our target consumers;

• anticipating and responding to changing consumer demands in a timely manner;

• ensuring product availability and optimizing supply chain effectiveness;

• the pricing of merchandise;

• creating an acceptable value proposition for consumers;

• providing an inviting, customer friendly shopping environment;

• using a customer focused sales staff to provide attentive, product knowledgeable customer service; and

• providing strong and effective marketing support.

Competition in the retail footwear industry has increased. Mass-market discount retailers such as Wal-Mart aggressively compete with us on the basis of price and have added significant numbers of locations, gaining market share as a result. Accordingly, there is substantial pressure on us to maintain the value proposition of our footwear. In addition, it is possible that mass-market discount retailers will increase their investment in their retail footwear operations, thereby achieving greater market penetration and placing additional competitive pressures on our business. If we are unable to respond effectively to these competitive pressures, our business, results of operations and financial condition could be adversely affected.

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A Majority of our Operating Expenses are Fixed Costs that are not Dependent Upon our Sales Performance. As a result, Declines in our Operating Performance are Magnified because We are Largely Unable to Reduce Expenses in Response to a Potential Sales Shortfall

A majority of our operating expenses are fixed costs that are not dependent on our sales performance, as opposed to variable costs, which increase as sales performance increases. These fixed costs include the leasing costs of our stores, our interest expenses and the majority of our labor expenses. If our sales were to decline, we would be unable to reduce these fixed operating expenses in the short term. Accordingly, the effect of any sales decline is magnified because a larger percentage of our earnings are committed to paying these fixed costs. As a result, our net earnings and cash flow would be disproportionately negatively affected as a result of decline in sales.

We May be Unable to Maintain or Increase our Sales Volume and Margins

We have a substantial market presence in all 50 states and the District of Columbia and we currently derive approximately 86% of our revenue from our U.S. stores. Because of our substantial market presence, and because the U.S. footwear retailing industry is mature, for us to increase our sales volume on a unit basis and margins in the United States, we must capture market share from our competitors. We have attempted to capture additional market share through a variety of strategies; however, if we are not successful we may be unable to increase or maintain our sales volumes and margins in the United States, adversely affecting our business, results of operations and financial condition.

We Must Provide Consumers with Seasonally Appropriate Merchandise, Making Some of our Sales Dependent on Seasonal Weather Conditions

The domestic retail footwear industry is characterized by four high volume seasons: Easter, early summer, back-to-school and winter. During each of these seasons, we increase our inventory levels to support the increased demand for our products, as well as offer styles particularly suited for the relevant season, such as sandals in the early summer season and boots during the winter season. If the weather conditions for a particular season vary significantly from those typical for such season, such as an unusually cold early summer or an unusually warm winter, consumer demand for the seasonally appropriate merchandise that we have available in our stores could be adversely affected and negatively impact net sales and margins. Lower demand for seasonally appropriate merchandise may leave us with an excess inventory of our seasonally appropriate products and/or basic products, forcing us to sell both types of products at significantly discounted prices and adversely affect our net sales margins and operating cash flow. Consequently, our results of operations are highly dependent on relatively predictable weather conditions.

We May be Unable to Adjust to Constantly Changing Fashion Trends

Our success depends, in large part, upon our ability to gauge the evolving fashion tastes of our consumers and to provide merchandise that satisfies such fashion tastes in a timely manner. The worldwide retailing footwear industry fluctuates according to changing fashion tastes and seasons, and merchandise usually must be ordered well in advance of the season, frequently before consumer fashion tastes are evidenced by consumer purchases. In addition, the cyclical nature of the worldwide footwear retailing industry also requires us to maintain substantial levels of inventory, especially prior to peak selling seasons when we build up our inventory levels. As a result, if we fail to properly gauge the fashion tastes of consumers, or to respond in a timely manner, this failure could adversely affect retail and consumer acceptance of our merchandise and leave us with substantial unsold inventory. If that occurs, we may be forced to rely on markdowns or promotional sales to dispose of excess, slow-moving inventory, which would negatively impact financial results.

The Worldwide Footwear Retailing Industry is Heavily Influenced by General Economic Cycles

Footwear retailing is a cyclical industry that is heavily dependent upon the overall level of consumer spending. Purchases of footwear and related goods tend to be highly correlated with the cycles of the levels of disposable income of our consumers. As a result, any substantial deterioration in general economic conditions could adversely affect our net sales and results of operations.

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We May be Unsuccessful in Opening New Stores or Relocating Existing Stores to New Locations, Adversely Affecting our Ability to Grow

Our growth is largely dependent upon our ability to expand our retail operations by opening and operating new stores, as well as relocating existing stores to new locations, on a profitable basis. In 2006, we opened 169 new Payless ShoeSource stores, of which 106 were relocations.

Our ability to open new stores and relocate existing stores to new locations on a timely and profitable basis is subject to various contingencies, some of which are beyond our control. These contingencies include our ability to:

• locate suitable store sites;

• negotiate acceptable lease terms;

• build-out or refurbish sites on a timely and cost effective basis;

• hire, train and retain qualified managers and personnel;

• obtain adequate capital resources; and

• successfully integrate new stores into our existing operations.

In addition, the opening of stores outside of the United States is subject to a number of additional contingencies, including compliance with local laws and regulations and cultural issues and, because we operate a number of our international stores under joint ventures, issues may arise in our dealings with our joint venture partners or their compliance with the joint venture agreements.

We may be unsuccessful in opening new stores or relocating existing stores for any of these reasons. In addition, we cannot assure you that, even if we are successful in opening new stores or relocating existing stores, those stores will achieve levels of sales and profitability comparable to our existing stores.

We Rely on Third Parties to Manufacture and Distribute Our Products

We depend on contract manufacturers to manufacture the merchandise that we sell in our stores. If these contract manufacturers are unable to secure sufficient supplies of raw materials, or maintain adequate manufacturing and shipping capacity, they may be unable to provide us with timely delivery of products of acceptable quality. In addition, if the prices charged by these contractors increase for reasons such as increases in the price of raw materials, increases in labor costs or currency fluctuations, our cost of manufacturing would increase, adversely affecting our results of operations. We also depend on third parties to transport and deliver our products. Due to the fact that we do not have any independent transportation or delivery capabilities of our own, if these third parties are unable to transport or deliver our products for any reason, or if they increase the price of their services, including as a result of increases in the cost of fuel, our operations and financial performance may be adversely affected.

We require our contract manufacturers to meet our standards in terms of working conditions and other matters before we are willing to contract with them to manufacture our merchandise. As a result, we may not be able to obtain the lowest possible manufacturing costs. In addition, any failure by our contract manufacturers to meet these standards, to adhere to labor or other laws or to diverge from our mandated labor practices, and the potential negative publicity relating to any of these events, could harm our business and reputation.

We do not have long-term agreements with any of our contract manufacturers, and any of these manufacturers may unilaterally terminate their relationship with us at any time. There is also substantial competition among footwear retailers for quality manufacturers. To the extent we are unable to secure or maintain relationships with quality manufacturers, our business could be harmed.

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There are Risks Associated with Our Importation of Products

We import finished merchandise into the United States and the other countries in which we operate from the People’s Republic of China and seven other countries. Substantially all of this imported merchandise is subject to:

- customs duties and tariffs imposed by the governments of countries into which this merchandise is imported; and

- penalties imposed for, or adverse publicity relating to, violations of labor and wage standards by foreign contractors.

The United States and countries in which our merchandise is manufactured or imported may from time to time impose additional new quotas, tariffs, duties or other restrictions on our merchandise or adversely change existing restrictions or interpretation regarding the application timing. Any such changes could adversely affect our ability to import, and/or the cost of, our products and the results of operations of our business or interpretations of these items.

Manufacturers in China are our major suppliers. China was a direct source of approximately 96% of our merchandise based on cost during 2006. In addition to the products we import directly, a significant amount of the products we purchase from other suppliers has been imported from China. Any deterioration in the trade relationship between the United States and China or any other disruption in our ability to import footwear, accessories, or other products from China could have a material adverse effect on our business, financial condition or results of operations.

In addition to the risks of foreign sourcing stemming from international trade laws, there are also operational risks of relying on such imported merchandise. Our ability to successfully import merchandise derived from foreign sources into the United States is dependent on stable labor conditions in the major ports of the United States. Any instability or deterioration of the domestic labor environment in these ports, such as the work stoppage at West Coast ports in 2002, could result in increased costs, delays or disruption in product deliveries that could cause loss of revenue, damage to customer relationships or materially affect our business.

If we are unable to maintain our current Customs-Trade Partnership Against Terrorism (“C-TPAT”) status, it would increase the time it takes to get products into our stores. Such delays could materially impact our ability to move the current product in our stores to meet customer demand.

Our International Operations are Subject to Political and Economic Risks

In 2006, approximately 14% of our sales were generated outside the United States and almost all of our merchandise was manufactured outside the United States. We are accordingly subject to a number of risks relating to doing business internationally, any of which could significantly harm our business, including:

• political and economic instability;

• exchange controls and currency exchange rates;

• foreign tax treaties and policies; and

• restrictions on the transfer of funds to and from foreign countries.

Our financial performance on a U.S. dollar denominated basis is also subject to fluctuations in currency exchange rates. These fluctuations could cause our results of operations to vary materially.

From time to time, we may enter into agreements seeking to reduce the effects of our exposure to currency fluctuations, but these agreements may not be effective in reducing our exposure to currency fluctuations or may not be available at a cost effective price.

We May be Unable to Effectively Protect Our Trademarks and Other Intellectual Property Rights

Our trademarks and other intellectual property rights are important to our success and competitive position. If we were to lose or were unable to effectively protect such intellectual property rights, our business could be adversely affected.

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We are Subject to Liability if We Infringe the Trademarks or Other Intellectual Property Rights of Third Parties

We are subject to liability if we infringe the trademarks or other intellectual property rights of third parties. If we were to be found liable for any such infringement, we could be required to pay substantial damages and could be subject to injunctions preventing further infringement. If this were to happen, it could have a substantial adverse effect on our business. See also “Legal Proceedings,” included in this Form 10-K.

We Rely on Brands We Do Not Own

We are increasing our reliance on brands, some of which we do not own. During the last fiscal year, approximately 23% of our revenues were derived from brands that we did not own. Currently, we have agreements in place regarding the following brands: Champion^®, which expires on June 30, 2015; Airwalk^®, which expires on January 31, 2015; Spalding^®, which expires on June 1, 2008; American Ballet Theatre ™, which expires on January 31, 2010; Tailwind ^®, which expires on November 19, 2011; and various Disney properties and characters, which expires on December 31, 2010. We, through our agents, also utilize various character marks from time-to-time. If we are unable to renew or replace any brand or character that accounts for a significant portion of its revenue, our results could be adversely affected.

Adverse Occurrences at Our Topeka Distribution Center Could Negatively Impact Our Business

We operate a distribution center in Topeka, Kansas, which serves as the main source of replenishment of inventory for our stores. In comparison to our total distribution network, the distribution needs of our stores are heavily dependent on products delivered through our Topeka distribution center. If complications arise with our Topeka distribution center or our Topeka distribution center is severely damaged or destroyed, our other distribution centers may not be able to support the resulting additional distribution demands and we may be unable to locate alternative persons or entities capable of doing so. This may adversely affect our ability to deliver inventory to our stores on a timely basis, which could adversely affect our results of operations.

Integration Risks of New Distribution Facilities Could Negatively Impact Our Business

If we are unable to smoothly transition product flow from one distribution facility in the United States to two facilities in the United States, there could be delays in shipping products to stores. If product arrives late in the selling cycle, we could be forced to mark down or use other promotions to liquidate such inventory which could adversely affect the net sales, margins and operating cash flow.

We May Be Unable to Attract and Retain Talented Personnel

Our success is dependent upon our ability to attract and retain qualified and talented individuals. If we are unable to attract or retain key executives, including senior management, marketing and merchandising personnel, it could adversely affect our business.

Prolonged Work Stoppages Could Adversely Affect our Results of Operations

At the end of 2006, approximately 600 of our employees, including substantially all of our non-management employees at our Topeka distribution center, are covered by four separate collective bargaining agreements that expire between 2007 and 2009. We cannot assure you that these agreements will be renewed on similar terms or renegotiated on acceptable terms. Any prolonged work stoppages in one or more of our facilities could materially adversely affect our results of operations. Although there have been no work stoppages or disruptions since the inception of these collective bargaining agreements, we cannot assure you that there will be no disruptions in the future.

If more of our employees unionize, it could result in demands that may increase our operating expenses and adversely affect our profitability. If any group of our employees were to unionize and we were unable to reach agreement on the terms of their collective bargaining agreement or we were to experience widespread employee dissatisfaction, we could be subject to work slowdowns or stoppages. In addition, we may be subject to disruptions by organized labor groups protesting the non-union

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status of the majority of our employees. Any of these events would be disruptive to our operations and could harm our business.

An Outbreak of Asian Flu or Other Similar Infectious Diseases May Have a Material Adverse Effect on Our Ability to Purchase Merchandise from Manufacturers and Our Operations Generally

An outbreak and spread of infectious diseases such as Asian flu in Southern China and other countries in which our manufacturers are located could impact the availability or timely delivery of merchandise. Although our ability to purchase and import our merchandise has not been negatively impacted to date, an outbreak of infectious diseases could prevent the manufacturers we use from manufacturing our merchandise or hinder our ability to import those goods to the countries in which our stores are located, either of which could have an adverse effect on our results of operations.

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

ITEM 2. PROPERTIES

We lease substantially all of our stores. Our leases typically have an initial term of five or ten years, and either one or two renewal options. During 2007, approximately 987 of our leases are due to expire. This includes 263 leases that, as of February 3, 2007, were month-to-month tenancies and 321 lease modifications that are pending execution (of the 321 pending modifications, 157 are currently month-to-month). Leases usually require payment of base rent, applicable real estate taxes, common area expenses and, in some cases, percentage rent based on the store’s sales volume.

Payless ShoeSource stores average 3,200, 2,500 and 2,900 square feet in the United States and Canada, the Central American Region, and the South American Region, respectively. We operate a 305,000 square foot world headquarters building and 850,000 square foot distribution facility including office space and an adjacent 12,000 square foot dyeing facility, all of which are located in Topeka, Kansas. We also lease office space in Toronto, Ontario, Canada; Topeka, Kansas; New York, New York and at various international locations to support our sourcing, accounting and store operations.

On October 5, 2006, we, through a subsidiary, entered into a lease for a portion of a building to be used by us as a warehouse / distribution facility. The facility is approximately 415,000 square feet and is located in Redlands, California. The initial lease term is for 15 years, with two five-year options to extend the lease term. The lease also provides us the right to purchase the entire building prior to the landlord selling the building to an unrelated third party, and the right of us to terminate the lease after 10 years with proper notice and a penalty payment to the landlord. In addition, we will open and operate a new distribution center east of the Mississippi river (in a location to be determined) which is expected to begin operation in the summer of 2008. In 2008, when both new facilities are open and running to our satisfaction, we plan to close the Topeka distribution center.

ITEM 3. LEGAL PROCEEDINGS

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

On or about February 5, 2004, a complaint was filed against us in the U.S. District Court for the Central District of California, captioned K-Swiss, Inc. v. Payless ShoeSource, Inc. The Complaint seeks injunctive relief and unspecified monetary damages for trademark and trade dress infringement, trademark dilution and unfair competition. On May 14, 2005, a First Amended Complaint was filed, to include a breach of contract claim. We believe we have meritorious defenses to the claims asserted in the lawsuit and have filed an answer. A pre-trial conference was held on November 13, 2006, during which the trial judge indicated that he was transferring the case to a new judge for all further proceedings. The case subsequently was assigned to Judge George P. Schiavelli and a status conference was held on January 29, 2007. During that status conference, Judge Schiavelli set a February 5, 2008 trial date, with the pretrial conference to be held on January 7, 2008. On October 12, 2006, we filed a suit against St. Paul Fire and Marine Insurance Company (“St. Paul”), in Kansas state court seeking damages and a declaratory judgment that St. Paul is obligated to provide coverage in connection with the underlying lawsuit brought by K-

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Swiss. On October 18, 2006, St. Paul filed a separate declaratory judgment action in the U.S. District Court for the Central District of California seeking a declaration that there is no coverage for the underlying lawsuit. We have moved to dismiss the California action filed by St. Paul, which was granted on February 12, 2007. On November 2, 2006, St. Paul removed the action from state court to the U.S. District Court for the District of Kansas. Also, on November 2, 2006, St. Paul moved to transfer the Kansas action to the U.S. District Court for the Central District of California, which was denied on January 10, 2007. On January 23, 2007, St. Paul filed a motion to stay the Kansas Action until the underlying lawsuit is resolved, which was granted on March 2, 2007. An estimate of the possible loss, if any, or the range of the loss cannot be made. However, the ultimate resolution of this matter could have a material adverse effect on our Consolidated Financial Statements.

On or about December 20, 2001, a First Amended Complaint was filed against us in the U.S. District Court for the District of Oregon, captioned adidas America, Inc. and adidas-Salomon AG v. Payless ShoeSource, Inc. The First Amended Complaint seeks injunctive relief and unspecified monetary damages for trademark and trade dress infringement, unfair competition, deceptive trade practices and breach of contract. We believe we have meritorious defenses to claims asserted in the lawsuit and have filed an answer and a motion for summary judgment which the court granted in part. On June 18, 2004, the plaintiff appealed the District Court’s ruling on the motion for summary judgment. On January 5, 2006, the 9^th Circuit Court of Appeals entered an order reversing the District Court’s partial summary judgment order. We requested a rehearing en banc, which was denied by the 9^th Circuit Court of Appeals. On June 29, 2006, we filed a petition for writ of certiorari to the United States Supreme Court, which was denied on October 2, 2006. On August 22, 2006, the District Court entered an amended scheduling order setting an August 14, 2007 trial date. An estimate of the possible loss, if any, or the range of loss cannot be made. However, the ultimate resolution of this matter could have a material adverse effect on our Consolidated Financial Statements.

On or about April 3, 2006, Crocs Inc. filed two companion actions against several manufacturers of foam clog footwear asserting claims for patent infringement, trade dress infringement, and unfair competition. One complaint was filed before the United States International Trade Commission (“ITC”) in Washington D.C. The other complaint was filed in federal district court in Colorado. Collective Licensing International LLC (“Collective”), who licenses Airwalk^® brand to us, was named as a Respondent in the ITC Investigation, and as a Defendant in the Colorado federal court action. We have not been named in either matter, however, we owe certain indemnity obligations to Collective under our licensing agreement. The ITC published notice in the Federal Register on May 8, 2006, announcing that it is commencing an investigation into the allegations contained in Crocs’ complaint. In accordance with federal law, the Colorado federal court action will be stayed pending the outcome of the ITC investigation. A motion to stay the Colorado federal court action was filed on May 12, 2006. Before the ITC, Crocs seeks an order and injunction prohibiting any of the respondents from importing or selling any imported shoes that infringe on Crocs’ patent and trade dress rights. In the federal court action, which, as noted above, will be stayed, Crocs seeks damages and injunctive relief prohibiting the defendants from infringing on Crocs’ intellectual property rights. On November 7, 2006, the Administrative Law Judge in the ITC action entered an order granting summary judgment of non-infringement of design patent No. 0517,589 in favor of Collective and the other remaining respondents. Further, because Crocs’ expert and fact witnesses admitted that the recent versions of the shoes of all respondents did not infringe the separate utility patent at issue, Crocs proposed that the trial, which was to commence on November 13, 2006, be continued pending review. All respondents agreed not to oppose Crocs’ request to continue the trial and on November 8, 2006, the Administrative Law Judge entered an order on Crocs’ motion postponing the trial indefinitely pending review of the summary judgment motion by the ITC. On December 21, 2006, the ITC decided to review, in part, the initial determination granting summary determination of non-infringement of design patent No. D517,589. On February 15, 2007, the ITC vacated the initial determination and remanded for further proceedings. On February 22, 2007, the Administrative Law Judge entered an order extending the date for completion of the investigation to August 11, 2008; affirming his previous narrow claim construction of design patent No. D517,789; and rejecting the claim construction proposed by Crocs. Also, under this order, hearing has been set for January 14 – 18, 2008, and the deadline for an initial determination by the Administrative Law Judge is April 11, 2008. We believe we have meritorious defenses to the claims asserted in the lawsuits and have filed an answer. An estimate of the possible loss, if any, or the range of loss cannot be made. However, the ultimate resolution of this matter could have a material adverse effect on our Consolidated Financial Statements.

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

There were no matters submitted to a vote of security holders during the 14 weeks ended February 3, 2007.

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PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

There were approximately 12,100 registered holders of the Company’s Common Stock as of February 3, 2007, compared to approximately 12,700 registered holders as of January 28, 2006.

Common Stock and Market Prices

The Company’s common stock is listed on the New York Stock Exchange under the trading symbol PSS. The quarterly intraday price ranges of the common stock in 2006 and 2005 were:

	2006				2005
	High		Low		High		Low
Fiscal Quarter
First	$	24.39	$	20.64	$	16.09	$	11.49
Second		27.80		20.36		21.71		13.37
Third		28.80		22.07		20.18		15.02
Fourth		35.14		25.76		25.74		17.50
Year	$	35.14	$	20.36	$	25.74	$	11.49

We have not paid a cash dividend on outstanding shares of common stock since our spin-off from The May Department Stores Company. We are subject to certain restrictions contained in our senior secured revolving credit facility and the Indenture governing our 8.25% Senior Subordinated Notes which restrict our ability to pay dividends. We do not currently plan to pay any cash dividends.

Recent Sales of Unregistered Securities

On May 27, 2004, May 26, 2005, and May 25, 2006, 2,215 shares, 4,150 shares, and 5,865 shares, respectively, were credited to Directors’ accounts under the Company’s Restricted Stock Plan for Non-Management Directors as the annual restricted stock grant portion of their director’s fees. In addition, the following directors received a prorated director’s fee based on their date of election as a director during the year: Ms. Hofer received 3,347 shares on July 23, 2004; Mr. Weiss received 2,013 shares on January 27, 2005; Mr. Olivet received 1,340 shares on September 21, 2006; and Mr. Moran received 412 shares on March 1, 2007. Each director is permitted to defer receipt of a portion of their compensation including their annual restricted stock grant pursuant to the Company’s Deferred Compensation Plan for Non-Management Directors. In the past three years, non-management directors have deferred an aggregate of 67,082 shares under the Deferred Compensation Plan for Non-Management Directors. These grants were made as partial compensation for the recipients’ services as directors. The offer and issuance of these securities are exempt from registration under Section 4(2) of the Securities Act of 1933 and the rules and regulations promulgated thereunder, as transactions by an issuer not involving any public offering or alternatively, registration of such shares was not required because their issuance did not involve a “sale” under Section 2(3) of the Securities Act of 1933.

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Issuer Purchases of Equity Securities

The following table provides information about purchases by the Company (and its affiliated purchasers) during the quarter ended February 3, 2007, of equity securities that are registered by the Company pursuant to Section 12 of the Exchange Act:

					Total Number		Approximate Dollar
					of Shares Purchased		Value of Shares
	Total Number				as Part of Publicly		that May Yet Be
	of Shares				Announced Plans		Purchased Under the
	Purchased (1)		Average Price		or Programs		Plans or Programs
Period	(in thousands)		Paid per Share		(in thousands)		(in millions)
10/29/06 - 11/25/06		2	$	27.24		—	$	76.9
11/26/06 - 12/30/06		530		32.14		529		59.9
12/31/06 - 02/03/07		613		33.63		612		39.3
Total		1,145	$	32.93		1,141	$	39.3	(2)

(1)

Includes an aggregate of approximately four thousand shares of our common stock that was repurchased in connection with our employee stock purchase and stock incentive plans.

(2)

In 2001, our Board of Directors approved the repurchase of our common stock having a value of up to $250 million in the aggregate pursuant to the Program. On March 6, 2007, we announced that on March 2, 2007, our Board of Directors authorized an aggregate of $250 million of share repurchases. The timing and amount of share repurchases, if any, are limited by the terms of our Credit Agreement and Senior Subordinated Notes.

New York Stock Exchange Corporate Governance Matters

As a listed Company with the NYSE, the Company is subject to certain Corporate Governance standards as required by the NYSE and/or the Securities and Exchange Commission (“SEC”). The Certification of the Chief Executive Officer required by Section 303A.12(a) of The New York Stock Exchange Listing Standards relating to the Company’s compliance with The New York Stock Exchange Corporate Governance Listing Standards was submitted to the NYSE on June 21, 2006. Also, included as Exhibits to this Form 10-K are the required certifications by the Company’s CEO and CFO pursuant to Sarbanes-Oxley Act Sections 302 and 906.

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The graph below compares the cumulative total stockholder return on Payless Common Stock against the cumulative returns of the Standard and Poor’s Corporation Composite Index (the “S&P 500 Index”), and the Peer Group, some of which are competitors and many of which were used in determining bonuses under the Company’s performance based incentive plans.

Comparison of Five Fiscal Year Cumulative Returns of the Company,
the S&P 500 Index and Peer Group

Investment Value at End of Fiscal Year:

	2001		2002		2003		2004		2005		2006
Payless		100.00		81.63		68.78		58.85		121.60		178.92
S&P500		100.00		76.98		103.59		110.02		121.43		139.04
Peer Group		100.00		89.07		123.03		147.37		140.00		158.82

The graph assumes $100 was invested on February 2, 2002, (the end of fiscal 2001) in Payless Common Stock, in the S&P 500 Index, and the Peer Group and assumes the reinvestment of dividends.

Companies comprising the Peer Group are: The Gap, Inc., Limited Brands, Inc., Ross Stores, Inc., The TJX Companies, Inc., Brown Shoe Company, Inc., Footstar, Inc., Genesco Inc., Shoe Carnival, Inc., The Finish Line, Inc., Foot Locker, Inc., and The Stride Rite Corporation.

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ITEM 6. SELECTED FINANCIAL DATA

Our summary consolidated financial information set forth below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our Notes to Consolidated Financial Statements, included elsewhere in this Form 10-K .

							Fiscal Year(1)
(dollars in millions, except per share; shares in thousands)	2006(8)			2005			2004			2003			2002
Statements of Earnings (Loss) Data:
Net sales	$	2,796.7		$	2,665.7		$	2,656.2		$	2,662.4		$	2,736.1
Cost of sales		1,821.0			1,777.1			1,836.5			1,920.9			1,883.5
Gross margin		975.7			888.6			819.7			741.5			852.6
Selling, general and administrative expenses		808.5			767.1			730.0			715.7			663.0
Restructuring charges (benefits)(2)		0.8			3.8			24.9			(0.2	)		2.1
Operating profit from continuing operations		166.4			117.7			64.8			26.0			187.5
Interest expense		19.2			19.7			22.1			20.7			23.5
Interest income		(22.7	)		(12.3	)		(5.3	)		(3.9	)		(4.3	)
Earnings from continuing operations before income taxes and minority interest		169.9			110.3			48.0			9.2			168.3
Provision (benefit) for income taxes		39.9			30.8			13.2			(4.0	)		60.8
Earnings from continuing operations before minority interest		130.0			79.5			34.8			13.2			107.5
Minority interest, net of income taxes		(4.6	)		(3.0	)		2.3			3.7			3.0
Net earnings from continuing operations		125.4			76.5			37.1			16.9			110.5
Loss from discontinued operations, net of income taxes and minority interest(2)(3)		(3.4	)		(6.0	)		(39.1	)		(17.0	)		(4.6	)
Net earnings (loss) before cumulative effect of change in accounting principle		122.0			70.5			(2.0	)		(0.1	)		105.9
Cumulative effect of change in accounting principle, net of income taxes and minority interest(4)		—			(4.1	)		—			—			—
Net earnings (loss)	$	122.0		$	66.4		$	(2.0	)	$	(0.1	)	$	105.9
Diluted earnings (loss) per share:
Earnings from continuing operations	$	1.87		$	1.13		$	0.55		$	0.25		$	1.62
Loss from discontinued operations		(0.05	)		(0.09	)		(0.58	)		(0.25	)		(0.07	)
Diluted earnings (loss) per share before cumulative effect of change in accounting principle		1.82			1.04			(0.03	)		—			1.55
Cumulative effect of change in accounting principle		—			(0.06	)		—			—			—
Diluted earnings (loss) per share	$	1.82		$	0.98		$	(0.03	)	$	—		$	1.55
Average shares outstanding — diluted		66,974			67,854			68,020			68,031			68,383
Balance Sheet Data:
Working capital	$	526.3		$	516.0		$	391.6		$	367.9		$	291.0
Property and equipment, net		421.2			385.1			421.2			423.5			408.1
Total assets		1,427.4			1,314.5			1,239.8			1,204.3			1,169.0
Total long-term debt(5)		202.1			204.6			204.6			203.7			223.9
Total equity(6)		700.1			652.0			595.0			604.4			595.1
Other Financial Data:
Capital expenditures	$	118.6		$	64.3		$	102.0		$	107.7		$	97.0
Present value of operating leases		1,011.9			945.7			1,018.2			979.8			918.4
Net retail sales growth, continuing operations		4.9	%		0.4	%		(0.2	)%		(2.7	)%		(0.3)	%
Same-store sales growth, continuing operations(7)		3.5	%		2.4	%		(0.8	)%		(3.3	)%		(2.6)	%
Return on equity, including discontinued operations		18.7	%		11.2	%		(0.3	)%		—	%		22.8	%
Return on net assets, including discontinued operations		12.3	%		9.9	%		4.4	%		4.4	%		14.8	%
Return on invested capital, continuing operations		14.5	%		10.3	%		5.8	%		4.6	%		15.0	%
Stores open (at year-end)		4,572			4,605			4,640			5,042			4,992

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(1)	All years include 52 weeks, except 2006, which includes 53 weeks. During 2003, we changed the reporting for our operations in the Central and South American Regions to use a December 31 year-end.
(2)	In 2006, 2005 and 2004, the restructuring activity relates to our decision to exit all Parade, Peru and Chile stores, as well as 264 Payless ShoeSource stores. We also eliminated approximately 200 management and administrative positions. In 2003 and 2002, the restructuring activity relates to changes in estimated net costs associated with the restructuring charge recorded in 2001 in connection with our decision to close certain domestic division offices, as well as approximately 100 under-performing stores.
(3)	During 2006, we exited retail operations in Japan and closed its one store location. The financial results for retail operations in Japan have been reflected as discontinued operations for all periods presented. In addition, as a result of the 2004 restructuring, the results of operations for Parade, Peru, Chile and 26 Payless closed stores are classified as discontinued operations for all periods presented.
(4)	As discussed in Note 20 “Change in Accounting Principle” under the Notes to Consolidated Financial Statements included in Item 8, “Financial Statements and Supplementary Data” of this Form 10-K, we adopted FASB Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations — An Interpretation of FASB Statement No. 143,” during the fourth quarter of 2005.
(5)	Excluded from total long-term debt for all periods are demand notes payable entered into to finance our subsidiaries in the Central American Region, which totaled $2.0 million at February 3, 2007. We maintain certificates of deposit, which totaled $2.0 million at February 3, 2007, in amounts equal to those demand notes, as compensating balances to collateralize those notes payable. The certificates of deposit are reflected as restricted cash in our consolidated balance sheets found elsewhere in this Form 10-K.
(6)	During 2002, 2003, 2004, 2005 and 2006, we repurchased $2.1 million (108 thousand shares), $1.7 million (117 thousand shares), $11.4 million (938 thousand shares), $71.2 million (3.3 million shares), and $129.3 million (5.0 million shares), respectively, of common stock under our stock repurchase programs and in connection with our employee stock purchase, deferred compensation and stock incentive plans.
(7)	Same-store sales are presented on a 52 week comparing basis for all years. Same-store sales are calculated on a weekly basis and exclude liquidation sales. If a store is open the entire week in each of the two years being compared, its sales are included in the same-store sales calculation for that week. Relocated and remodeled stores are also included in the same-store sales calculation if they were open during the entire week in each of the two years being compared. The same-store sales calculation excludes the South American and Central American Regions.
(8)	During 2006, we adopted the fair value recognition provisions of SFAS No 123(R), “Share-Based Payment.” See Note 2 “Share-Based Compensation” under the Notes to Consolidated Financial Statements included in Item 8, “Financial Statements and Supplementary Data” of this Form 10-K.

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

We are the largest specialty family footwear retailer by number of locations in the Western Hemisphere with retail stores in the United States, Canada, the Caribbean, and the Central and South American Regions. The Central American Region is composed of operations in Costa Rica, the Dominican Republic, El Salvador, Guatemala, Honduras, Nicaragua, Panama and Trinidad & Tobago. The South American Region is composed of operations in Ecuador. Our stores offer fashionable, quality, private label and branded footwear and accessories for women, men and children at affordable prices in a self-selection shopping format.

During 2006, we exited retail operations in Japan, closing our one store location. The financial information for our Japan retail operations has been classified as discontinued operations for all periods presented. During 2004, we substantially completed a series of strategic initiatives as part of a restructuring plan designed to sharpen our focus on our core business strategy, reduce expenses, accelerate decision-making, increase profitability, improve our operating margin and build value for stockholders over the long-term. The strategic initiatives included: 1) closing all Parade stores and related operations, 2) the sale of Chile and Peru entities, 3) closing of approximately 260 Payless ShoeSource stores, 4) ceasing wholesaling businesses with no significant growth opportunity, and 5) eliminating approximately 200 management and administrative positions. As a result of the restructuring, we have reflected the financial information of the Parade, Peru and Chile stores and 26 of the Payless closed stores as discontinued operations in the Consolidated Financial Statements. Unless otherwise noted, the amounts and discussions included in this Management’s Discussion and Analysis of Financial Condition and Results of Operations relate to continuing operations.

Fiscal year 2006 contains 53 weeks. For the fiscal year 2006, total sales increased 4.9% or $131.0 million, to $2.8 billion, over the prior year. Sales in the 53rd week of 2006 were $36.4 million. On a 52 week comparing basis, same-store sales increased 3.5%. We achieved positive same-store sales growth in all four quarters of the fiscal year 2006. During 2006, we sold approximately 2.4% less footwear units than the prior year, but our footwear average selling price per unit was approximately

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8.8% higher. Gross margin was 34.9% of sales in 2006, versus 33.3% in the prior year primarily due to more favorable initial mark-on. The combination of sales growth with solid margin improvement contributed to an improvement of $48.7 million in operating profit from continuing operations between years.

Our cash and cash equivalents balance at the end of 2006 was $371.4 million, a decrease of $6.8 million from 2005. Short-term investments at the end of 2006 were $90.0 million, an increase of $31.0 million from 2005. Total inventories at the end of 2006 were $361.9 million, an increase of $29.3 million from the prior year. The increase was primarily driven by the timing of receipts for the Easter holiday selling season and an increase in raw materials due to a higher percentage of products sourced directly by the Company. On a per store basis, store inventory was virtually flat comparing 2005 to 2006.

Our strategy is focused on four key elements: on-trend, targeted product; effective brand marketing; a great shopping experience; and efficient operations. Our mission is to become the first choice for style and value in footwear and accessories for our target consumers. Creating an emotional connection with our target consumers is central to our overall strategy.

By offering on-trend targeted product, we successfully build a connection with our customers. We interpret fashion trends timely and translate this into on-trend product in our stores through an extensive due diligence process. Beginning about a year in advance, we review key fashion markets in Europe and the U.S. We employ trend services and examine the industry’s ready-to-wear forecasts. Then, we test product. By doing so, we gain valuable intelligence well in advance of the seasons’ arrival. We refine our ideas, commit to a product assortment, and display that assortment in our stores at about the same time as other fashion-conscious higher-priced competitors. Customers demand on-trend products, but have different definitions of what that means. So we inspire possibilities for the classic woman, the fashion woman, for juniors, and for children. Importantly, we believe customers can be on-trend at a great value. Customers will always find segmented pricing at Payless with good-better-best price points. Through elements of promotion and pricing tiers, we plan to maintain market share with budget-oriented shoppers while driving the opportunity to increase market share with expressive customers. Customers believe Payless delivered greater value in 2006 versus 2005 in spite of higher 2006 average retails because, in large part, we offered more on-trend products.

The next component of our strategy is brand marketing effectiveness, and the development of a “House of Brands” architecture in our overall Payless brand positioning. We intend to build, license or buy appropriate aspirational brands to cover all of our major customer segments. As we continue to increase the proportion of branded footwear in our assortment, we will have more pricing flexibility to increase the average selling price per unit. On March 6, 2007, we entered into an agreement to acquire 100% of the partnership interest of Collective International, LP (“Collective”) for $91 million in cash, excluding transaction costs and subject to customary purchase price adjustments to reflect current assets and total liabilities at closing. Collective is a brand development, management and licensing company that currently licenses the Airwalk^® brand to us. This transaction closed on March 30, 2007. This transaction, combined with the acquisition of the American Eagle^TM brand, our designer partnerships with Laura Poretsky and Lela Rose, our direct-to-retail licensing agreement with Disney Enterprises, Inc., and our alliance with Exeter Brands Group LLC, a wholly-owned subsidiary of Nike, Inc., to launch a new brand of performance athletic shoes called Tailwind^®, are examples of this strategy that will continue to be implemented over a period of years. In June 2006, we officially launched the new Payless logo, which incorporates key design elements that leverage our heritage and communicate a “new and improved” Payless, a brand that is contemporary, fun, friendly and above all, stylish. The logo amplifies the new Payless brand essence . . . inspiring fun, fashion possibilities for the family. We use the new logo in all facets of marketing and communications, including television and print advertising, in stores, and online. All new stores feature the new logo on store fronts; current stores will receive new exterior signage concurrent with any remodel in a phased approach over time.

During 2006, we introduced two new store designs to improve our ability to showcase our merchandise, improve the in-store experience for our customers, and further support the Payless brand identity. The first design, known as “hot zone,” was the design for virtually all of our 2006 store openings. As of the end of fiscal 2006, we had 249 stores in this format. We anticipate about another 100 hot zones by year-end 2007. Fiscal 2006 also marked the launch of the new Payless “fashion lab” concept. This store format allows customers to shop by style first rather than size. It also incorporates several improvements to the store environment such as lighting, gondolas and sight lines. In 2007 we intend to open approximately 15 new fashion lab stores in highly productive fashion malls and central business districts. Overall, we intend to remodel approximately 500 stores to some degree in 2007. This is a key part of our strategy, but we plan to approach investing in new store formats thoughtfully, before committing meaningful capital resources.

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We are also creating a great shopping experience through improved store operations execution. Our passionate and skilled store teams offer friendly helpful service. Third party consumer research in 2006 showed that we are #2 in customer service among all footwear retailers, even though we are a self-service format. Our retail operations management coaches store teams to engage customers and execute the important operating details that are a necessary part of retail. By striking this balance of engagement and operational excellence, we delight customers with the kind of shopping experience they value.

The last major component of our strategy is improving the efficiency of our operations. We are reviewing all of the significant operational elements of our business model; whether that entails achieving more cost effective sourcing, improving the efficiency of our supply chain and physical distribution network, or identifying productivity improvements within the four walls of our stores. Where we can realize appropriate returns on capital, we will move quickly but prudently to enhance our overall return on invested capital. An example of this strategy is our recently announced plan to shift to a dual-distribution center model. The new model will allow us to more quickly deliver on-trend, targeted product to our stores and customers. We plan to open our West Coast distribution center in the summer of 2007, as well as another distribution center east of the Mississippi River in the summer of 2008. Once both new distribution centers are operating satisfactorily, we plan to close our current distribution center in Topeka, Kansas. Total exit costs related to the closing of the Topeka distribution center are currently estimated to be approximately $14 million, consisting of approximately $4 million of non-cash accelerated depreciation expenses, approximately $8 million for employee severance expenses, and approximately $2 million related to other exit costs. A portion of the employee severance expenses will be recognized in the first quarter of 2007. The majority of the remaining exit costs will be recognized over the period until the Topeka distribution center is closed. Actual results could vary from these estimates.

Investing in our business will remain a top priority. These investments will take place on a variety of levels. We are increasing the total amount of capital investments driven mostly by supply chain. We will continue to invest in all elements of our business that impact the customer experience, while ensuring that an efficient supporting infrastructure is in place.

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Review of Operations

The following discussion summarizes the significant factors affecting operating results for the fiscal years ended February 3, 2007 (2006), January 28, 2006 (2005), and January 29, 2005 (2004). Fiscal year 2006 contains 53 weeks of operating results compared to fiscal years 2005 and 2004 which contain 52 weeks. This discussion and analysis should be read in conjunction with the Consolidated Financial Statements and notes to the Consolidated Financial Statements. References to years relate to fiscal years rather than calendar years unless otherwise designated. Results for the past three years were as follows:

	53 Weeks Ended						52 Weeks Ended						52 Weeks Ended
(dollars in millions, except per share)	2006						2005						2004
				% of						% of						% of
				Sales						Sales						Sales
Net sales	$	2,796.7			100.0	%	$	2,665.7			100.0	%	$	2,656.2			100.0	%
Cost of sales		1,821.0			65.1			1,777.1			66.7			1,836.5			69.1
Gross margin		975.7			34.9			888.6			33.3			819.7			30.9
Selling, general and administrative expenses		808.5			28.9			767.1			28.8			730.0			27.5
Restructuring charges		0.8			—			3.8			0.1			24.9			0.9
Operating profit from continuing operations		166.4			6.0			117.7			4.4			64.8			2.5
Interest expense		19.2			0.7			19.7			0.7			22.1			0.8
Interest income		(22.7	)		(0.8	)		(12.3	)		(0.4	)		(5.3	)		(0.2	)
Earnings from continuing operations before income taxes and minority interest		169.9			6.1			110.3			4.1			48.0			1.9
Provision for income taxes(1)		39.9			23.5			30.8			27.9			13.2			27.5
Earnings from continuing operations before minority interest		130.0			4.6			79.5			3.0			34.8			1.3
Minority interest, net of income taxes		(4.6	)		(0.1	)		(3.0	)		(0.1	)		2.3			0.1
Net earnings from continuing operations		125.4			4.5			76.5			2.9			37.1			1.4
Loss from discontinued operations, net of income taxes and minority interest		(3.4	)		(0.1	)		(6.0	)		(0.3	)		(39.1	)		(1.5	)
Net earnings (loss) before cumulative effect of change in accounting principle		122.0			4.4			70.5			2.6			(2.0	)		(0.1	)
Cumulative effect of change in accounting principle, net of income taxes and minority interest		—			—			(4.1	)		(0.2	)		—			—
Net earnings (loss)	$	122.0			4.4	%	$	66.4			2.4	%	$	(2.0	)		(0.1)	%
Basic earnings (loss) per share:
Earnings from continuing operations	$	1.90					$	1.13					$	0.55
Loss from discontinued operations		(0.05	)					(0.09	)					(0.58	)
Basic earnings (loss) per share before cumulative effect of change in accounting principle		1.85						1.04						(0.03	)
Cumulative effect of change in accounting principle		—						(0.06	)					—
Basic earnings (loss) per share	$	1.85					$	0.98					$	(0.03	)
Diluted earnings (loss) per share:
Earnings from continuing operations	$	1.87					$	1.13					$	0.55
Loss from discontinued operations		(0.05	)					(0.09	)					(0.58	)
Diluted earnings (loss) per share before cumulative effect of change in accounting principle		1.82						1.04						(0.03	)
Cumulative effect of change in accounting principle		—						(0.06	)					—
Diluted earnings (loss) per share	$	1.82					$	0.98					$	(0.03	)
Return on sales from continuing operations		4.5	%					2.9	%					1.4	%
Return on equity, including discontinued operations(2)		18.7	%					11.2	%					(0.3	)%
Return on net assets, including discontinued operations(3)		12.3	%					9.9	%					4.4	%
Return on invested capital, continuing operations(4)		14.5	%					10.3	%					5.8	%

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(1)	Percent of sales columns for the provision for income taxes represents effective income tax rates.
(2)	Return on equity is computed as net earnings (loss), including discontinued operations, divided by beginning shareowners’ equity and measures our ability to invest shareowners’ funds profitably. The increase in return on equity from 2005 to 2006 and 2004 to 2005 is primarily due to an increase in net earnings.
(3)	Return on net assets is computed as pre-tax net earnings, including discontinued operations, plus net interest expense and the interest component of operating leases, divided by beginning of year net assets, including present value of operating leases (“PVOL”), and represents performance independent of capital structure. The increase in return on net assets from 2005 to 2006 and 2004 to 2005 is primarily due to an increase in net earnings.
(4)	Return on invested capital is computed as operating profit from continuing operations, adjusted for income taxes at the applicable effective rate, divided by the average amount of long-term debt and shareowners’ equity. The increase in return on invested capital from 2005 to 2006 and 2004 to 2005 is primarily due to an increase in operating profit from continuing operations.

Net Sales

Net sales are recognized at the time the sale is made to the customer, are net of estimated returns and current promotional discounts and exclude sales tax. Third-party liquidation sales related to restructuring are recognized at the time the sale is made to the customer, are calculated based upon contractually guaranteed amounts pursuant to our agreements with liquidators and are net of associated fees. Same-store sales are calculated on a weekly basis and exclude liquidation sales. If a store is open the entire week in each of the two years being compared, its sales are included in the same-store sales calculation for that week. Relocated and remodeled stores are also included in the same-store sales calculation if they were open during the entire week in each of the two years being compared.

Sales percent increases (decreases) are as follows:

	2006			2005			2004
Net sales		4.9	%		0.4	%		(0.2	)%
Same-store sales*		3.5			2.4			(0.8	)
Average selling price per unit		9.4			7.6			9.0
Unit volume		(4.1	)		(6.3	)		(9.1	)
Footwear average selling price per unit		8.8			4.6			6.6
Footwear unit volume		(2.4	)		(2.9	)		(7.0	)
Non-footwear average selling price per unit		2.9			12.2			16.4
Non-footwear unit volume		(10.3	)		(17.2	)		(15.0	)
*Calculated on a 52 week comparing basis

Net sales for fiscal 2006 totaled $2.80 billion. The impact of the additional week of sales in 2006 due to the 53^rd week was $36.4 million. On a 52 week comparing basis, net sales and same-store sales increased in 2006 from 2005 primarily due to positive sales performance across all segments of the women’s category and girl’s shoes, partially offset by weaker performance in accessories, boy’s shoes, men’s boots and men’s athletics.

Net sales for fiscal 2005 totaled $2.67 billion. During 2005, net sales and same-store sales increased over 2004 primarily due to positive sales performance in the women’s category (particularly in the casual and dress departments), and in the women’s athletics and children’s categories. Weaker categories during 2005 were men’s and accessories.

Cost of Sales

Cost of sales includes cost of merchandise sold and our buying and occupancy costs. Cost of sales was $1.82 billion in 2006 up 2.5% from $1.78 billion in 2005. As a percent of net sales, cost of sales was 65.1% in 2006, compared with 66.7% in 2005. The decrease in cost of sales as a percentage of net sales was due primarily to more favorable initial mark-ons relative to last year.

Cost of sales was $1.78 billion in 2005 compared with $1.84 billion in 2004, a 3.2% decrease. As a percent of net sales, cost of sales was 66.7% in 2005, compared with 69.1% in 2004. Cost of sales, as a percentage of sales, decreased primarily due to more favorable initial mark-ons relative to 2004.

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Selling, General and Administrative Expenses

In 2006, selling, general and administrative expenses were $808.5 million, an increase of 5.4% from $767.1 million in the 2005 period. Selling, general and administrative expenses as a percentage of net sales were 28.9% in 2006 compared with 28.8% in 2005. The increase, as a percentage of net sales, primarily reflects the result of 0.5 percentage points of additional costs for employee incentive programs (including a 0.3 percentage point increase related to the incremental impact of SFAS No. 123(R)), partially offset by a 0.5 percentage point reduction in payroll and related costs driven primarily by 2005 management transition costs that did not repeat in 2006.

Selling, general and administrative expenses were $767.1 million in 2005 compared with $730.0 million in 2004, a 5.1% increase. As a percent of net sales, selling, general and administrative expenses were 28.8% for 2005 compared with 27.5% in 2004. This increase, as a percentage of net sales, primarily reflected a 0.8 percentage point increase related to the cost of employee incentive programs, a 0.3 percentage point increase in advertising, and a 0.2 percentage point increase in professional services primarily related to our brand architecture and customer engagement training initiatives.

Restructuring Charges

Restructuring charges relate to strategic initiatives that were substantially completed in 2004. In 2006, we incurred pre-tax restructuring charges of $1.6 million relating to contract termination costs in excess of previous estimates. The $1.6 million pre-tax charge was comprised of $0.8 million relating to continuing operations and $0.8 relating to discontinued operations. In 2005, we incurred pre-tax restructuring charges of $9.7 million primarily relating to contract termination costs in excess of previous estimates and other exit costs associated with our strategic initiatives. The $9.7 million pre-tax charge was comprised of $3.8 million relating to continuing operations and $5.9 million relating to discontinued operations. The 2004 pre-tax restructuring charge of $67.9 million ($24.9 million related to continuing operations and $43.0 million related to discontinued operations) included $34.7 million for asset impairments and net disposal losses, $21.3 million for contract termination costs, $9.3 million for employee severance costs and $2.6 million for other exit costs. Employee severance costs included estimates regarding the amount of severance payments made to certain terminated associates, and contract termination costs included estimates regarding the length of time required to sublease vacant space and expected recovery rates. Actual results could vary from these estimates.

The significant components of the restructuring charge incurred as of February 3, 2007, are summarized as follows:

	Total Charges		Accrual Balance as of		Accrual		Cash			Accrual Balance as of
(dollars in millions)	to Date		January 28, 2006		Adjustments		Payments			February 3, 2007
Employee severance costs	$	9.0	$	1.0	$	—	$	(0.8	)	$	0.2
Contract termination costs		30.1		5.5		1.6		(4.3	)		2.8
Other exit costs		5.1		—		—		—			—
		44.2	$	6.5	$	1.6	$	(5.1	)	$	3.0
Asset impairments and net disposal losses		35.0
Total Charges	$	79.2

Interest (Income) Expense

Interest income and expense components were:

(dollars in millions)	2006			2005			2004
Interest expense	$	19.2		$	19.7		$	22.1
Interest income		(22.7	)		(12.3	)		(5.3	)
Interest (income) expense, net	$	(3.5	)	$	7.4		$	16.8

Interest expense decrease in 2006 is due primarily to a reduction of debt. Interest income increased in 2006 due primarily to an increase in invested balances and increased yield.

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The decrease in 2005 interest expense was a result of an average lower notes payable balance throughout 2005 versus 2004. The increase in 2005 interest income was a result of increased cash and short-term investment balances over 2004 and an increase in the rate of return earned on available funds. This was offset by a decrease in interest earned on certificates of deposit maintained to collateralize notes payable.

Income Taxes

The effective tax rate from continuing operations was 23.50% in 2006 versus 27.90% in 2005 and 27.50% in 2004.

Our effective tax rates have differed from the U.S. statutory rate principally due to the impact of our operations conducted in jurisdictions with rates different than the U.S. statutory rate, the benefit of jurisdictional tax credits, favorable adjustments to our income tax reserves due primarily to favorable settlements of examinations by taxing authorities, the impact of repatriating earnings from offshore and the on-going implementation of tax efficient business initiatives. See Note 8 of our Consolidated Financial Statements for more information detailing the relative impact of these items on our tax rate on a comparative basis.

The amount of income taxes we pay is subject to ongoing audits by federal, state and foreign tax authorities, which often result in proposed assessments. Our estimate for the potential outcome for any uncertain tax issue is often highly judgmental. Our future results may include favorable or unfavorable adjustments to our estimated tax liabilities in the periods in which assessments are made or resolved or when statutes of limitation on potential assessments expire. During 2006, 2005, and 2004, adjustments to our prior year estimates have favorably impacted our effective tax rates. The favorable impact of the adjustment is more significant in 2006 relative to 2005 and 2004.

At February 3, 2007, deferred tax assets for state and foreign net operating loss carryforwards are $8.5 million, less a valuation allowance of $1.9 million. The net operating losses related to recorded assets will expire as follows: $0.4 million in 2007 through 2009, $0.2 million in 2008 through 2009, $2.2 million in 2010 through 2011, and $3.8 million by 2024. In addition, state income tax credit carryforwards are $8.1 million, less a valuation allowance of $4.7 million. The remaining valuation allowance relates to other deferred tax assets in a Latin American country that does not have a history of earnings. The state tax credit carryforwards related to the recorded assets expire as follows: $1.0 million by 2013, and $2.4 million may be carried forward indefinitely.

The American Jobs Creation Act of 2004, enacted on October 22, 2004 (the “Jobs Act”), provided for a temporary 85% dividends received deduction on certain foreign earnings repatriated during a one-year period. To qualify for the deduction, the earnings must be reinvested in the U.S. pursuant to a domestic reinvestment plan established by a company’s Chief Executive Officer and approved by its Board of Directors. Certain other criteria in the Jobs Act must be satisfied as well. During 2005, our Chief Executive Officer established domestic reinvestment plans which were approved by the Board of Directors. Pursuant to the plans, we repatriated $85.0 million from foreign subsidiaries during 2005. The repatriation resulted in recognition of income tax expense of $3.7 million, for which we provided $2.3 million in 2004 and $1.4 million in 2005. At the close of 2006, we have not provided tax on our cumulative undistributed earnings of foreign subsidiaries of approximately $50 million, because it is our intention to reinvest these earnings indefinitely. The calculation of the unrecognized deferred tax liability related to these earnings is complex and is not practicable. If earnings were distributed, we would be subject to U.S. taxes and withholding taxes payable to various foreign governments. Based on the facts and circumstances at that time, we would determine whether a credit for foreign taxes already paid would be available to reduce or offset the U.S. tax liability. We anticipate that earnings would not be repatriated unless it was tax efficient to do so.

Impact of Inflation

Inflation did not have a material impact on our net sales growth or net earnings (loss) for the three years in the period ended February 3, 2007.

Minority Interest, Net of Income Taxes

Minority interest represents our joint venture partners’ share of net earnings or losses on applicable international operations. The increase in minority interest expense from 2005 to 2006 and 2004 to 2005 is due to increased earnings from our joint ventures.

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Discontinued Operations

During 2006, we committed to a plan to exit retail operations in Japan and close our one store location. As of February 3, 2007, we are substantially complete with the exit process, and total exit costs were $1.8 million, before income taxes and minority interest. Discontinued operations include all Parade, Chile, and Peru stores, as well as 26 Payless stores in North America and Japan retail operations. The decrease in loss from discontinued operations from 2004 to 2005 is primarily due to the fact that our decision to exit Parade, Peru, Chile and 26 Payless stores in North America occurred in 2004 which is also when a majority of the exit costs where incurred.

International Segment Operating Results

Our international segment includes retail operations in Canada, the Central and South American Regions, Puerto Rico and the U.S. Virgin Islands. The following table summarizes the operating results of the international segment:

(dollars in millions)	2006		2005		2004
Revenues from external customers	$	401.5	$	359.7	$	329.7
Operating profit from continuing operations		50.5		34.3		11.3

In general, gross margin percentages in our international segment exceed those in the domestic segment due to greater initial mark-on. Also, as a percent of revenue, our selling, general and administrative expenses in the international segment are lower than in the domestic segment primarily due to lower payroll-related expenses. Therefore, as a percentage of revenue, operating profits in our international segment exceed those in our domestic segment.

The increase in operating profit from continuing operations from 2005 to 2006 is primarily due to increased sales and improved gross margin percentages in Canada and Latin America, partially offset by reduced net sales and increased selling, general and administrative expenses in Puerto Rico. The increase in operating profit from continuing operations from 2004 to 2005 is primarily due to increased net sales and improved gross margin percentages in Latin America.

Store Activity

During 2006, we had a net decrease of 33 stores (63 openings and 96 closings). We also relocated 106 stores. As of February 3, 2007, store count was 4,572 stores, including 3,986 stores in the domestic United States, 315 stores in Canada, 88 stores in Puerto Rico and U.S. Virgin Islands, 152 stores in the Central American region and 31 stores in the South American region.

Our store activity plan for fiscal year 2007 includes a net decrease of approximately 10 stores. This includes approximately 60 new stores and 70 store closings. We also intend to relocate approximately 60 stores. The current plan for 2007 through 2009 will not materially increase or decrease the net number of Payless ShoeSource stores. We review our store activity plan at least on an annual basis.

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Liquidity and Capital Resources

We ended 2006 with a cash and cash equivalents balance of $371.4 million, a decrease of $6.8 million from 2005, and short-term investments of $90.0 million, an increase of $31.0 million over 2005. Internally generated cash flow from operations is expected to continue to be the most important component of our capital resources. Sources and (uses) of cash are summarized below:

(dollars in millions)	2006			2005			2004
Net earnings (loss)	$	122.0		$	66.4		$	(2.0	)
Non-cash component of restructuring charges		—			—			10.8
Working capital (increases) decreases		(17.5	)		30.0			103.2
Other operating activities		36.7			40.1			48.9
Depreciation and amortization		88.5			90.4			94.6
Cash flow provided by operating activities		229.7			226.9			255.5
Payments for capital expenditures		(118.6	)		(64.3	)		(102.0	)
Net purchases of investments		(27.4	)		(36.4	)		(11.3	)
Other investing activities		(10.9	)		2.1			30.0
Cash flow used in investing activities		(156.9	)		(98.6	)		(83.3	)
Net purchases of common stock		(82.2	)		(21.6	)		(9.8	)
Net payments of debt and deferred financing costs		(3.0	)		(1.3	)		(29.8	)
Distributions to minority owners		(1.5	)		—			—
Contributions from minority owners		—			—			2.1
Other financing activities		9.2			0.9			1.6
Cash flow used in financing activities		(77.5	)		(22.0	)		(35.9	)
Effect of exchange rate changes on cash		(2.1	)		0.9			(2.0	)
(Decrease) increase in cash and cash equivalents	$	(6.8	)	$	107.2		$	134.3

Cash Flow Provided by Operating Activities

Cash flow from operations was $229.7 million in 2006 compared with $226.9 million in 2005 and $255.5 million in 2004. The significant changes in cash flow from operations from 2006 compared with 2005 are due to increases in net earnings, offset by a change in inventory. The significant changes in cash flow from operations in 2005 as compared to 2004 were due to changes in accrued expenses, accounts payable and inventory, offset by an increase in net earnings.

Cash Flow Used in Investing Activities

In 2006, our capital expenditures totaled $118.6 million including $45.6 million for new and relocated stores, $35.6 million to remodel existing stores, $19.3 million for information technology hardware and systems development, $4.2 million for costs associated with the West Coast distribution center and $13.9 million for other necessary improvements. We also spent $15.5 million on the acquisition of intangible assets in 2006. We expect that cash paid for capital expenditures during 2007 will be approximately $160.0 million. We intend to use internal cash flow and available financing from our $200 million revolving credit agreement to finance all of these expenditures.

Cash Flow Used in Financing Activities

The Company has made the following common stock repurchases:

(dollars in millions, shares in thousands)	2006				2005				2004
	Dollars		Shares		Dollars		Shares		Dollars		Shares
Stock repurchase program	$	128.4		4,960	$	70.4		3,234	$	10.1		839
Employee stock purchase, deferred compensation and stock incentive plans		0.9		34		0.8		45		1.3		99
	$	129.3		4,994	$	71.2		3,279	$	11.4		938

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Under the indenture governing our 8.25% Senior Subordinated Notes, we may repurchase approximately an additional $12.4 million of common stock. This limit may increase or decrease based upon our net earnings. As of February 3, 2007, we had approximately $39.3 million of remaining common stock repurchase authorization from our Board of Directors. On March 2, 2007, our Board of Directors authorized an aggregate of $250 million of share repurchases.

We maintain a $200 million senior secured revolving credit facility (the “Facility”). Funds borrowed under the Facility are secured by domestic merchandise inventory and receivables. In April 2006, we entered into our first Amendment to the Facility. Among other things, the amendment extends the term of the Facility until January 15, 2011, allows us to increase the maximum borrowing amount up to $250 million from $200 million prior to the expiration of the Facility, and decreases the quarterly commitment fee payable on the unborrowed balance from 0.30% to 0.25%. The Facility bears interest at the London Inter-bank Offered Rate (“LIBOR”), plus a variable margin of 1.0% to 1.5%, or the base rate as defined in the agreement governing the Facility, based upon certain borrowing levels. The variable interest rate including the applicable variable margin at February 3, 2007, was 6.37%. A quarterly commitment fee of 0.25% per annum is payable on the unborrowed balance. No amounts were drawn on the Facility as of February 3, 2007. Based on our current borrowing base, we may borrow up to $187.1 million under our Facility, less $30.4 million in outstanding letters of credit as of February 3, 2007.

In July 2003, we sold $200.0 million of 8.25% Senior Subordinated Notes (the “Notes”) for $196.7 million, due 2013. The discount of $3.3 million is being amortized to interest expense over the life of the Notes. The Notes are guaranteed by all of our domestic subsidiaries. Interest on the Notes is payable semi-annually. The Notes contain various covenants including those that may limit our ability to pay dividends, repurchase stock, accelerate the retirement of other subordinated debt or make certain investments. As of February 3, 2007, we are in compliance with all covenants. As of February 3, 2007, the fair value of the Notes is $207.0 million based on recent trading activity of the Notes. On or after August 1, 2008, we may, on any one or more occasions, redeem all or a part of the Notes at the redemption prices set forth below, plus accrued and unpaid interest, if any, on the Notes redeemed, to the applicable redemption date:

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

We have entered into $2.0 million of demand notes payable to efficiently finance our subsidiaries in the Central American Region. We maintain cash balances of $2.0 million in certificates of deposit as compensating balances to collateralize these notes payable. The notes payable accrue interest at a weighted average of 6.75%. The certificates of deposit earn interest at a weighted average of 6.00% and are reflected as restricted cash in the accompanying consolidated balance sheet. During 2005, we repaid $1.0 million of the $3.0 million balance outstanding as of the end of 2004.

Financial Commitments

As of February 3, 2007, no amounts were drawn against the $187.1 million borrowing base available under the $200.0 million Facility. However, the $187.1 million borrowing base available under the Facility is reduced by $30.4 million in outstanding letters of credit.

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Our financial commitments as of February 3, 2007, are described below:

	Payments due by Period
			Less than						More than
(dollars in millions)	Total		One Year		1-3 Years		3-5 Years		Five Years
Senior subordinated notes (including unamortized discount)	$	200.0	$	—	$	—	$	—	$	200.0
Capital lease obligations (including interest)		0.5		0.4		0.1		—		—
Operating lease obligations		1,233.5		254.4		417.5		286.6		275.0
Interest on notes payable and long-term debt		107.7		16.6		25.0		41.3		24.8
Royalty obligations		46.7		9.7		18.2		6.4		12.4
Equipment purchases		18.3		18.3		—		—		—
Intangible asset obligations		10.0		3.0		7.0		—		—
Service agreement obligations		10.1		5.7		3.6		0.8		—
Employment agreement obligations		3.1		2.7		0.4		—		—
Employee severance		2.5		1.7		0.8		—		—
Other long-term debt		4.0		—		4.0		—		—
	$	1,636.4	$	312.5	$	476.6	$	335.1	$	512.2

We lease substantially all of our stores and are committed to making lease payments over varying lease terms. The operating lease obligations presented above represent the total lease obligations due to landlords, including obligations related to closed stores as well as our obligations related to leases that we have sublet. In instances where failure to exercise renewal options would result in an economic penalty, the calculation of lease obligations includes renewal option periods. Our royalty obligations consist of minimum royalty payments for the purchase of branded merchandise. Our equipment purchases consist of equipment purchased for our new distribution facility in Redlands, California. Our intangible asset obligations include payments for trademarks we have purchased. Our service agreement obligations consist of minimum payments for services that we cannot avoid without penalty. Our employment agreement obligations consist of minimum payments to certain of our executives. Employee severance obligations consist of contractually-specified payments associated with our restructuring initiatives and management transition.

Amounts not reflected in the table above:

• We issue cancelable purchase orders to various vendors for the purchase of our merchandise. As of February 3, 2007, we had merchandise purchase obligations in the amount of approximately $193 million for which we will likely take delivery.

• As previously discussed, we have demand notes payable of $2.0 million to efficiently finance our subsidiaries in the Central American Region.

We believe that our liquid assets, cash generated from operations and the Facility will provide us with sufficient funds for capital expenditures, repurchases of our common stock and other operating activities for the next twelve months and thereafter for the foreseeable future.

Financial Condition Ratios

The debt-to-capitalization ratio was 22.6%, 24.0%, and 25.9% for 2006, 2005 and 2004, respectively. The 2006 debt-to-capitalization ratio decreased primarily due to the increase in net earnings, partially offset by a reduction in equity due to repurchase of common stock. For purposes of the debt-to-capitalization ratio, total debt is long-term debt including current maturities, notes payable and borrowings under the revolving line of credit. Capitalization is defined as total debt and shareowners’ equity. The debt-to-capitalization ratio, including the present value of future minimum rental payments under operating leases (including certain option periods where failure to exercise such options would result in an economic penalty) as debt and as capitalization, would be 63.5%, 63.8% and 67.3% in 2006, 2005 and 2004, respectively.

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Critical Accounting Policies

Management’s Discussion and Analysis of Financial Condition and Results of Operations are based upon our Consolidated Financial Statements, which were prepared in accordance with accounting principles generally accepted in the United States of America. These principles require us to make estimates and assumptions that affect the reported amounts in the Consolidated Financial Statements and notes thereto. Actual results may differ from these estimates, and such differences may be material to the Consolidated Financial Statements. We believe that the following critical accounting policies involve a higher degree of judgment or complexity. See the Notes to our Consolidated Financial Statements for a complete discussion of our significant accounting policies.

Inventories

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

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

Property and Equipment

Property and equipment are recorded at cost and depreciated on a straight-line basis over their estimated useful lives. The costs of repairs and maintenance are expensed when incurred, while expenditures for store remodels, refurbishments and improvements that significantly add to the product capacity or extend the useful life of an asset are capitalized. Projects in progress are stated at cost, which includes the cost of construction and other direct costs attributable to the project. No provision for depreciation is made on projects in progress until such time as the relevant assets are completed and put into service.

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

Rent Expense

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

Insurance Programs

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

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

Accounting for Taxes

We are routinely under audit by the United States federal, state, local and foreign tax authorities in the areas of income taxes and sales and use taxes. In evaluating the potential exposures associated with our various tax filings, we accrue charges for exposures. Based upon our quarterly evaluations of tax positions, we believe we have appropriately filed our tax returns and accrued for potential exposures. To the extent we prevail in income tax matters for which accruals have been established or we are required to pay amounts in excess of reserves, our effective income tax rate in a given financial period might be impacted. We have various domestic and foreign tax examinations currently in process.

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

Asset Retirement Obligations

We follow FASB Interpretation No. 47 (“FIN 47”), “Accounting for Conditional Asset Retirement Obligations – An Interpretation of FASB Statement No. 143,” which requires entities to record a liability equal to the fair value of the estimated future cost to retire an asset, if the liability’s fair value can be reasonably estimated. Our asset retirement obligation (“ARO”) liabilities are primarily associated with our personal property and trade fixtures which, at the end of a lease, we are contractually obligated to remove in order to restore the facility back to a condition specified in the lease agreement. We estimate the fair value of these liabilities based on current store closing costs and discount the removal costs back as if they were to be performed at the inception of the lease. At the inception of such a lease, we record the ARO as a liability and also record a related asset in an amount equal to the estimated fair value of the liability. The capitalized asset is then depreciated on a straight-line basis over the useful life of the asset. Upon retirement of the asset, any difference between the actual retirement costs incurred and the previously recorded estimated ARO liability is recognized as a gain or loss in the consolidated statement of earnings (loss).

In future periods, we may make adjustments to the ARO liability as a result of the availability of new information, changes in labor costs and other factors. The estimate of the ARO liability is based on a number of assumptions requiring professional judgment, and we cannot predict what revisions to these assumptions will be required in future periods.

We adopted FIN 47 during the fourth quarter of 2005. The initial adoption resulted in a charge of $4.1 million (net of income taxes and minority interest), which was recorded as a cumulative effect of a change in accounting principle. The adoption increased net property and equipment by $1.7 million, increased asset retirement obligations by $8.5 million, and increased deferred tax assets by $2.7 million.

Share-based Compensation

We account for share-based awards in accordance with SFAS No. 123(R), “Share-Based Payment” (“SFAS No. 123(R)”). As required by SFAS No. 123(R), share-based compensation is estimated for equity awards at fair value at the grant date. We determine the fair value of equity awards using a binomial model. The binomial model requires various highly judgmental assumptions including the expected life, stock price volatility and the forfeiture rate. If any of the assumptions used in the model change significantly, share-based compensation expense may differ materially in the future from that recorded in the current period.

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New Accounting Standards

In February 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments – an amendment of SFAS No. 133 and 140.” This Statement simplifies accounting for certain hybrid financial instruments, eliminates the interim guidance in Statement 133 Implementation Issue No. D1, “Application of Statement 133 to Beneficial Interest in Securitized Financial Assets,” and eliminates a restriction of the passive derivative instruments that a qualifying special-purpose entity may hold. The Statement is effective for fiscal years beginning after September 15, 2006. The adoption of this Statement is not anticipated to have a material impact on our Consolidated Financial Statements.

In March 2006, the Emerging Issues Task Force (“EITF”) issued EITF Issue 06-3, “How Taxes Collected From Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement.” A consensus was reached that entities may adopt a policy of presenting sales taxes in the income statement on either a gross or net basis. If taxes are significant, an entity should disclose its policy of presenting taxes and the amounts of taxes. The guidance is effective for periods beginning after December 15, 2006. In the consolidated statement of earnings, we present sales net of such taxes within the scope of EITF Issue 06-3. Other than the additional required disclosure, this EITF will not have an impact on our Consolidated Financial Statements.

In June 2006, the Financial Accounting Standards Board issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FAS 109, Accounting for Income Taxes” (“FIN 48”), to create a single model to address accounting for uncertainty in tax positions. FIN 48 clarifies the accounting for income taxes, by prescribing a minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. We will adopt FIN 48 in the first fiscal quarter of 2007, as required, and the cumulative effect of adopting FIN 48 will be recorded in retained earnings. We are in the process of evaluating FIN 48’s impact on our Consolidated Financial Statements.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” This statement defines fair value, establishes a framework for using fair value to measure assets and liabilities, and expands disclosures about fair value measurements. The statement applies whenever other standards require or permit assets or liabilities to be measured at fair value. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. We are evaluating the impact the adoption of SFAS No. 157 will have on our Consolidated Financial Statements.

In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans – An Amendment of FASB Statements No. 87, 88, 106, and 132(R).” This statement requires companies to recognize a net liability or asset and an offsetting adjustment to accumulated other comprehensive income to report the funded status of defined benefit pension and other postretirement benefit plans. The statement requires prospective application, and the recognition and disclosure requirements are effective for companies with fiscal years ending after December 15, 2006. Additionally, SFAS No. 158 requires companies to measure plan assets and obligations at their year-end balance sheet date. This requirement is effective for fiscal years ending after December 15, 2008. We adopted SFAS No. 158 effective February 3, 2007. Please refer to Note 7 of our Consolidated Financial Statements for further discussion related to the adoption of this Statement.

In September 2006, the SEC issued Staff Accounting Bulletin (“SAB”) No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements,” which provides interpretive guidance regarding the consideration given to prior year misstatements when determining materiality in current year financial statements. SAB No. 108 is effective for fiscal years ending after November 15, 2006. The impact of this adoption was not material to our Consolidated Financial Statements.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Liabilities.” This statement permits entities to choose to measure many financial instruments and certain other items at fair value. If the fair value option is elected, unrealized gains and losses will be recognized in earnings at each subsequent reporting date. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. We are currently evaluating the impact of this adoption on our Consolidated Financial Statements.

35

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest Rate Risk

Interest on our senior secured revolving credit facility, which is entirely comprised of a revolving line of credit, is based on the London Inter-Bank Offered Rate (“LIBOR”) plus a variable margin of 1.0% to 1.5%, or the base rate, as defined in the credit agreement. There are no outstanding borrowings on the revolving line of credit at February 3, 2007; however, if we were to borrow against our revolving line of credit, borrowing costs may fluctuate depending upon the volatility of LIBOR.

Foreign Currency Risk

We have retail operations in foreign countries; therefore, our cash flows in U.S. dollars are impacted by fluctuations in foreign currency exchange rates. We adjust our retail prices, when possible; to reflect changes in exchange rates to mitigate this risk. To further mitigate this risk, we may, from time to time, enter into forward contracts to purchase or sell foreign currencies. For the fiscal years ended February 3, 2007, January 28, 2006, and January 29, 2005, fluctuations in foreign currency exchange rates did not have a material impact on our operations or cash flows and we did not enter into any forward contracts to purchase or sell foreign currencies.

In 2006, approximately 96% of our footwear, based on cost, was sourced from the People’s Republic of China (the “PRC”). The national currency of the PRC, the Yuan, is currently not a freely convertible currency. The value of the Yuan depends to a large extent on the PRC government’s policies and upon the PRC’s domestic and international economic and political developments. Since 1994, the official exchange rate for the conversion of the PRC’s currency was pegged to the U.S. dollar at a virtually fixed rate of approximately 8.28 Yuan per U.S. dollar. However, on July 21, 2005, the PRC’s government revalued the Yuan by 2.1%, setting the exchange rate at 8.11 Yuan per U.S. dollar, and adopted a more flexible system based on a trade-weighted basket of foreign currencies of the PRC’s main trading partners. Under the new “managed float” policy, the exchange rate of the Yuan may shift each day up to 0.3% in either direction from the previous day’s close, and as a result, the valuation of the Yuan may increase incrementally over time should the PRC central bank allow it to do so, which could significantly increase the cost of the products we source from the PRC. As of February 2, 2007, the last day of trading in our fiscal year, the exchange rate was 7.75 Yuan per U.S. dollar.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

	Page
Report of Management		37
Management’s Annual Report on Internal Control over Financial Reporting		37
Reports of Deloitte & Touche LLP, Independent Registered Public Accounting Firm		38
Consolidated Statements of Earnings (Loss)		40
Consolidated Balance Sheets		41
Consolidated Statements of Shareowners’ Equity and Comprehensive Income		42
Consolidated Statements of Cash Flows		44
Notes to Consolidated Financial Statements		45

36

Report of Management

Management is responsible for the preparation, integrity and objectivity of the financial information included in this annual report. The financial statements have been prepared in conformity with accounting principles generally accepted in the United States applied on a consistent basis.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts. Although the financial statements reflect all available information and management’s judgment and estimates of current conditions and circumstances, and are prepared with the assistance of specialists within and outside the Company, actual results could differ from those estimates.

Management has established and maintains an internal control structure to provide reasonable assurance that assets are safeguarded against loss from unauthorized use or disposition that the accounting records provide a reliable basis for the preparation of financial statements, and that such financial statements are not misstated due to material fraud or error. Internal controls include the careful selection of associates, the proper segregation of duties and the communication and application of formal policies and procedures that are consistent with high standards of accounting and administrative practices. An important element of this system is a comprehensive internal audit and loss prevention program.

Management continually reviews, modifies and improves its systems of accounting and controls in response to changes in business conditions and operations and in response to recommendations in the reports prepared by the independent registered public accounting firm and internal auditors.

Management believes that it is essential for the Company to conduct its business affairs in accordance with the highest ethical standards and in conformity with the law. This standard is described in the Company’s policies on business conduct, which are publicized throughout the Company.

Audit and Finance Committee of the Board of Directors

The Board of Directors, through the activities of its Audit and Finance Committee (the “Committee”), participates in the reporting of financial information by the Company. The Committee meets regularly with management, the internal auditors and the independent registered public accounting firm. The Committee reviewed the scope, timing and fees for the annual audit and the results of the audit examinations completed by the internal auditors and independent registered public accounting firm, including the recommendations to improve certain internal controls and the follow-up reports prepared by management. The independent registered public accounting firm and internal auditors have free access to the Committee and the Board of Directors and attend each regularly scheduled Committee meeting.

The Committee consists of six outside directors all of whom have accounting or financial management expertise. The members of the Committee are Daniel Boggan Jr., Howard R. Fricke, Robert F. Moran, Michael E. Murphy, John F. McGovern and David Scott Olivet. The Audit and Finance Committee regularly reports the results of its activities to the full Board of Directors.

Management’s Annual Report on Internal Control Over Financial Reporting

The management of Payless ShoeSource, Inc. is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. With the participation of the Chief Executive Officer and the Chief Financial Officer, our management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework and criteria established in Internal Control — Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, our management has concluded that our internal control over financial reporting was effective as of February 3, 2007.

Payless ShoeSource, Inc.’s independent registered public accounting firm, Deloitte & Touche LLP, has issued an audit report dated March 30, 2007 on our management’s assessment of our internal control over financial reporting.

/s/ Matthew E. Rubel	/s/ Ullrich E. Porzig
Chief Executive Officer and President	Senior Vice President — Chief Financial Officer and Treasurer

37

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Shareowners of
Payless ShoeSource, Inc.
Topeka, Kansas

We have audited management’s assessment, included in the accompanying Management’s Annual Report on Internal Control Over Financial Reporting, that Payless ShoeSource, Inc. and subsidiaries (the “Company”) maintained effective internal control over financial reporting as of February 3, 2007, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.

A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, management’s assessment that the Company maintained effective internal control over financial reporting as of February 3, 2007, is fairly stated, in all material respects, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of February 3, 2007, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements and financial statement schedule as of and for the year ended February 3, 2007 of the Company and our report dated March 30, 2007 expressed an unqualified opinion on those financial statements and financial statement schedule and included an explanatory paragraph regarding the change in accounting for stock-based compensation upon adoption of Statement of Financial Accounting Standards No. 123(R), “Share-Based Payment” and change in accounting for pension and other postretirement benefits upon adoption of Statement of Financial Accounting Standards No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans – An Amendment of Financial Accounting Standards Board Statements No. 87, 88, 106, and 132(R).”

DELOITTE & TOUCHE LLP

Kansas City, Missouri
March 30, 2007

38

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Shareowners of
Payless ShoeSource, Inc.
Topeka, Kansas

We have audited the accompanying consolidated balance sheets of Payless ShoeSource, Inc. and subsidiaries (the “Company”) as of February 3, 2007 and January 28, 2006, and the related consolidated statements of income, shareowners’ equity and comprehensive income, and cash flows for each of the three fiscal years in the period ended February 3, 2007. Our audits also included the financial statement schedule listed in the Index at Item 15. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Payless ShoeSource, Inc. and subsidiaries as of February 3, 2007 and January 28, 2006, and the results of their operations and their cash flows for each of the three fiscal years in the period ended February 3, 2007, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

As discussed in Note 2 to the consolidated financial statements, the Company changed its method of accounting for stock-based compensation upon adoption of Statement of Financial Accounting Standards No. 123(R), “Share-Based Payment” and as discussed in Note 7 to the consolidated financial statements, the Company changed its method of accounting for pension and other postretirement benefits upon adoption of Statement of Financial Accounting Standards No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans – An Amendment of Financial Accounting Standards Board Statements No. 87, 88, 106, and 132(R).”

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of February 3, 2007, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 30, 2007 expressed an unqualified opinion on management’s assessment of the effectiveness of the Company’s internal control over financial reporting and an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

DELOITTE & TOUCHE LLP

Kansas City, Missouri
March 30, 2007

39

PAYLESS SHOESOURCE, INC.

CONSOLIDATED STATEMENTS OF EARNINGS (LOSS)
(dollars in millions, except per share)

	53 Weeks Ended			52 Weeks Ended			52 Weeks Ended
	February 3, 2007			January 28, 2006			January 29, 2005
Net sales	$	2,796.7		$	2,665.7		$	2,656.2
Cost of sales		1,821.0			1,777.1			1,836.5
Gross margin		975.7			888.6			819.7
Selling, general and administrative expenses		808.5			767.1			730.0
Restructuring charges		0.8			3.8			24.9
Operating profit from continuing operations		166.4			117.7			64.8
Interest expense		19.2			19.7			22.1
Interest income		(22.7	)		(12.3	)		(5.3	)
Earnings from continuing operations before income taxes and minority interest		169.9			110.3			48.0
Provision for income taxes		39.9			30.8			13.2
Earnings from continuing operations before minority interest		130.0			79.5			34.8
Minority interest, net of income taxes		(4.6	)		(3.0	)		2.3
Net earnings from continuing operations		125.4			76.5			37.1
Loss from discontinued operations, net of income taxes and minority interest		(3.4	)		(6.0	)		(39.1	)
Net earnings (loss) before cumulative effect of change in accounting principle		122.0			70.5			(2.0	)
Cumulative effect of change in accounting principle, net of income taxes and minority interest		—			(4.1	)		—
Net earnings (loss)	$	122.0		$	66.4		$	(2.0	)
Basic earnings (loss) per share:
Earnings from continuing operations	$	1.90		$	1.13		$	0.55
Loss from discontinued operations		(0.05	)		(0.09	)		(0.58	)
Basic earnings (loss) per share before cumulative effect of change in accounting principle		1.85			1.04			(0.03	)
Cumulative effect of change in accounting principle		—			(0.06	)		—
Basic earnings (loss) per share	$	1.85		$	0.98		$	(0.03	)
Diluted earnings (loss) per share:
Earnings from continuing operations	$	1.87		$	1.13		$	0.55
Loss from discontinued operations		(0.05	)		(0.09	)		(0.58	)
Diluted earnings (loss) per share before cumulative effect of change in accounting principle		1.82			1.04			(0.03	)
Cumulative effect of change in accounting principle		—			(0.06	)		—
Diluted earnings (loss) per share	$	1.82		$	0.98		$	(0.03	)

See Notes to Consolidated Financial Statements

40

PAYLESS SHOESOURCE, INC.

CONSOLIDATED BALANCE SHEETS
(dollars in millions)

	February 3,			January 28,
	2007			2006
ASSETS
Current Assets:
Cash and cash equivalents	$	371.4		$	378.2
Short-term investments		90.0			59.0
Restricted cash		2.0			2.0
Inventories		361.9			332.6
Current deferred income taxes		15.6			20.2
Prepaid expenses		46.5			39.4
Other current assets		18.1			20.2
Current assets of discontinued operations		1.1			2.9
Total current assets		906.6			854.5
Property and Equipment:
Land		6.6			7.7
Property, buildings and equipment		1,245.1			1,185.2
Accumulated depreciation and amortization		(830.5	)		(807.8	)
Property and equipment, net		421.2			385.1
Favorable leases, net		12.8			18.2
Deferred income taxes		37.7			27.5
Goodwill		5.9			5.9
Other assets		43.2			21.9
Noncurrent assets of discontinued operations		—			1.4
Total Assets	$	1,427.4		$	1,314.5
LIABILITIES AND SHAREOWNERS’ EQUITY
Current Liabilities:
Current maturities of long-term debt	$	0.4		$	0.4
Notes payable		2.0			2.0
Accounts payable		185.6			168.6
Accrued expenses		190.2			163.5
Current liabilities of discontinued operations		2.1			4.0
Total current liabilities		380.3			338.5
Long-term debt		201.7			204.2
Other liabilities		132.6			109.3
Minority interest		12.7			10.5
Commitments and contingencies (Note 16)
Shareowners’ Equity:
Preferred stock, $.01 par value; 25,000,000 shares authorized; none issued		—			—
Common stock, $.01 par value; 240,000,000 shares authorized; 88,130,874 issued; 64,996,287 and 67,305,608 shares outstanding in 2006 and 2005 respectively		0.9			0.9
Treasury stock, $.01 par value; 23,134,587 and 20,825,266 shares in 2006 and 2005, respectively		(0.2	)		(0.2	)
Additional paid-in-capital		0.7			15.3
Unearned nonvested shares		—			(4.3	)
Retained earnings		698.1			628.4
Accumulated other comprehensive income, net of income taxes		0.6			11.9
Total shareowners’ equity		700.1			652.0
Total Liabilities and Shareowners’ Equity	$	1,427.4		$	1,314.5

See Notes to Consolidated Financial Statements

41

PAYLESS SHOESOURCE, INC.

CONSOLIDATED STATEMENTS OF SHAREOWNERS’ EQUITY
AND COMPREHENSIVE INCOME

(dollars in millions, shares in thousands)

	Outstanding														Accumulated
	Common Stock					Additional			Unearned						Other			Total
						Paid-in			Nonvested			Retained			Comprehensive			Shareowner’s			Comprehensive
	Shares			Dollars		Capital			Shares			Earnings			Income			Equity			Income
Balance at January 31, 2004		67,992		$	0.7	$	35.7		$	(0.7	)	$	564.0		$	4.7		$	604.4
Net loss		—			—		—			—			(2.0	)		—			(2.0	)	$	(2.0	)
Translation adjustments		—			—		—			—			—			2.8			2.8			2.8
Issuances of common stock under stock plans		228			—		2.8			(1.2	)		—			—			1.6
Purchases of common stock		(938	)		—		(11.4	)		—			—			—			(11.4	)
Amortization of unearned restricted stock		—			—		—			0.7			—			—			0.7
Restricted stock cancellation		(90	)		—		(1.5	)		0.4			—			—			(1.1	)
Comprehensive income																						0.8
Balance at January 29, 2005		67,192			0.7		25.6			(0.8	)		562.0			7.5			595.0
Net earnings		—			—		—			—			66.4			—			66.4			66.4
Translation adjustments		—			—		—			—			—			4.9			4.9			4.9
Change in unrecognized pension liability		—			—		—			—			—			(0.5	)		(0.5	)		(0.5	)
Issuances of common stock under stock plans		3,408			—		54.7			(5.1	)		—			—			49.6
Purchases of common stock		(3,279	)		—		(71.2	)		—			—			—			(71.2	)
Amortization of unearned restricted stock		—			—		—			1.3			—			—			1.3
Income tax benefit of stock option exercise		—			—		6.5			—			—			—			6.5
Restricted stock cancellation		(15	)		—		(0.3	)		0.3			—			—			—
Comprehensive income																						70.8
Balance at January 28, 2006		67,306			0.7		15.3			(4.3	)		628.4			11.9			652.0
Net earnings		—			—		—			—			122.0			—			122.0			122.0
Translation adjustments		—			—		—			—			—			(3.0	)		(3.0	)		(3.0	)
Minimum pension liability adjustment, net of taxes of $2.0		—			—		—			—			—			(3.6	)		(3.6	)		(3.6	)
Adoption of SFAS No. 158 (Note 7), net of taxes of $3.3		—			—		—			—			—			(4.7	)		(4.7	)		(4.7	)
Reclassification of unearned nonvested shares related to the adoption of SFAS No.123(R) (Note 2)		—			—		(4.3	)		4.3			—			—			—
Issuances of common stock under stock plans		2,698			—		47.1			—			—			—			47.1
Purchases of common stock		(4,994	)		—		(77.0	)		—			(52.3	)		—			(129.3	)
Amortization of unearned nonvested shares		—			—		2.2			—			—			—			2.2
Income tax benefit of stock option exercise		—			—		8.6			—			—			—			8.6
Stock Option Expense		—			—		8.8			—			—			—			8.8
Restricted stock cancellation		(14	)		—		—			—			—			—			—
Comprehensive income																					$	110.7
Balance at February 3, 2007		64,996		$	0.7	$	0.7		$	—		$	698.1		$	0.6		$	700.1

42

Outstanding common stock is net of shares held in treasury and is presented net of $0.2 million of treasury stock in 2006, 2005 and 2004, respectively. Treasury stock is accounted for using the par value method. Treasury share activity for the last three years is summarized below:

(shares in thousands)	2006			2005			2004
Balance, beginning of year		20,825			20,939			20,139
Issuances of common stock:
Stock options and employee stock purchase plan		(2,617	)		(3,145	)		(147	)
Deferred compensation plan		(7	)		(6	)		(5	)
Net restricted stock (grants) cancellations		(60	)		(242	)		14
		(2,684	)		(3,393	)		(138	)
Purchases of common stock		4,994			3,279			938
Balance, end of year		23,135			20,825			20,939

See Notes to Consolidated Financial Statements

43

PAYLESS SHOESOURCE, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in millions)

	53 Weeks Ended			52 Weeks Ended			52 Weeks Ended
	February 3, 2007			January 28, 2006			January 29, 2005
Operating Activities:
Net earnings (loss)	$	122.0		$	66.4		$	(2.0	)
Loss from discontinued operations, net of income taxes and minority interest		3.4			6.0			39.1
Adjustments for non-cash items included in net earnings:
Cumulative effect of change in accounting principle, net of income taxes and minority interest		—			4.1			—
Restructuring charges		—			—			10.8
Loss on impairment of and disposal of assets		10.3			9.8			7.0
Depreciation and amortization		88.5			90.4			94.6
Amortization of deferred financing costs		1.1			1.2			0.9
Share-based compensation expense		12.2			1.3			0.7
Deferred income taxes		9.1			13.7			(6.4	)
Minority interest, net of income taxes		4.6			3.0			(2.3	)
Income tax benefit from share-based compensation		0.6			6.5			—
Accretion of investments		(3.6	)		(1.3	)		—
Changes in working capital:
Inventories		(29.8	)		13.5			31.3
Prepaid expenses and other current assets		(9.0	)		(2.0	)		9.4
Accounts payable		15.6			9.0			28.6
Accrued expenses		5.7			9.5			33.9
Other assets and liabilities, net		3.0			6.4			7.7
Net cash used in discontinued operations		(4.0	)		(10.6	)		2.2
Cash flow provided by operating activities		229.7			226.9			255.5
Investing Activities:
Capital expenditures		(118.6	)		(64.3	)		(102.0	)
Proceeds from sale of property and equipment		4.6			1.2			3.0
Restricted cash		—			1.0			30.5
Intangible asset additions		(15.5	)		—			—
Purchases of investments		(215.6	)		(146.4	)		(34.3	)
Sales and maturities of investments		188.2			110.0			23.0
Net cash used in discontinued operations		—			(0.1	)		(3.5	)
Cash flow used in investing activities		(156.9	)		(98.6	)		(83.3	)
Financing Activities:
Repayment of notes payable		—			(1.0	)		(30.5	)
Issuance of debt		—			1.2			2.4
Repayment of debt		(2.8	)		(1.5	)		(1.5	)
Payment of deferred financing costs		(0.2	)		—			(0.2	)
Issuances of common stock		47.1			49.6			1.6
Purchases of common stock		(129.3	)		(71.2	)		(11.4	)
Excess tax benefits from share-based compensation		8.0			—			—
Distributions to minority owners		(1.5	)		—			—
Contributions from minority owners		—			—			2.1
Net cash provided by discontinued operations		1.2			0.9			1.6
Cash flow used in financing activities		(77.5	)		(22.0	)		(35.9	)
Effect of exchange rate changes on cash		(2.1	)		0.9			(2.0	)
(Decrease)/Increase in cash and cash equivalents		(6.8	)		107.2			134.3
Cash and cash equivalents, beginning of year		378.2			271.0			136.7
Cash and cash equivalents, end of year	$	371.4		$	378.2		$	271.0
Supplemental cash flow information:
Interest paid	$	28.5		$	20.8		$	23.3
Income taxes paid	$	29.4		$	14.9		$	(11.0	)
Non-cash investing and operating activities:
Accrued capital additions	$	23.0		$	9.4		$	16.4
Accrued intangible asset additions	$	10.0		$	—		$	—

See Notes to Consolidated Financial Statements

44

PAYLESS SHOESOURCE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1 — Summary of Significant Accounting Policies

Description of Business and Basis of Presentation

Payless ShoeSource, Inc., a Delaware corporation, together with its subsidiaries (the “Company”), is the largest family footwear specialty retailer by number of locations in the Western Hemisphere.

As of February 3, 2007, the Company operated 4,572 retail shoe stores offering quality footwear and accessories in all 50 of the United States, the District of Columbia, Puerto Rico, Guam, Saipan, the U.S. Virgin Islands, Canada, and the Central and South American Regions. The Central American Region is composed of operations in Costa Rica, the Dominican Republic, El Salvador, Guatemala, Honduras, Nicaragua, Panama and Trinidad and Tobago. The South American Region is composed of operations in Ecuador. The Company’s operations in the Central and South American Regions are operated as consolidated joint ventures in which the Company maintains a 60% ownership.

The Company utilizes a network of agents with factories in eight foreign countries and the United States to source its footwear products, which are manufactured to meet the Company’s specifications and standards. During 2006, factories in the People’s Republic of China were a direct source of approximately 96% of the Company’s footwear, based on merchandise cost.

The Consolidated Financial Statements include the accounts of the Company, all wholly-owned subsidiaries and all subsidiaries and joint ventures in which the Company owns a controlling interest. The Company’s Central American and South American Regions use a December 31 year-end, primarily to match the local countries’ statutory reporting requirements. The effect of this one-month lag on the Company’s financial position and results of operations is not significant.

As a result of the restructuring, as discussed in Note 3 below, the financial information of the Parade, Peru and Chile stores and 26 of the Payless closed stores has been classified as discontinued operations for all periods presented. In addition, during 2006 the Company exited retail operations in Japan, closing its one store location. The financial information for Japan retail operations has been classified as discontinued operations for all periods presented. These Notes to Consolidated Financial Statements, except where otherwise indicated, relate to continuing operations only.

Fiscal Year

The Company’s fiscal year ends on the Saturday closest to January 31. Fiscal years 2006, 2005 and 2004 ended on February 3, 2007, January 28, 2006, and January 29, 2005, respectively. Fiscal year 2006 contains 53 weeks of results compared to fiscal years 2005 and 2004 which contain 52 weeks. References to years in these financial statements and notes relate to fiscal years rather than calendar years. The Company’s operations in the Central American and South American Regions are consolidated using a December 31 year-end.

Use of Estimates

Management makes estimates and assumptions that affect the amounts reported within the Consolidated Balance Sheets and the Statements of Earnings (Loss), Shareowners’ Equity and Comprehensive Income and Cash Flows, and the Notes to Consolidated Financial Statements. Actual results could differ from these estimates.

Net Sales

Net sales (“sales”) are recognized at the time the sale is made to the customer, are net of estimated returns and current promotional discounts and exclude sales tax. Third-party liquidation sales related to restructuring are recognized at the time the sale is made to the customer, are calculated based upon contractually guaranteed amounts pursuant to the Company’s agreements with liquidators and are net of associated fees. During fiscal year 2006, approximately 23% of the Company’s net sales were obtained from externally licensed branded product.

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Gift Cards

The Company records a liability in the period in which a gift card is issued and proceeds are received. As gift cards are redeemed, this liability is reduced and revenue is recognized as a sale. The estimated value of gift cards expected to go unused is recognized ratably in proportion to actual redemptions as gift cards are redeemed.

Cost of Sales

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

Rent Expense

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

Pre-Opening Expenses

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

Advertising Costs

Advertising costs and sales promotion costs are expensed at the time the advertising takes place. Selling, general and administrative expenses include advertising and sales promotion costs of $112.7 million, $106.7 million and $107.3 million in 2006, 2005 and 2004, respectively.

Income Taxes

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

Cash and Cash Equivalents

Cash equivalents consist of liquid investments with an original maturity of three months or less. Amounts due from banks and credit card companies of $15.3 million and $14.4 million for the settlement of credit card transactions are included in cash and cash equivalents as of February 3, 2007, and January 28, 2006, respectively, as they are generally collected within three business days. Cash equivalents are stated at cost, which approximates fair value.

Short-Term Investments

As of February 3, 2007, and January 28, 2006, short-term investments consisted of the following:

(dollars in millions)	2006		2005
Held-to-maturity securities:
Commercial paper	$	90.0	$	58.5
Certificates of deposit		—		0.5
Total held-to-maturity securities	$	90.0	$	59.0

Held-to-maturity securities are carried at amortized cost. As of February 3, 2007, the maturities for all held-to-maturity securities were less than one year. As of February 3, 2007, and January 28, 2006, the estimated fair value of each investment approximated its amortized cost and, therefore, there were no significant unrecognized holding gains or losses.

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Inventories

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

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

The Company takes ownership of certain raw materials as the materials enter the production process. These raw materials are included in inventories and accounted for under the FIFO basis. Raw materials of $29.5 million and $20.1 million are held by third parties and included in inventories in the consolidated balance sheet at February 3, 2007, and January 28, 2006, respectively.

Property and Equipment

Property and equipment are recorded at cost and are depreciated on a straight-line basis over their estimated useful lives. The costs of repairs and maintenance are expensed when incurred, while expenditures for store remodels, refurbishments and improvements that significantly add to the productive capacity or extend the useful life of an asset are capitalized. Projects in progress are stated at cost, which includes the cost of construction and other direct costs attributable to the project. No provision for depreciation is made on projects in progress until such time as the relevant assets are completed and put to use. The estimated useful life for each major class of property and equipment is as follows:

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

The following is a summary of the components of property, buildings and equipment:

(dollars in millions)	2006		2005
Buildings and leasehold improvements	$	633.0	$	631.1
Furniture, fixtures and equipment		532.5		524.0
Property under capital leases		0.9		0.9
Projects in progress		78.7		29.2
	$	1,245.1	$	1,185.2

Depreciation expense for 2006, 2005, and 2004 was $85.3 million, $87.0 million, and $90.5 million, respectively.

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

47

store-by-store basis. Excluding restructuring charges as discussed in Note 3, total impairment charges related to assets held and used for 2006, 2005 and 2004 were $1.7 million, $2.4 million, and $1.5 million, respectively. These charges are included in cost of sales.

Intangible Assets

Goodwill and indefinite-lived intangible assets are not amortized, but are tested for impairment annually, or more frequently if circumstances indicate potential impairment, through a comparison of fair value to its carrying amount. Favorable leases and other intangible assets with finite lives are amortized over their useful lives using the straight-line method. During 2006, the Company performed the required annual impairment testing and no impairment losses were necessary.

Insurance Programs

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

Foreign Currency Translation

Local currencies are the functional currencies for most foreign subsidiaries. Accordingly, assets and liabilities of these subsidiaries are translated at the rate of exchange at the balance sheet date. Adjustments from the translation process are accumulated as part of other comprehensive income and are included as a separate component of shareowners’ equity. The changes in foreign currency translation adjustments were not adjusted for income taxes since they relate to indefinite term investments in non-United States subsidiaries. Income and expense items of these subsidiaries are translated at average rates of exchange. As of fiscal year-end 2006, 2005 and 2004, cumulative translation adjustments included in accumulated other comprehensive income (loss) were $9.4 million, $12.4 million and $7.5 million, respectively.

For those foreign subsidiaries operating in a highly inflationary economy or having the U.S. Dollar as their functional currency, net non-monetary assets are translated at historical rates and net monetary assets are translated at current rates. Translation adjustments are included in the determination of net earnings.

Asset Retirement Obligations

The Company follows FASB Interpretation No. 47 (“FIN 47”), “Accounting for Conditional Asset Retirement Obligations — An Interpretation of FASB Statement No. 143,” which requires entities to record a liability equal to the fair value of the estimated future cost to retire an asset, if the liability’s fair value can be reasonably estimated. The Company’s asset retirement obligation (“ARO”) liabilities are primarily associated with the disposal of personal property and trade fixtures which, at the end of a lease, the Company is contractually obligated to remove in order to restore the facility back to a condition specified in the lease agreement. The Company estimates the fair value of these liabilities based on current store closing costs and discounts the costs back as if they were to be performed at the inception of the lease. At the inception of such a lease, the Company records the ARO as a liability and also records a related asset in an amount equal to the estimated fair value of the liability. The capitalized asset is then depreciated on a straight-line basis over the useful life of the asset. Upon retirement of the asset, any difference between the actual retirement costs incurred and the previously recorded estimated ARO liability is recognized as a gain or loss in the consolidated statement of earnings (loss).

The Company adopted FIN 47 in the fourth quarter of 2005. Please refer to Note 20 for further discussion regarding this change in accounting principle. In future periods, the Company may make adjustments to the ARO liability as a result of the availability of new information, changes in labor costs and other factors. The estimate of the ARO liability is based on a number of assumptions requiring professional judgment, including average store closing costs, inflation rates and asset re-use rates.

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The following table summarizes the Company’s ARO liability included on its consolidated balance sheets.

(in millions)	2006
Beginning asset retirement obligation	$	8.5
Liabilities incurred in current year		0.1
Liabilities settled in current year		(0.4	)
Accretion expense		0.3
Ending asset retirement obligation	$	8.5

Note 2 – Share-Based Compensation

Effective January 29, 2006, the Company adopted the fair value recognition provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123(R), “Share-Based Payment”, using the modified prospective transition method and therefore has not retroactively adjusted results from prior periods. Under this transition method, compensation cost associated with share-based awards recognized in fiscal year 2006 includes: (a) compensation cost for all share-based payments granted prior to, but not yet vested, as of January 29, 2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS No. 123, “Accounting for Stock-Based Compensation”, and (b) compensation cost for all share-based payments granted subsequent to January 29, 2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS No. 123(R).

The Company elected to adopt the alternative transition method to account for the tax effects of share-based payment awards as provided in FASB Staff Position FAS 123(R)-3: “Transition Election Related to Accounting for the Tax effects of Share-Based Payment Awards” (“FSP 123(R)-3”) during the second quarter of 2006.

Prior to the adoption of SFAS No. 123(R), the Company followed the disclosure provisions of SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure, an amendment of FASB Statement No. 123.” The Statement required prominent disclosures in both annual and interim financial statements regarding the method of accounting for stock-based employee compensation and the effect of the method used on reported results. Prior to fiscal year 2006, the Company accounted for stock compensation awards under the intrinsic value method of Accounting Principles Board (“APB”) Opinion No. 25. APB Opinion No. 25 required compensation cost to be recognized based on the excess, if any, between the quoted market price of the stock at the date of grant and the amount an employee must pay to acquire the stock. All options awarded under the Company’s plans were granted with an exercise price equal to the fair market value on the date of the grant.

SFAS No. 123 established a fair value based method of accounting for employee stock options or similar equity instruments. In order to calculate fair value under SFAS No. 123, the Company used the Black-Scholes option pricing model to estimate the grant date fair value of options granted in fiscal years 1996 through 2005. The fair value was recognized over the option vesting period using tranche specific expense attribution as discussed in FASB Interpretation No. 28, “Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans — An Interpretation of APB Opinions No. 15 and 25.”

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The following table presents the effect on net earnings and earnings per share had share-based compensation expense been recorded for the 52 weeks ended January 28, 2006 and January 29, 2005, respectively, based on the fair-value method under SFAS No. 123.

(dollars in millions, except per share amounts)	January 28, 2006		January 29, 2005
Net earnings (loss):
As reported	$	66.4	$	(2.0	)
Add: Total stock-based employee compensation expense included in net earnings (loss) as reported, net of related income taxes		3.2		1.2
Less: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related income taxes		6.8		3.0
Pro forma	$	62.8	$	(3.8	)
Basic earnings (loss) per share:
As reported	$	0.98	$	(0.03	)
Pro forma	$	0.93	$	(0.06	)
Diluted earnings (loss) per share:
As reported	$	0.98	$	(0.03	)
Pro forma	$	0.93	$	(0.06	)

Equity Incentive Plans

Under its equity incentive plans, the Company currently grants share appreciation vehicles consisting of stock options, stock-settled stock appreciation rights (“stock-settled SAR’s”) and cash-settled stock appreciation rights (“cash-settled SAR’s”), as well as full value vehicles consisting of nonvested shares and phantom stock units. Appreciation vehicles granted under the 1996 and 2006 Stock Incentive Plans are granted at the average of the high and low trading price on the date of grant and may be exercised only after stated vesting dates or other vesting criteria, as applicable, has been achieved. Generally, vesting of appreciation vehicles is conditioned upon continued employment with the Company, although appreciation vehicles may be exercised during certain periods following retirement, disability or death. Historically, the Company has used treasury shares for settlement of share-based compensation.

Under the 1996 Stock Incentive Plan, which expired in April 2006, the Company was authorized to grant a maximum of 15,600,000 shares, of which no more than 1,200,000 could be issued pursuant to nonvested share grants. Appreciation vehicles granted under the plan had a maximum term of 10 years and could vest on a graded schedule or a cliff basis. The exercise prices of appreciation vehicles equaled the average of the high and low trading prices of the Company’s stock on the grant date. Nonvested shares granted under the plan could be granted with or without performance restrictions. Restrictions, including performance restrictions, lapse over periods of up to ten years, as determined at the date of grant. Associates who received nonvested shares paid no monetary consideration.

On May 25, 2006, the Company’s shareowners approved the 2006 Stock Incentive Plan. Under the 2006 Stock Incentive Plan, the Company is authorized to grant a maximum of 2,500,000 shares. Appreciation vehicles to be granted under the plan have a maximum term of seven years and can vest on a graded schedule, a cliff basis or based on performance. The exercise price of an appreciation vehicle may not be less than the average of the high and low trading prices of the Company’s stock on the grant date. Associates who receive full value vehicles pay no monetary consideration. Awards under the 2006 Stock Incentive Plan can be granted with or without performance restrictions. Restrictions, including performance restrictions, lapse over periods of up to seven years, as determined at the date of grant.

On May 25, 2006, the Company’s shareowners approved amendments to and restatement of the Stock Plan for Non-Management Directors (the “Director Plan”). Under the Company’s amended and restated Director Plan, each Director who is not an officer of the Company is eligible to receive share-based compensation in the form of non-qualified stock options and/or stock awards, including, but not limited to, restricted and unrestricted stock awards. All shares of common stock issued under the Director Plan are subject to restrictions on transferability and to forfeiture during a specified restricted period. The Director Plan provides for the issuance of not more than 350,000 shares of common stock, subject to adjustment for changes in the Company’s capital structure. The Company may not, without stockholder approval, amend the Director Plan in a manner

50

that would increase the number of shares of common stock available for awards, decrease the exercise price of any award, or otherwise materially increase benefits or modify eligibility requirements. The material differences between the amended and prior Director Plans are: (1) participants may, if certain conditions are met, transfer or otherwise dispose of shares of stock received pursuant to the amended plan prior to their termination from the board, and (2) the maximum number of shares of common stock available for issuance under the Director Plan was reduced from 900,000.

Under the Company’s Amended Stock Ownership Plan, a maximum of 6,000,000 shares of the Company’s common stock may be purchased by employees at a 5% discount. The terms of the Stock Ownership plan are such that the plan is non-compensatory. As a result, the purchase of shares by employees does not give rise to compensation cost.

Stock Options

During 2006, the Company granted 200,060 stock options under the 1996 Stock Incentive Plan that will vest in installments over three years. Additionally, 269,500 stock options were granted that cliff vest after three years. Neither of these stock option grants contain performance vesting conditions.

On July 18, 2005, the Company granted its Chief Executive Officer and President an option on 720,000 shares of the Company’s common stock at $20.65 (the closing price on the date of grant). The option vests as follows: 120,000 shares on the first and fourth anniversary of the grant, 240,000 shares on the second and third anniversary of the grant.

Transactions for stock options for the fiscal year 2006 were as follows:

	53 Weeks Ended February 3, 2007
				Weighted Average
(units in thousands)	Options			Exercise Price
Outstanding at beginning of period		5,738		$	18
Granted		470			22
Exercised		(2,597	)		18
Forfeited or expired		(216	)		18
Outstanding at end of period		3,395			19
Vested and expected to vest at end of period		3,332			19
Exercisable or convertible at end of period		1,547			17

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The following table summarizes information about stock options outstanding, options vested or expected to vest, and exercisable at February 3, 2007:

Options Outstanding
			Weighted
			Average
	Number of		Remaining		Aggregate		Weighted
Range of	Outstanding		Contractual Life		Intrinsic Value		Average
Exercise Prices	(in thousands)		(in years)		(in thousands)		Exercise Price
$13-15		187		3	$	3,789	$	15
16-18		1,755		5		32,268		17
19-24		1,453		5		19,436		22

Options Vested and Expected to Vest
			Weighted
	Number Vested		Average
	and Expected		Remaining		Aggregate		Weighted
	to Vest		Contractual Life		Intrinsic Value		Average
	(in thousands)		(in years)		(in thousands)		Exercise Price
$13-15		186		3	$	3,761	$	15
16-18		1,750		5		32,171		17
19-24		1,396		5		18,733		22

Options Exercisable
			Weighted
			Average
	Number		Remaining		Aggregate		Weighted
	Exercisable		Contractual Life		Intrinsic Value		Average
	(in thousands)		(in years)		(in thousands)		Exercise Price
$13-15		187		3	$	3,789	$	15
16-18		1,017		4		18,862		16
19-24		343		4		4,468		22

The aggregate intrinsic value was calculated using the difference between the current market price and the grant price for only those awards that have a grant price that is less than the current market price.

The total intrinsic value of options exercised during 2006, 2005 and 2004 was $24.0 million, $17.9 million and $0.1 million respectively. Cash received from option exercises for 2006, 2005 and 2004 was $46.6 million, $48.9 million and $1.0 million respectively, excluding cash received from the Company’s employee stock purchase and deferred compensation plans. The tax benefit realized for the deductions from options exercised during 2006 and 2005 was $8.6 million and $6.5 million, respectively. There were no tax benefits realized in 2004. The weighted average fair value of units granted per unit for 2006, 2005 and 2004 was $10, $7 and $7, respectively.

Stock-settled SAR’s

During 2006, the Company granted 802,630 stock-settled SAR’s under the 1996 Stock Incentive Plan, of which 202,680 are subject to a performance condition for vesting purposes (the “performance grant”). The performance grant vests only if the performance condition is met. The performance condition has been met for 2006 and the performance grant will vest in thirds on May 31, 2007, 2008 and 2009, respectively. The remaining 599,950 stock-settled SAR’s are subject to a three-year graded vesting schedule, which is not based on any performance vesting conditions.

During 2006, the Company granted 172,339 stock-settled SAR’s, of which 21,934 are a performance grant under the 2006 Stock Incentive Plan. The performance grant will vest only if the performance condition is met. The performance condition has been met for 2006 and the performance grant will vest in thirds on May 31, 2007, 2008 and 2009, respectively. The

52

remaining 150,405 stock-settled SAR’s are subject to a three-year graded vesting schedule, which is not based on any performance vesting conditions.

Upon exercise of a stock-settled SAR, employees will receive a number of shares of common stock equal to the appreciation in the fair market value of the underlying common stock from the grant date to the exercise date of the SAR. All of the stock-settled SAR’s issued by the Company to-date contain an appreciation cap, which limits the appreciation for which shares of common stock will be granted to 200% of the fair market value of the underlying common stock on the grant date of the SAR. As a result of the appreciation cap, a maximum of 2/3 of a share of common stock may be issued for each stock-settled SAR granted.

Transactions for stock–settled SAR’s for the fiscal year 2006 were as follows:

	53 Weeks Ended February 3, 2007
	Stock-Settled			Weighted Average
(units in thousands)	SAR’s			Exercise Price
Outstanding at beginning of period		—		$	—
Granted		975			23
Exercised		—			—
Forfeited or expired		(86	)		22
Outstanding at end of period		889			24
Vested and expected to vest at end of period		833			23
Exercisable or convertible at end of period		—			—
Weighted average fair value of units granted (per unit)	$	9

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The following table summarizes information about stock-settled SAR’s outstanding and exercisable at February 3, 2007:

Stock-settled SAR’s Outstanding
			Weighted
			Average
	Number of		Remaining		Aggregate		Weighted
Range of	Outstanding		Contractual Life		Intrinsic Value		Average
Exercise Prices	(in thousands)		(in years)		(in thousands)		Exercise Price
$21-23		757		6	$	9,415	$	23
24-27		62		6		117		27
28-31		70		7		240		32

Stock-settled SAR’s Vested and Expected to Vest
			Weighted
	Number Vested		Average
	and Expected		Remaining		Aggregate		Weighted
	to Vest		Contractual Life		Intrinsic Value		Average
	(in thousands)		(in years)		(in thousands)		Exercise Price
$21-23		720		6	$	8,960	$	23
24-27		53		6		100		27
28-31		60		7		206		32

Stock-settled SAR’s Exercisable
			Weighted
			Average
	Number		Remaining		Aggregate		Weighted
	Exercisable		Contractual Life		Intrinsic Value		Average
	(in thousands)		(in years)		(in thousands)		Exercise Price
$21-23		—		—	$	—	$	—
24-27		—		—		—		—
28-31		—		—		—		—

Nonvested Shares

During 2006, the Company granted 61,100 nonvested shares for certain associates under the 1996 Stock Incentive Plan. The nonvested shares are subject to a three-year graded vesting schedule and are not subject to any performance vesting conditions.

During 2006, the Company granted 4,800 nonvested shares to certain associates under the 2006 Stock Incentive Plan. The nonvested shares are subject to a three-year graded vesting schedule and are not subject to any performance vesting conditions.

During 2006, the Company granted 7,205 nonvested shares under the Director Plan. These shares will vest on May 1, 2007. In addition, pursuant to the provisions of the Director Plan, Directors elected to defer compensation into 16,422 stock units that will be issued as common stock subsequent to the Directors’ resignation from the Board. Of these stock units, 9,775 will vest on May 1, 2007. The remaining 6,647 stock units will vest ratably over a one-year period. Deferral does not affect vesting. Deferred stock units are excluded from the summary table of nonvested shares.

On July 18, 2005, the Company granted its Chief Executive Officer and President 214,250 nonvested shares. The nonvested shares will cliff vest on the third anniversary of the grant.

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Transactions for nonvested shares for the fiscal year 2006 were as follows:

	53 Weeks Ended February 3, 2007
				Weighted Average
				Grant Date Fair
(shares in thousands)	Nonvested Shares			Value
Nonvested at beginning of period		301		$	19
Granted		73			23
Vested		(46	)		16
Forfeited or expired		(10	)		19
Nonvested at end of period		318			21

The weighted average grant date fair value of units granted in 2005 and 2004 was $20 and $16, respectively.

Cash-settled SAR’s

During 2006, the Company issued 105,530 cash-settled SAR’s on 105,530 shares. Transactions for cash-settled SAR’s for the fiscal year 2006 were as follows:

	53 Weeks Ended February 3, 2007
	Cash-Settled			Weighted Average
(shares in thousands)	SAR’s			Exercise Price
Outstanding at beginning of period		108		$	17
Granted		106			22
Exercised		(38	)		18
Forfeited or expired		(57	)		19
Outstanding at end of period		119			20
Exercisable or convertible at end of period		43			17
Weighted average fair value of units granted (per unit)	$	9

Fair Value

Effective January 29, 2006, grants under the Company’s equity incentive plans are accounted for as provided by SFAS No. 123(R). Compensation expense for appreciation vehicles is based on the fair market value as of the grant date. For nonvested share grants, compensation expense is based upon the grant date fair value (i.e., the average of the high and low trading prices of the Company’s stock on the grant date.)

Beginning in fiscal year 2006, the Company changed its method of determining the fair value of share-based awards from the Black-Scholes model to a binomial model. The binomial model considers a range of assumptions relative to volatility, risk-free interest rates and employee exercise behavior, which more accurately models actual employee behaviors. The Company believes the binomial model provides a fair value that is more representative of actual and future experience.

55

The fair value of options and stock-settled SAR’s granted were calculated using the following assumptions:

	53 Weeks Ended			52 Weeks Ended			52 Weeks Ended
	February 3, 2007			January 28, 2006			January 29, 2005
Risk-free interest rate		4.9	%		3.9	%		4.3	%
Expected dividend yield		—	%		—	%		—	%
Expected appreciation vehicle life (in years)		6			5			7
Weighted-average expected volatility		35	%		34	%		33	%

Risk-free interest rate – The rate is based on zero-coupon U.S. Treasury yields in effect at the date of grant, utilizing separate rates for each whole year up to the contractual term of the appreciation vehicle and interpolating for time periods between those not listed.

Expected dividend yield – the Company has not historically paid dividends and has no immediate plans to do so; as a result, the dividend yield is assumed to be zero.

Expected appreciation vehicle life – The expected life is derived from the output of the binomial lattice model and represents the period of time that the appreciation vehicles are expected to be outstanding. This model incorporates time-based early exercise assumptions based on an analysis of historical exercise patterns.

Expected Volatility –The rate used in the binomial model is based on an analysis of historical prices of the Company’s stock. The Company currently believes that historical volatility is a good indicator of future volatility.

The total fair value of shares vested during 2006, 2005 and 2004 was $5.5 million, $8.9 million and $9.6 million, respectively.

Compensation Expense

SFAS No. 123(R) requires compensation expense associated with share-based awards to be recognized over the requisite service period, which for the Company is the period between the grant date and the award’s stated vesting term.

The Company used the tranche specific attribution method for stock option and nonvested share awards with graded vesting issued prior to the adoption of SFAS No. 123(R). Share-based awards issued after the adoption of SFAS No. 123(R) will be expensed under the straight-line attribution method, with the exception of performance-based stock-settled SAR’s that are expensed under the tranche specific attribution method.

The amount of share-based compensation recognized during a period is based on the value of the portion of the awards that are expected to vest. SFAS No. 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. This analysis is evaluated quarterly and the forfeiture rate is adjusted as necessary. For performance-based stock-settled SAR’s, compensation expense is recorded over the vesting period based on estimates of achieving the performance goal. Ultimately, the actual expense recognized over the vesting period will be based on only those shares that vest.

Total share-based compensation expense of $12.2 million before tax has been included in the Company’s consolidated statement of earnings (loss) for the 53 weeks ended February 3, 2007. Included in this amount is $8.8 million of stock option and stock-settled SAR expense that was recognized as a result of adopting SFAS No. 123(R). No amount of share-based compensation has been capitalized. Total share-based compensation expense is summarized as follows:

	53 Weeks Ended			52 Weeks Ended			52 Weeks Ended
(dollars in millions, except per share amounts)	February 3, 2007			January 28, 2006			January 29, 2005
Cost of sales	$	4.1		$	—		$	—
Selling, general and administrative expenses		8.1			5.0			1.7
Share-based compensation expense before income taxes		12.2			5.0			1.7
Tax benefit		(4.4	)		(1.8	)		(0.5	)
Share-based compensation expense after income taxes	$	7.8		$	3.2		$	1.2
Effect on:
Basic earnings per share	$	0.12		$	0.05		$	0.02
Diluted earnings per share	$	0.12		$	0.05		$	0.02

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As of February 3, 2007, the Company had unrecognized compensation expense related to nonvested awards of approximately $15.4 million, which is expected to be recognized over a weighted average period of 1.5 years.

Note 3 — Restructuring Charges

During 2004, the Company initiated a restructuring plan to build long-term shareowner value. The Company has substantially completed the restructuring, which included: 1) closing all Parade stores, 2) sale of Chile and Peru entities, 3) closing of 264 Payless ShoeSource stores, 4) ceasing all wholesale businesses with no significant growth opportunity and 5) eliminating approximately 200 management and administrative positions.

In accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”), the results of operations of Parade, Peru, Chile and 26 Payless ShoeSource stores have been classified as discontinued operations in the Company’s consolidated statements of earnings (loss).

In accordance with SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities,” employee severance, contract termination and other exit costs are recorded at their estimated fair value when they are incurred. Employee severance costs include estimates regarding the amount of severance payments made to certain terminated associates, and contract termination costs include estimates regarding the length of time required to sublease vacant space and expected recovery rates. Actual results could vary from these estimates.

The significant components of the restructuring charge incurred as of February 3, 2007, are summarized as follows:

	Total Charges		Accrual Balance as of		Accrual		Cash			Accrual Balance as of
(dollars in millions)	to Date		January 28, 2006		Adjustments		Payments			February 3, 2007
Employee severance costs	$	9.0	$	1.0	$	—	$	(0.8	)	$	0.2
Contract termination costs		30.1		5.5		1.6		(4.3	)		2.8
Other exit costs		5.1		—		—		—			—
		44.2	$	6.5	$	1.6	$	(5.1	)	$	3.0
Asset impairments and net disposal losses		35.0
Total Charges	$	79.2

The Company expects that the payments of employee severance costs will be substantially completed by June 2007. The remaining contract termination obligations primarily relate to lease obligations for vacant space (certain lease terms extend through June 2014) resulting from the store closings.

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Note 4 — Discontinued Operations

Payless Domestic

In accordance SFAS No. 144, the results of operations for the 53 weeks ended February 3, 2007, and the 52 weeks ended January 28, 2006, and January 29, 2005, for Parade and 26 Payless closed stores are classified as discontinued operations within the Payless Domestic segment. Payless stores are considered for discontinued operations disclosure if the nearest store is greater than 10 miles from the closed store. If the nearest store is greater than 10 miles from the store to be closed, the store is generally not expected to realize a migration of significant direct cash inflows as a result of the closure and, consequently, these stores are considered to be discontinued operations. If the nearest store is less than 10 miles from the closed store, the Company generally expects to realize a migration of significant direct cash inflows as a result of the closure and those stores are not reported as discontinued operations. The following is a summary of Payless Domestic results:

	53 Weeks Ended			52 Weeks Ended			52 Weeks Ended
	February 3,			January 28,			January 29,
(dollars in millions)	2007			2006			2005
Net Sales	$	—		$	—		$	100.8
Loss from discontinued operations before income taxes		(0.8	)		(5.9	)		(11.5	)
Benefit for income taxes		(0.3	)		(2.2	)		(4.5	)
Loss before disposal		(0.5	)		(3.7	)		(7.0	)
Loss on disposal of discontinued operations, net of income taxes of $12.9 for the 52 weeks ended January 29, 2005		—			—			(20.4	)
Loss from discontinued operations, net of income taxes	$	(0.5	)	$	(3.7	)	$	(27.4	)

Additionally, the consolidated balance sheets include the assets of Parade and the 26 Payless closed stores presented as discontinued operations. As of February 3, 2007, and January 28, 2006, the current assets and liabilities of discontinued operations within the Payless Domestic segment were as follows:

	February 3,		January 28,
(dollars in millions)	2007		2006
Assets
Current assets:
Current deferred income taxes	$	0.8	$	1.3
Other current assets		0.2		0.3
Total current assets of discontinued operations	$	1.0	$	1.6
Liabilities
Current liabilities:
Accrued expenses	$	2.1	$	3.4
Total current liabilities of discontinued operations	$	2.1	$	3.4

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Payless International

During 2006, the Company exited its retail operations in Japan and closed its one store location. As of February 3, 2007, the Company is substantially complete with the exit process. In 2004, the Company closed all stores in Peru and Chile. The following is a summary of Japan, Peru and Chile results and balance sheets of which all activity and balances are components of the Payless International segment:

	53 Weeks Ended			52 Weeks Ended			52 Weeks Ended
	February 3,			January 28,			January 29,
(dollars in millions)	2007			2006			2005
Net Sales	$	0.8		$	1.6		$	9.3
Loss from discontinued operations before income taxes and minority interest		(3.0	)		(3.9	)		(9.4	)
Provision for income taxes		—			—			0.4
Minority interest		1.2			1.6			3.9
Loss before disposal		(1.8	)		(2.3	)		(5.9	)
Loss on disposal of discontinued operations, net of minority interest of $0.7 and $3.9 for the 53 weeks ended February 3, 2007 and 52 weeks ended January 29, 2005, respectively, and income taxes of zero for all periods		(1.1	)		—			(5.8	)
Loss from discontinued operations, net of income taxes and minority interest	$	(2.9	)	$	(2.3	)	$	(11.7	)

	February 3,		January 28,
(dollars in millions)	2007		2006
Assets
Current Assets:
Cash and cash equivalents	$	0.1	$	0.7
Inventories		—		0.4
Other current assets		—		0.2
Total current assets of discontinued operations		0.1		1.3
Noncurrent Assets:
Property and equipment, net		—		1.0
Other assets		—		0.4
Total noncurrent assets of discontinued operations		—		1.4
Total assets of discontinued operations	$	0.1	$	2.7
Liabilities
Current Liabilities:
Accounts payable	$	—	$	0.3
Accrued expenses		—		0.3
Total current liabilities of discontinued operations	$	—	$	0.6

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Note 5 — Quarterly Results (Unaudited)

The tables below summarize quarterly results for the last two years. Quarterly results are determined in accordance with annual accounting policies and all adjustments (consisting only of normal recurring adjustments, except as noted below) necessary for a fair statement of the results for the interim periods have been included; however, certain items are based upon estimates for the entire year.

(dollars in millions, except per share)	2006(4)
Quarter	First(3)			Second(3)			Third			Fourth			Year
Net sales	$	694.5		$	706.1		$	703.4		$	692.7		$	2,796.7
Gross margin		255.8			244.0			241.3			234.6			975.7
Net earnings from continuing operations		36.8			33.0			30.6			25.0			125.4
Loss from discontinued operations, net of income taxes and minority interest		(0.8	)		(0.5	)		(1.7	)		(0.4	)		(3.4	)
Net earnings	$	36.0		$	32.5		$	28.9		$	24.6		$	122.0
Basic earnings per share:(1)
Earnings from continuing operations	$	0.55		$	0.50		$	0.47		$	0.38		$	1.90
Loss from discontinued operations		(0.01	)		(0.01	)		(0.03	)		—			(0.05	)
Basic earnings per share	$	0.54		$	0.49		$	0.44		$	0.38		$	1.85
Diluted earnings per share:(1)
Earnings from continuing operations	$	0.54		$	0.49		$	0.46		$	0.38		$	1.87
Loss from discontinued operations		(0.01	)		(0.01	)		(0.03	)		(0.01	)		(0.05	)
Diluted earnings per share	$	0.53		$	0.48		$	0.43		$	0.37		$	1.82

	2005
Quarter	First(3)			Second(3)			Third			Fourth			Year
Net sales	$	694.8		$	693.4		$	666.5		$	611.0		$	2,665.7
Gross margin		244.4			235.1			218.6			190.5			888.6
Net earnings (loss) from continuing operations		32.3			22.4			22.4			(0.6	)		76.5
Loss from discontinued operations, net of income taxes and minority interest		(2.1	)		(2.5	)		(0.5	)		(0.9	)		(6.0	)
Cumulative effect of change in accounting principle, net(2)		—			—			—			(4.1	)		(4.1	)
Net earnings (loss)	$	30.2		$	19.9		$	21.9		$	(5.6	)	$	66.4
Basic (loss) earnings per share:(1)
Earnings (loss) from continuing operations	$	0.48		$	0.33		$	0.33		$	(0.01	)	$	1.13
Loss from discontinued operations		(0.03	)		(0.04	)		(0.01	)		(0.01	)		(0.09	)
Cumulative effect of change in accounting principle(2)		—			—			—			(0.06	)		(0.06	)
Basic earnings (loss) per share	$	0.45		$	0.29		$	0.32		$	(0.08	)	$	0.98
Diluted earnings (loss) per share:(1)
Earnings (loss) from continuing operations	$	0.48		$	0.33		$	0.33		$	(0.01	)	$	1.13
Loss from discontinued operations		(0.03	)		(0.04	)		(0.01	)		(0.01	)		(0.09	)
Cumulative effect of change in accounting principle(2)		—			—			—			(0.06	)		(0.06	)
Diluted earnings (loss) per share	$	0.45		$	0.29		$	0.32		$	(0.08	)	$	0.98

(1)	Earnings (loss) per share were computed independently for each of the quarters presented. The sum of the quarters may not equal the total year amount due to the impact of changes in average quarterly shares outstanding.
(2)	As discussed in Note 20, during the fourth quarter of 2005 the Company adopted FASB Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations – An Interpretation of FASB Statement No. 143.”
(3)	Quarterly results for first and second quarter reflect the effect of Japan being reported as discontinued operations and are different than what was reported in the Company’s Form 10-Q’s as filed on June 6, 2006 and September 6, 2006, respectively. See Note 4.
(4)	During 2006, we adopted the fair value recognition provisions of SFAS No 123(R), “Share-Based Payment.” See Note 2.

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Note 6 — Profit Sharing Plan

The Company has two qualified profit sharing plans (“Payless Profit Sharing Plans”) that cover full-time associates who have worked for the Company for 60 days and have attained age 21 or part-time associates who work 1,000 hours or more in a year and have attained age 21. The Payless Profit Sharing Plans are defined contribution plans that provide for Company contributions related to the Company’s annual performance and are at the discretion of the Board of Directors. The Company funds a minimum guaranteed Company matching contribution of $0.25 per $1.00 contributed by associates. Associate contributions up to 5% of their pay are eligible for the match. The Company has historically contributed 2.5% of net profits as defined by the plans. At the discretion of the Board of Directors, the 2006 contribution was determined to be 2.5% of pre-tax earnings from continuing operations. Associates may voluntarily contribute to the Company’s profit sharing plans on both a pre-tax and after-tax basis. For 2006, the Company’s contribution is allocated to all associates participating in the Payless Profit Sharing Plans who have worked for the Company for at least six months, if full-time, or one year, if part-time, as of December 31. Total profit sharing contributions for 2006, 2005 and 2004 were $4.2 million, $2.7 million and $1.3 million, respectively.

Note 7. — Pension Plan

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

Pension expense is based on information provided to an outside actuarial firm that uses assumptions to estimate the total benefits ultimately payable to each management employee and allocates this cost to service periods. The actuarial assumptions used to calculate pension expense are reviewed annually for reasonableness. The measurement date used for the 2006 actuarial valuation was January 31, 2007.

In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans – An Amendment of FASB Statements No. 87, 88, 106, and 132(R).” This statement requires companies to recognize a net liability or asset and an offsetting adjustment to accumulated other comprehensive income (“AOCI”) to report the funded status of defined benefit pension and other postretirement benefit plans. The adjustment to AOCI at adoption represents the net unrecognized actuarial losses and unrecognized prior service costs. These amounts will be subsequently recognized as net periodic pension cost subject to the Company’s historical accounting policy for amortizing such amounts. Additional minimum pension liabilities (“AML”) and related intangible assets are also derecognized upon adoption of the new standard. The statement requires prospective application, and the recognition and disclosure requirements are effective for companies with fiscal years ending after December 15, 2006. The Company adopted SFAS No. 158 as of February 3, 2007. The following table summarizes the incremental effect of adopting the provisions of SFAS No. 158 on the Company’s consolidated balance sheets. The adoption of SFAS No. 158 had no impact on the Company’s consolidated statement of earnings for the fiscal year ended February 3, 2007, or for any prior period presented, and it will not affect the Company’s operating results in future periods.

	Prior to AML
	Adjustment and					Effect of
	Adoption of SFAS		AML			Adopting			As Reported at
(dollars in millions)	158		Adjustment			SFAS 158			February 3, 2007
Other assets	$	44.6	$	1.8		$	(3.2	)	$	43.2
Accrued expenses		188.7		—			1.5		$	190.2
Other liabilities		121.0		6.9			4.7		$	132.6
Accumulated other comprehensive income, net of income taxes	$	8.4	$	(3.1	)	$	(4.7	)	$	0.6

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Included in accumulated other comprehensive income are the following amounts that have not yet been recognized in net periodic pension cost:

(dollars in millions)	2006
Net loss, net of income taxes of $4.1	$	6.3
Prior service cost, net of income taxes of $1.2		2.0
Total	$	8.3

The net loss and prior service cost included in accumulated other comprehensive income and expected to be recognized in net periodic pension cost during fiscal year 2007 is $0.6 million and $0.4 million, respectively.

The following information provides a summary of the funded status of the plan, amounts recognized in the consolidated balance sheets, and major assumptions used to determine these amounts:

(dollars in millions)	2006			2005
Change in projected benefit obligation:
Obligation at beginning of year	$	21.5		$	20.8
Service cost		0.8			0.7
Interest cost		1.3			1.1
Plan amendments		2.3			0.4
Actuarial loss (gain)		6.4			(0.7	)
Benefits paid		(1.2	)		(0.8	)
Obligation at end of year	$	31.1		$	21.5
Accumulated benefit obligation at end of year	$	26.4		$	18.0
Reconciliation of funded status:
Funded status	$	(31.1	)	$	(21.5	)
Unrecognized net actuarial loss		*			4.0
Unrecognized prior service cost		*			1.4
Net amount recognized	$	(31.1	)	$	(16.1	)
* Not applicable due to SFAS No. 158
Assumptions:
Discount rate		5.75	%		5.50	%
Salary increases		3.0	%		3.0	%

Of the $31.1 million liability recognized as of February 3, 2007, $1.5 million is recorded in accrued expenses and $29.6 million is recorded in other liabilities.

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

(dollars in millions)	2006			2005			2004
Components of pension expense:
Service cost	$	0.8		$	0.7		$	0.8
Interest cost		1.3			1.1			1.1
Amortization of prior service cost		0.4			0.2			0.2
Amortization of actuarial loss		0.2			0.1			0.2
Total	$	2.7		$	2.1		$	2.3
Assumptions:
Discount rate		5.75	%		5.50	%		5.50	%
Salary increases		3.0	%		3.0	%		3.0	%

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Estimated future benefit payments for the next five years and the aggregate amount for the following five years are:

(dollars in millions)
2007	$	1.5
2008		1.7
2009		1.7
2010		7.7
2011		1.2
2012- 2016		7.7

Note 8 — Income Taxes

The provision (benefit) for income taxes from continuing operations consisted of the following:

(dollars in millions)	2006			2005		2004
Federal	$	21.2		$	6.7	$	15.9
State and local		3.1			0.7		0.7
Foreign		6.5			9.7		3.0
Current tax provision		30.8			17.1		19.6
Federal		0.8			10.2		(4.7	)
State and local		(0.1	)		0.8		(0.6	)
Foreign		8.4			2.7		(1.1	)
Deferred tax provision (benefit)		9.1			13.7		(6.4	)
Total provision	$	39.9		$	30.8	$	13.2

The reconciliation between the statutory federal income tax rate and the effective income tax rate as applied to continuing operations was as follows:

(dollars in millions)	2006						2005						2004
Statutory federal income tax rate		35.0	%	$	59.4			35.0	%	$	38.6			35.0	%	$	16.8
State and local income taxes, net of federal tax benefit		1.8			3.0			1.4			1.5			0.4			0.2
Rate differential on foreign earnings, net of valuation allowance		(5.8	)		(9.8	)		(2.5	)		(2.8	)		(8.5	)		(4.1	)
Canada statutory rate change		0.2			0.4			—			—			0.4			0.2
Repatriation of foreign earnings		—			—			1.3			1.4			4.8			2.3
Decrease in excess tax reserves		(8.7	)		(14.7	)		(5.3	)		(5.9	)		(3.8	)		(1.8	)
Federal employment tax credits		(0.8	)		(1.3	)		(1.0	)		(1.1	)		(1.7	)		(0.8	)
Other, net		1.8			2.9			(1.0	)		(0.9	)		0.9			0.4
Effective income tax rate		23.5	%	$	39.9			27.9	%	$	30.8			27.5	%	$	13.2

The amount of income taxes the Company pays is subject to ongoing audits by federal, state and foreign tax authorities, which often result in proposed assessments. The Company’s estimate for the potential outcome for any uncertain tax issue is highly judgmental. The Company believes it has adequately provided for any reasonable foreseeable outcome related to these matters. However, future results may include favorable or unfavorable adjustments to estimated tax liabilities in the period the assessments are made or resolved or when statutes of limitation on potential assessments expire. Additionally, the jurisdictions in which the Company’s earnings or deductions are realized may differ from the Company’s current estimates. As a result, the Company’s effective tax rate may fluctuate significantly on a quarterly basis due to discrete events.

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Major components of deferred income tax assets and (liabilities) were as follows:

(dollars in millions)	2006			2005
Deferred Tax Assets:
Accrued expenses and reserves	$	49.4		$	42.9
Tax net operating losses and tax credits		16.6			20.8
Other deferred income taxes, net		1.1			1.2
Gross deferred income tax assets		67.1			64.9
Depreciation/amortization and basis differences		(7.1	)		(9.4	)
Valuation allowance		(6.7	)		(7.8	)
Net deferred income tax assets		53.3			47.7
Less: Net current deferred income tax assets		(15.6	)		(20.2	)
Net noncurrent deferred income tax assets	$	37.7		$	27.5
Deferred Tax Liabilities:
Depreciation/amortization and basis differences	$	(0.2	)	$	(0.8	)
Short term assets basis differences		(9.6	)		—
Total deferred tax liabilities		(9.8	)		(0.8	)
Less: Net current deferred income tax liabilities (included in accrued expenses on the consolidated balance sheets)		9.6			—
Net noncurrent deferred tax liabilities (included in other liabilities on the consolidated balance sheets)	$	(0.2	)	$	(0.8	)

During 2006, the Company recorded an increase to its deferred tax assets, related to items of other comprehensive income, of $5.3 million, net of translation adjustments of $0.4 million.

The Company provides a valuation allowance against net deferred tax assets if, based on management’s assessment of historical and projected future operating results and other available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized. The Company carries valuation allowances related primarily to realization of foreign net operating loss carryforwards and state income tax credits. During 2006, the Company increased its valuation allowance relating to state income tax credits originating in prior years by $1.4 million, and decreased its valuation allowance relating to foreign net operating losses originating in prior years by $1.2 million, due to a change in circumstances causing a change in judgment about the Company’s ability to realize the value of the assets.

At February 3, 2007, deferred tax assets for state and foreign net operating loss carryforwards are $8.5 million, less a valuation allowance of $1.9 million. The net operating losses related to recorded assets will expire as follows: $0.4 million in 2007 through 2009, $0.2 million in 2008 through 2009, $2.2 million in 2010 through 2011, and $3.8 million by 2024. In addition, state income tax credit carryforwards are $8.1 million, less a valuation allowance of $4.7 million. The remaining valuation allowance relates to other deferred tax assets in a Latin American country that does not have a history of earnings. The tax credit carryforwards related to the recorded assets expire as follows: $1.0 million by 2013 and $2.4 million may be carried forward indefinitely.

The American Jobs Creation Act of 2004, enacted on October 22, 2004 (the “Jobs Act”), provided for a temporary 85% dividends received deduction on certain foreign earnings repatriated during a one-year period. To qualify for the deduction, the earnings must be reinvested in the U.S. pursuant to a domestic reinvestment plan established by a company’s Chief Executive Officer and approved by its Board of Directors. Certain other criteria in the Jobs Act must be satisfied as well. During 2005, the Company’s Chief Executive Officer established domestic reinvestment plans which were approved by the Board of Directors. Pursuant to the plans, the Company repatriated $85.0 million from foreign subsidiaries during 2005. The repatriation resulted in recognition of income tax expense of $3.7 million, for which the Company provided $2.3 million in 2004 and $1.4 million in 2005. At the close of 2006, the Company has not provided tax on its cumulative undistributed earnings of foreign subsidiaries of approximately $50 million, because it is the Company’s intention to reinvest these earnings indefinitely. The calculation of the unrecognized deferred tax liability related to these earnings is complex and is not practicable. If earnings were distributed, the Company would be subject to U.S. taxes and withholding taxes payable to various foreign governments. Based on the facts and circumstances at that time, the Company would determine whether a

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credit for foreign taxes already paid would be available to reduce or offset the U.S. tax liability. The Company anticipates that earnings would not be repatriated unless it was tax efficient to do so.

Note 9 — Earnings Per Share

Basic earnings per share are computed by dividing net earnings by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share include the effect of conversions of stock options, stock-settled stock appreciation rights (“SSAR’s”) and nonvested shares. Diluted earnings per share have been computed as follows:

(dollars in millions, except per share amounts; shares in thousands)	2006		2005		2004
Net earnings from continuing operations	$	125.4	$	76.5	$	37.1
Weighted average shares outstanding — basic		65,894		67,520		67,947
Net effect of dilutive stock options based on the treasury stock method		952		306		23
Net effect of dilutive SSAR’s based on the treasury stock method		6		—		—
Dilutive shares due to nonvested shares		122		28		50
Outstanding shares for diluted earnings per share		66,974		67,854		68,020
Diluted earnings per share from continuing operations	$	1.87	$	1.13	$	0.55

The Company uses the treasury stock method for calculating the dilutive effect of employee stock options, stock-settled stock appreciation rights (“stock-settled SAR’s”) and nonvested shares. These instruments will have a dilutive effect under the treasury stock method only when the respective period’s average market value of the underlying Company common stock exceeds the actual proceeds. In applying the treasury stock method, assumed proceeds include the amount, if any, the employee must pay upon exercise, the amount of compensation cost for future services that the Company has not yet recognized, and the amount of tax benefits, if any, that would be credited to additional paid-in capital assuming exercise of the options and stock-settled SAR’s and the vesting of nonvested shares. There were no stock options or stock-settled stock appreciation rights excluded from the calculation of diluted earnings per share for the 53 weeks ended February 3, 2007. The Company excluded approximately 1.4 million and 7.3 million stock options from the calculation of diluted earnings per share for the 52 weeks ended January 28, 2006, and January 29, 2005, respectively.

Note 10 – Favorable Leases

Favorable lease rights subject to amortization pursuant to SFAS 142 are as follows:

(dollars in millions)	2006			2005
Gross carrying amount	$	67.2		$	75.6
Less: accumulated amortization		(54.4	)		(57.4	)
Carrying amount, end of year	$	12.8		$	18.2

Amortization expense on favorable lease rights was as follows:

(dollars in millions)	2006		2005		2004
Amortization expense on favorable lease rights	$	3.2	$	3.4	$	4.1

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

Year	Amount
2007	$	2.6
2008		2.2
2009		1.8
2010		1.5
2011		1.3

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Note 11 — Notes Payable

The Company has entered into $2.0 million of demand notes payable to efficiently finance its subsidiaries in the Central American Region. The Company maintains balances of $2.0 million in certificates of deposit as compensating balances to collateralize these notes payable. The notes payable accrue interest at a weighted average rate of 6.75%. The certificates of deposit earn interest at a weighted average rate of 6.00% and are reflected as restricted cash in the accompanying consolidated balance sheet.

Note 12 — Accrued Expenses and Other Liabilities

Major components of accrued expenses included:

(dollars in millions)	2006		2005
Profit sharing, bonus and salaries	$	68.3	$	56.1
Sales, use and other taxes		34.3		30.2
Income taxes		26.6		23.9
Accrued restructuring costs		0.9		3.2
Other accrued expenses		60.1		50.1
Total	$	190.2	$	163.5

Major components of other liabilities included:

(dollars in millions)	2006		2005
Pension plan	$	29.6	$	18.0
Deferred tenant improvement allowances, net		26.1		25.0
Accrued step rent		24.6		21.7
Workers’ compensation and general liability insurance reserves		16.3		18.9
Other		36.0		25.7
Total	$	132.6	$	109.3

Note 13 — Long-term Debt

Long-term debt and capital-lease obligations were:

(dollars in millions)	2006		2005
Senior subordinated notes*	$	197.6	$	197.3
Capital-lease obligations		0.5		0.9
Other		4.0		6.4
Total debt		202.1		204.6
Less: current maturities of long-term debt		0.4		0.4
Long-term debt	$	201.7	$	204.2

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Future debt maturities as of February 3, 2007, are as follows:

(dollars in millions)

	Senior			Capital
	Subordinated			Lease
Year	Notes			Obligations		Other		Total
2007	$	—		$	0.4	$	—	$	0.4
2008		—			0.1		—		0.1
2009		—			—		4.0		4.0
2010		—			—		—		—
2011		—			—		—		—
Thereafter		200.0	*		—		—		200.0
Total	$	200.0		$	0.5	$	4.0	$	204.5

* At February 3, 2007, the $200 million of 8.25% Senior Subordinated Notes are recorded at $197.6 million (net of $2.4 million discount). At January 28, 2006, the notes were recorded at $197.3 million (net of $2.7 million discount).

The Company maintains a $200 million senior secured revolving credit facility (the “Facility”). Funds borrowed under the Facility are secured by domestic merchandise inventory and receivables. In April 2006, the Company entered into its first Amendment to the Facility. Among other things, the amendment extends the term of the Facility until January 15, 2011, allows the Company to increase the maximum borrowing amount up to $250 million from $200 million prior to the expiration of the Facility, and decreases the quarterly commitment fee payable on the unborrowed balance from 0.30% to 0.25%. The Facility bears interest at the London Inter-bank Offered Rate (“LIBOR”), plus a variable margin of 1.0% to 1.5%, or the base rate as defined in the agreement governing the Facility, based upon certain borrowing levels. The variable interest rate including the applicable variable margin at February 3, 2007 was 6.37%. A quarterly commitment fee of 0.25% per annum is payable on the unborrowed balance. No amounts were drawn on the Facility as of February 3, 2007. Based on the Company’s current borrowing base, the Company may borrow up to $187.1 million under the Facility, less $30.4 million in outstanding letters of credit as of February 3, 2007.

In July 2003, the Company sold $200.0 million of 8.25% Senior Subordinated Notes (the “Notes”) for $196.7 million, due 2013. The discount of $3.3 million is being amortized to interest expense over the life of the Notes. The Notes are guaranteed by all of the Company’s domestic subsidiaries. Interest on the Notes is payable semi-annually. The Notes contain various covenants including those that may limit the Company’s ability to pay dividends, repurchase stock, accelerate the retirement of other subordinated debt or make certain investments. As of February 3, 2007, the Company is in compliance with all covenants. As of February 3, 2007, the fair value of the Notes is $207.0 million based on recent trading activity of the Notes. On or after August 1, 2008, the Company may, on any one or more occasions, redeem all or a part of the Notes at the redemption prices set forth below, plus accrued and unpaid interest, if any, on the Notes redeemed, to the applicable redemption date:

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

Note 14 — Lease Obligations

The Company leases substantially all of its stores. Rental expense for the Company’s operating leases consisted of:

(dollars in millions)	2006		2005		2004
Minimum rentals	$	270.6	$	264.2	$	266.5
Contingent rentals based on sales		7.1		7.0		7.0
Real property rentals		277.7		271.2		273.5
Equipment rentals		0.3		0.3		0.7
Total	$	278.0	$	271.5	$	274.2

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Most lease agreements contain renewal options and include escalating rents over the lease terms. Certain leases provide for contingent rentals based upon gross sales. Cumulative expense recognized on the straight-line basis in excess of cumulative payments is included in accrued expenses and other liabilities on the accompanying consolidated balance sheets. Certain of the Company’s lease agreements provide for scheduled rent increases during the lease term, as well as provisions for renewal options. Rent expense is recognized on a straight-line basis over the term of the lease from the time at which the Company takes possession of the property. In instances where failure to exercise renewal options would result in an economic penalty, the calculation of straight-line rent expense includes renewal option periods. Also, landlord-provided tenant improvement allowances are recorded as a liability and amortized as a credit to rent expense.

Future minimum lease payments under non-cancelable lease obligations as of February 3, 2007, were as follows:

	Capital		Operating
(dollars in millions)	Leases		Leases		Total
2007	$	0.4	$	254.4	$	254.8
2008		0.1		225.9		226.0
2009		—		191.6		191.6
2010		—		159.0		159.0
2011		—		127.6		127.6
2012 and thereafter		—		275.0		275.0
Minimum lease payments	$	0.5	$	1,233.5	$	1,234.0
Less: imputed interest component		0.1
Present value of net minimum lease payments, included in current liabilities	$	0.4

At February 3, 2007, the total amount of minimum rentals to be received in the future under non-cancelable subleases was $11.1 million.

Note 15 — Common Stock Repurchases

The Company has repurchased the following:

	2006				2005				2004
(dollars in millions, shares in thousands)	Dollars		Shares		Dollars		Shares		Dollars		Shares
Stock repurchase program	$	128.4		4,960	$	70.4		3,234	$	10.1		839
Employee stock purchase, deferred compensation and stock incentive plans		0.9		34		0.8		45		1.3		99
	$	129.3		4,994	$	71.2		3,279	$	11.4		938

Under the indenture governing the Company’s 8.25% Senior Subordinated Notes, the Company may repurchase approximately $12.4 million of common stock. This limit may increase or decrease based upon the Company’s earnings. As of February 3, 2007, the Company has approximately $39.3 million of remaining common stock repurchase authorization from its Board of Directors. On March 2, 2007, the Company’s board of directors authorized an aggregate of $250 million of share repurchases.

Note 16 — Commitments and Contingencies

As of February 3, 2007, the Company has $46.7 million of royalty obligations consisting of minimum royalty payments for the purchase of branded merchandise, $18.3 million of equipment purchase obligations related to a new distribution facility, $10.0 million of intangible asset obligations related to trademark purchases, $10.1 million of service agreement obligations relating to minimum payments for services that the Company cannot avoid without penalty and $3.1 million of employment agreement obligations related to minimum payments to certain of the Company’s executives.

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

On or about February 5, 2004, a complaint was filed against the Company in the U.S. District Court for the Central District of California, captioned K-Swiss, Inc. v. Payless ShoeSource, Inc. The Complaint seeks injunctive relief and unspecified monetary damages for trademark and trade dress infringement, trademark dilution and unfair competition. On May 14, 2005, a First Amended Complaint was filed, to include a breach of contract claim. The Company believes it has meritorious defenses to the claims asserted in the lawsuit and has filed an answer. A pre-trial conference was held on November 13, 2006, during which the trial judge indicated that he was transferring the case to a new judge for all further proceedings. The case subsequently was assigned to Judge George P. Schiavelli and a status conference was held on January 29, 2007. During that status conference, Judge Schiavelli set a February 5, 2008 trial date, with the pretrial conference to be held on January 7, 2008. On October 12, 2006, the Company filed a suit against St. Paul Fire and Marine Insurance Company (“St. Paul”), in Kansas state court seeking damages and a declaratory judgment that St. Paul is obligated to provide coverage in connection with the underlying lawsuit brought by K-Swiss. On October 18, 2006, St. Paul filed a separate declaratory judgment action in the U.S. District Court for the Central District of California seeking a declaration that there is no coverage for the underlying lawsuit. The Company has moved to dismiss the California action filed by St. Paul, which was granted on February 12, 2007. On November 2, 2006, St. Paul removed the action from state court to the U.S. District Court for the District of Kansas. Also, on November 2, 2006, St. Paul moved to transfer the Kansas action to the U.S. District Court for the Central District of California, which was denied on January 10, 2007. On January 23, 2007, St. Paul filed a motion to stay the Kansas Action until the underlying lawsuit is resolved, which was granted on March 2, 2007. An estimate of the possible loss, if any or the range of the loss cannot be made. However, the ultimate resolution of this matter could have a material adverse effect on the Company’s Consolidated Financial Statements.

On or about December 20, 2001, a First Amended Complaint was filed against the Company in the U.S. District Court for the District of Oregon, captioned adidas America, Inc. and adidas-Salomon AG v. Payless ShoeSource, Inc. The First Amended Complaint seeks injunctive relief and unspecified monetary damages for trademark and trade dress infringement, unfair competition, deceptive trade practices and breach of contract. The Company believes it has meritorious defenses to claims asserted in the lawsuit and has filed an answer and a motion for summary judgment which the court granted in part. On June 18, 2004, the plaintiff appealed the District Court’s ruling on the motion for summary judgment. On January 5, 2006, the 9^th Circuit Court of Appeals entered an order reversing the District Court’s partial summary judgment order. The Company requested a rehearing en banc, which was denied by the 9^th Circuit Court of Appeals. On June 29, 2006, the Company filed a petition for writ of certiorari to the United States Supreme Court, which was denied on October 2, 2006. On August 22, 2006, the District Court entered an amended scheduling order setting an August 14, 2007 trial date. An estimate of the possible loss, if any or the range of loss cannot be made. However, the ultimate resolution of this matter could have a material adverse effect on the Company’s Consolidated Financial Statements.

On or about April 3, 2006, Crocs Inc. filed two companion actions against several manufacturers of foam clog footwear asserting claims for patent infringement, trade dress infringement, and unfair competition. One complaint was filed before the United States International Trade Commission (“ITC”) in Washington D.C. The other complaint was filed in federal district court in Colorado. Collective Licensing International LLC (“Collective”), who licenses Airwalk^® brand to the Company, was named as a Respondent in the ITC Investigation, and as a Defendant in the Colorado federal court action. The Company has not been named in either matter; however, the Company owes certain indemnity obligations to Collective under its licensing agreement. The ITC published notice in the Federal Register on May 8, 2006, announcing that it is commencing an investigation into the allegations contained in Crocs’ complaint. In accordance with federal law, the Colorado federal court action will be stayed pending the outcome of the ITC investigation. A motion to stay the Colorado federal court action was filed on May 12, 2006. Before the ITC, Crocs seeks an order and injunction prohibiting any of the respondents from importing or selling any imported shoes that infringe on Crocs’ patent and trade dress rights. In the federal court action, which, as noted above, will be stayed, Crocs seeks damages and injunctive relief prohibiting the defendants from infringing on Crocs’ intellectual property rights. On November 7, 2006, the Administrative Law Judge in the ITC action entered an order granting summary judgment of non-infringement of design patent No. 0517,589 in favor of Collective and the other remaining respondents. Further, because Crocs’ expert and fact witnesses admitted that the recent versions of the shoes of all respondents did not infringe the separate utility patent at issue, Crocs proposed that the trial, which was to commence on November 13, 2006, be continued pending review. All respondents agreed not to oppose Crocs’ request to continue the trial and on

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November 8, 2006, the Administrative Law Judge entered an order on Crocs’ motion postponing the trial indefinitely pending review of the summary judgment motion by the ITC. On December 21, 2006, the ITC decided to review, in part, the initial determination granting summary determination of non-infringement of design patent No. D517,589. On February 15, 2007, the ITC vacated the initial determination and remanded for further proceedings. On February 22, 2007, the Administrative Law Judge entered an order extending the date for completion of the investigation to August 11, 2008; affirming his previous narrow claim construction of design patent No. D517,789; and rejecting the claim construction proposed by Crocs. Also, under this order, hearing has been set for January 14 - - 18, 2008, and the deadline for an initial determination by the Administrative Law Judge is April 11, 2008. The Company believes it has meritorious defenses to the claims asserted in the lawsuits and has filed an answer. An estimate of the possible loss, if any or the range of loss cannot be made. However, the ultimate resolution of this matter could have a material adverse effect on the Company’s Consolidated Financial Statements.

Note 17 — Segment Reporting

The Company and its subsidiaries are principally engaged in the operation of retail locations offering family footwear and accessories. The Company operates its business in two reportable business segments: Payless Domestic and Payless International. These segments have been determined based on internal management reporting and management responsibilities. The Payless Domestic segment includes retail operations in the United States, Guam and Saipan and sourcing operations. The Payless International segment includes retail operations in Canada, the South American Region, the Central American Region, Puerto Rico, and the U.S. Virgin Islands. The Company’s operations in its Central American and South American Regions are operated as joint ventures in which the Company maintains a 60% ownership interest. Certain management costs for services performed by Payless Domestic and certain royalty fees and sourcing fees charged by Payless Domestic are allocated to the Payless International segment. These total costs and fees amounted to $24.1 million, $18.1 million and $18.0 million during 2006, 2005 and 2004, respectively.

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The reporting period for operations in the Central and South American Regions use a December 31 year-end. The effect of this one-month lag on the Company’s financial position and results of operations is not significant. Information on the segments is as follows:

	Payless			Payless			Payless
(dollars in millions)	Domestic			International			Consolidated
Fiscal year ended February 3, 2007
Revenues from external customers	$	2,395.2		$	401.5		$	2,796.7
Operating profit from continuing operations		115.9			50.5			166.4
Interest expense		18.2			1.0			19.2
Interest income		(20.7	)		(2.0	)		(22.7	)
Earnings from continuing operations before income taxes and minority interest		118.4			51.5			169.9
Depreciation and amortization		74.3			14.2			88.5
Total assets		1,232.4			195.0			1,427.4
Long-lived assets		424.5			58.6			483.1
Additions to long-lived assets		146.4			12.7			159.1
Fiscal year ended January 28, 2006
Revenues from external customers	$	2,306.0		$	359.7		$	2,665.7
Operating profit from continuing operations		83.4			34.3			117.7
Interest expense		18.6			1.1			19.7
Interest income		(10.9	)		(1.4	)		(12.3	)
Earnings from continuing operations before income taxes and minority interest		75.7			34.6			110.3
Depreciation and amortization		76.4			14.0			90.4
Total assets		1,157.5			157.0			1,314.5
Long-lived assets		368.0			64.5			432.5
Additions to long-lived assets		54.3			5.3			59.6
Fiscal year ended January 29, 2005
Revenues from external customers	$	2,326.5		$	329.7		$	2,656.2
Operating profit from continuing operations		53.5			11.3			64.8
Interest expense		18.0			4.1			22.1
Interest income		(2.3	)		(3.0	)		(5.3	)
Earnings from continuing operations before income taxes and minority interest		37.8			10.2			48.0
Depreciation and amortization		80.3			14.3			94.6
Total assets		1,076.2			163.6			1,239.8
Long-lived assets		402.2			71.3			473.5
Additions to long-lived assets		98.6			12.0			110.6

Note 18 — Shareowner Protection Rights Agreement

The Company has adopted a Stockholder Protection Rights Agreement (the “Plan”) which provides for a dividend of one right (“Right”) for each outstanding share of the Company’s common stock. The Rights are separated by and traded with the Company’s common stock. There are no separate certificates or markets for the Rights, and the Rights will expire on or before May 21, 2008. No Rights were exercised under the Plan in fiscal 2006.

The Rights do not become exercisable or trade separately from the common stock unless 15% or more of the common stock of the Company has been acquired, or after a tender or exchange offer is made for 15% or greater ownership of the Company’s common stock. Should the Rights become exercisable; each Right will entitle the holder thereof to buy 1/100^th of a share of the Company’s Series A Preferred Stock at an exercise price of $83.33.

Under certain circumstances, each Right “flips-in” and becomes a right to buy, for the exercise price, the Company’s common stock at a 50% discount. Under certain other circumstances, each Right “flips-over” and becomes a right to buy, for the exercise price, an acquirer’s common stock at a 50% discount.

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The Rights may be redeemed by the Company for $0.01 per Right at any time on or prior to the first public announcement by the Company of the acquisition by any person of beneficial ownership of 15% or more of the Company’s stock (or a later date as determined by the Board of Directors).

Note 19 — Subsequent Events

Subsequent to the end of fiscal 2006, the Company’s Board of Directors approved a plan to shift to a dual-distribution center model. As part of the plan, the Company intends to open a new distribution center east of the Mississippi river (in a location to be determined) which will begin operation around June 2008. This distribution center will be in addition to the Company’s Redlands, California distribution center that will commence operations in the summer of 2007. Once both new distribution centers are operating satisfactorily, the Company plans to close its current distribution center in Topeka, Kansas. Total exit costs related to the closing of the Topeka distribution center are currently estimated to be approximately $14 million, consisting of approximately $4 million of non-cash accelerated depreciation expenses, approximately $8 million for employee severance expenses, and approximately $2 million related to other exit costs. A portion of the employee severance expenses will be recognized in the first quarter of 2007. The majority of the remaining exit costs will be recognized over the period until the Topeka distribution center is closed. Actual results could vary from these estimates.

On March 6, 2007, the Company entered into an agreement to acquire 100% of the partnership interest of Collective International, LP (“Collective”) for $91 million in cash, excluding transaction costs and subject to customary purchase price adjustments to reflect current assets and total liabilities at closing. Collective is a brand development, management and licensing company that currently licenses the Airwalk brand to the Company. This transaction closed on March 30, 2007.

Note 20 — Change in Accounting Principle

During the fourth quarter of 2005, the Company adopted FASB Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations — An Interpretation of FASB Statement No. 143” (“FIN 47”). FIN 47 clarified the timing of liability recognition for legal obligations associated with the retirement of a tangible long-lived asset when the timing and (or) method of settlement of the obligation are conditional on a future event. FIN 47 also clarified that an entity is required to recognize a liability for the fair value of a conditional asset retirement obligation when a tangible long-lived asset is obtained, if the liability’s fair value can be reasonably estimated. Please refer to Note 1 for further discussion regarding the Company’s accounting for asset retirement obligations. Prior to this change, the Company expensed such asset retirement costs when incurred. The initial adoption resulted in a charge of $4.1 million (net of income taxes and minority interest), which was recorded as a cumulative effect of a change in accounting principle. The adoption increased net property and equipment by $1.7 million, increased asset retirement obligations by $8.5 million, and increased deferred tax assets by $2.7 million.

As of the end of 2005, the ARO liability was $8.5 million, and had FIN 47 been applied during 2004, the pro forma ARO liabilities would have been $8.5 million.

Pro forma results of operations for 2004 had the Company applied the provisions of FIN 47 in those periods are as follows:

(dollars in millions, except per share amounts)	2004
Net earnings (loss) before cumulative effect of change in accounting principle:
As reported	$	(2.0	)
Add: Total asset retirement expenses included in net earnings (loss) as reported, net of related income taxes and minority interest		0.8
Less: Total asset retirement expenses determined under FIN 47, net of related income taxes and minority interest		0.4
Pro forma net loss	$	(1.6	)
Diluted earnings (loss) per share:
As reported	$	(0.03	)
Pro forma	$	(0.02	)

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Note 21 — New Accounting Standards

In February 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments — an amendment of SFAS No. 133 and 140.” This Statement simplifies accounting for certain hybrid financial instruments, eliminates the interim guidance in Statement 133 Implementation Issue No. D1, “Application of Statement 133 to Beneficial Interest in Securitized Financial Assets,” and eliminates a restriction of the passive derivative instruments that a qualifying special-purpose entity may hold. The Statement is effective for fiscal years beginning after September 15, 2006. The adoption of this Statement is not anticipated to have a material impact on the Company’s Consolidated Financial Statements.

In March 2006, the Emerging Issues Task Force (“EITF”) issued EITF Issue 06-3, “How Taxes Collected From Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement.” A consensus was reached that entities may adopt a policy of presenting sales taxes in the income statement on either a gross or net basis. If taxes are significant, an entity should disclose its policy of presenting taxes and the amounts of taxes. The guidance is effective for periods beginning after December 15, 2006. In the consolidated statement of earnings, The Company presents sales net of such taxes within the scope of EITF Issue 06-3. Other than the additional required disclosure, this EITF will not have an impact on the Company’s Consolidated Financial Statements.

In June 2006, the Financial Accounting Standards Board issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FAS 109, Accounting for Income Taxes” (“FIN 48”), to create a single model to address accounting for uncertainty in tax positions. FIN 48 clarifies the accounting for income taxes, by prescribing a minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company will adopt FIN 48 in the first fiscal quarter of 2007, as required, and the cumulative effect of adopting FIN 48 will be recorded in retained earnings. The Company is in the process of evaluating FIN 48’s impact on its Consolidated Financial Statements.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” This statement defines fair value, establishes a framework for using fair value to measure assets and liabilities, and expands disclosures about fair value measurements. The statement applies whenever other standards require or permit assets or liabilities to be measured at fair value. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. The Company is evaluating the impact the adoption of SFAS No. 157 will have on its Consolidated Financial Statements.

In September 2006, the SEC issued Staff Accounting Bulletin (“SAB”) No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements,” which provides interpretive guidance regarding the consideration given to prior year misstatements when determining materiality in current year financial statements. SAB No. 108 is effective for fiscal years ending after November 15, 2006. The impact of this adoption was not material to the Company’s Consolidated Financial Statements.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Liabilities.” This statement permits entities to choose to measure many financial instruments and certain other items at fair value. If the fair value option is elected, unrealized gains and losses will be recognized in earnings at each subsequent reporting date. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. The Company is currently evaluating the impact of this adoption on its Consolidated Financial Statements.

Note 22 — Related Party Transactions

The Company maintains banking relationships with certain financial institutions that are affiliated with some of the Company’s Latin America joint venture partners. Total deposits in these financial institutions at end of 2006, 2005 and 2004 were $7.9 million, $9.3 million and $5.6 million, respectively. Total borrowings from the Company’s Latin American partners were $4.0 million, $6.4 million and $6.4 million as of the end of 2006, 2005 and 2004, respectively. In addition, the Company recorded interest expense of $0.2 million, $0.3 million and $0.2 million during 2006, 2005 and 2004, respectively, related to these borrowings.

73

Mr. Matthew E. Rubel is the Company’s Chief Executive Officer and President. The Company began a relationship with Celadon Group, Inc. (“Celadon”) in 2002. Mr. Rubel’s father-in-law, Stephen Russell, is Chairman of the Board and Chief Executive Officer of Celadon. Pursuant to a competitive bid process, during 2006 Celadon won the right to be the primary carrier on two of the Company’s transportation lanes. These lanes account for less than two percent of the Company’s outbound line haul budget. The Company regularly competitively bids its line haul routes and as a result, Celadon could gain or lose routes based upon its bids.

In June 2006, the Company entered into a Marketing and License Agreement with Ballet Theatre Foundation Inc., a nonprofit organization, to use the American Ballet Theatre and ABT marks in connection with development, manufacture, marketing promotion, distribution, and sale of certain dance footwear. Mr. Rubel became a Trustee of Ballet Theatre Foundation, Inc., in January 2007.

Note 23 — Subsidiary Guarantors of Senior Notes — Consolidating Financial Information

The Company has issued Notes guaranteed by certain of its subsidiaries (the “Guarantor Subsidiaries”). The Guarantor Subsidiaries are direct or indirect wholly owned domestic subsidiaries of the Company. The guarantees are full and unconditional, to the extent allowed by law, and joint and several.

The following supplemental financial information sets forth, on a consolidating basis, the condensed statements of earnings for the Company (the “Parent Company”), for the Guarantor Subsidiaries and for the Company’s non-guarantor subsidiaries (the “Non-guarantor Subsidiaries”) and total consolidated Payless ShoeSource, Inc. and subsidiaries for the 53 week period ended February 3, 2007, and 52 week periods ended January 28, 2006, and January 29, 2005, condensed balanced sheets as of February 3, 2007, and January 28, 2006, and the condensed statements of cash flows for the 53 week period ended February 3, 2007, and the 52 week periods ended January 28, 2006, and January 29, 2005. With the exception of operations in the Central and South American Regions in which the Company has a 60% ownership interest, the Non-guarantor Subsidiaries are direct or indirect wholly-owned subsidiaries of the Guarantor Subsidiaries. The intercompany investment for each subsidiary is recorded by its parent in Other Assets.

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

Under the indenture governing the Notes, the Company’s subsidiaries in Singapore and Japan are designated as unrestricted. The effect of these subsidiaries on the Company’s financial position and results of operations and cash flows for fiscal years 2006, 2005 and 2004 is not significant.

74

CONDENSED CONSOLIDATING STATEMENTS OF EARNINGS
(dollars in millions)

	53 Weeks Ended February 3, 2007
	Parent			Guarantor			Non-guarantor
	Company			Subsidiaries			Subsidiaries			Eliminations			Consolidated
Net sales	$	—		$	2,522.6		$	872.8		$	(598.7	)	$	2,796.7
Cost of sales		—			1,732.4			674.5			(585.9	)		1,821.0
Gross margin		—			790.2			198.3			(12.8	)		975.7
Selling, general and administrative expense		4.5			706.3			110.5			(12.8	)		808.5
Restructuring charges		—			0.8			—			—			0.8
Operating (loss) profit from continuing operations		(4.5	)		83.1			87.8			—			166.4
Interest expense		39.0			1.2			1.0			(22.0	)		19.2
Interest income		—			(41.6	)		(3.1	)		22.0			(22.7	)
Equity in earnings of subsidiaries		(151.3	)		(67.4	)		—			218.7			—
Earnings from continuing operations before income taxes and minority interest		107.8			190.9			89.9			(218.7	)		169.9
(Benefit) provision for income taxes		(14.2	)		39.1			15.0			—			39.9
Earnings from continuing operations before minority interest		122.0			151.8			74.9			(218.7	)		130.0
Minority interest, net of income taxes		—			—			(4.6	)		—			(4.6	)
Net earnings from continuing operations		122.0			151.8			70.3			(218.7	)		125.4
Loss from discontinued operations, net of income taxes and minority interest		—			(0.5	)		(2.9	)		—			(3.4	)
Net earnings	$	122.0		$	151.3		$	67.4		$	(218.7	)	$	122.0

75

CONDENSED CONSOLIDATING STATEMENTS OF EARNINGS
(dollars in millions)

	52 Weeks Ended January 28, 2006
	Parent			Guarantor			Non-guarantor
	Company			Subsidiaries			Subsidiaries			Eliminations			Consolidated
Net sales	$	—		$	2,424.0		$	722.5		$	(480.8	)	$	2,665.7
Cost of sales		—			1,687.4			560.4			(470.7	)		1,777.1
Gross margin		—			736.6			162.1			(10.1	)		888.6
Selling, general and administrative expense		4.6			673.5			99.1			(10.1	)		767.1
Restructuring charges		—			4.1			(0.3	)		—			3.8
Operating (loss) profit from continuing operations		(4.6	)		59.0			63.3			—			117.7
Interest expense		32.0			1.5			1.1			(14.9	)		19.7
Interest income		—			(24.7	)		(2.5	)		14.9			(12.3	)
Equity in earnings of subsidiaries		(91.1	)		(44.4	)		—			135.5			—
Earnings from continuing operations before income taxes and minority interest		54.5			126.6			64.7			(135.5	)		110.3
(Benefit) provision for income taxes		(11.9	)		28.0			14.7			—			30.8
Earnings from continuing operations before minority interest		66.4			98.6			50.0			(135.5	)		79.5
Minority interest, net of income taxes		—			—			(3.0	)		—			(3.0	)
Net earnings from continuing operations		66.4			98.6			47.0			(135.5	)		76.5
Loss from discontinued operations, net of income taxes and minority interest		—			(3.7	)		(2.3	)		—			(6.0	)
Net earnings before cumulative effect of change in accounting principle		66.4			94.9			44.7			(135.5	)		70.5
Cumulative effect of change in accounting principle, net of income taxes and minority interest		—			(3.8	)		(0.3	)		—			(4.1	)
Net earnings	$	66.4		$	91.1		$	44.4		$	(135.5	)	$	66.4

76

CONDENSED CONSOLIDATING STATEMENTS OF EARNINGS (LOSS)
(dollars in millions)

	52 Weeks Ended January 29, 2005
	Parent			Guarantor			Non-guarantor
	Company			Subsidiaries			Subsidiaries			Eliminations			Consolidated
Net sales	$	—		$	2,457.0		$	652.2		$	(453.0	)	$	2,656.2
Cost of sales		—			1,752.3			530.2			(446.0	)		1,836.5
Gross margin		—			704.7			122.0			(7.0	)		819.7
Selling, general and administrative expense		2.4			639.0			95.6			(7.0	)		730.0
Restructuring charges		—			24.4			0.5			—			24.9
Operating (loss) profit from continuing operations		(2.4	)		41.3			25.9			—			64.8
Interest expense		26.9			0.6			4.1			(9.5	)		22.1
Interest income		—			(11.8	)		(3.0	)		9.5			(5.3	)
Equity in earnings of subsidiaries		(17.0	)		(16.5	)		—			33.5			—
(Loss) earnings from continuing operations before income taxes and minority interest		(12.3	)		69.0			24.8			(33.5	)		48.0
(Benefit) provision for income taxes		(10.3	)		24.6			(1.1	)		—			13.2
(Loss) earnings from continuing operations before minority interest		(2.0	)		44.4			25.9			(33.5	)		34.8
Minority interest, net of income taxes		—			—			2.3			—			2.3
Net (loss) earnings from continuing operations		(2.0	)		44.4			28.2			(33.5	)		37.1
Loss from discontinued operations, net of income taxes and minority interest		—			(27.4	)		(11.7	)		—			(39.1	)
Net (loss) earnings	$	(2.0	)	$	17.0		$	16.5		$	(33.5	)	$	(2.0	)

77

CONDENSED CONSOLIDATING BALANCE SHEET
As of February 3, 2007
(dollars in millions)

	Parent		Guarantor			Non-guarantor
	Company		Subsidiaries			Subsidiaries			Eliminations			Consolidated
ASSETS
Current Assets:
Cash and cash equivalents	$	—	$	239.4		$	132.0		$	—		$	371.4
Short-term investments		—		90.0			—			—			90.0
Restricted cash		—		—			2.0			—			2.0
Inventories		—		282.8			83.5			(4.4	)		361.9
Current deferred income taxes		—		13.2			2.4			—			15.6
Prepaid expenses		0.6		40.2			5.7			—			46.5
Other current assets		42.3		15.3			57.9			(97.4	)		18.1
Current assets of discontinued operations		—		1.0			0.1			—			1.1
Total current assets		42.9		681.9			283.6			(101.8	)		906.6
Property and Equipment:
Land		—		6.6			—			—			6.6
Property, buildings and equipment		—		1,096.7			148.4			—			1,245.1
Accumulated depreciation and amortization		—		(741.4	)		(89.1	)		—			(830.5	)
Property and equipment, net		—		361.9			59.3			—			421.2
Favorable leases, net		—		12.8			—			—			12.8
Deferred income taxes		—		31.3			6.4			—			37.7
Goodwill		—		5.9			—			—			5.9
Other assets		1,315.4		487.0			1.3			(1,760.5	)		43.2
Total Assets	$	1,358.3	$	1,580.8		$	350.6		$	(1,862.3	)	$	1,427.4
LIABILITIES AND SHAREOWNERS’ EQUITY
Current Liabilities:
Current maturities of long-term debt	$	—	$	0.4		$	—		$	—		$	0.4
Notes payable		—		—			2.0			—			2.0
Accounts payable		—		146.6			59.5			(20.5	)		185.6
Accrued expenses		175.4		32.3			63.8			(81.3	)		190.2
Current liabilities of discontinued operations		—		2.1			—			—			2.1
Total current liabilities		175.4		181.4			125.3			(101.8	)		380.3
Long-term debt		480.7		0.1			4.0			(283.1	)		201.7
Other liabilities		2.1		115.2			15.3			—			132.6
Minority interest		—		—			12.7			—			12.7
Commitments and contingencies
Total shareowners’ equity		700.1		1,284.1			193.3			(1,477.4	)		700.1
Total Liabilities and Shareowners’ Equity	$	1,358.3	$	1,580.8		$	350.6		$	(1,862.3	)	$	1,427.4

78

CONDENSED CONSOLIDATING BALANCE SHEET
As of January 28, 2006
(dollars in millions)

	Parent		Guarantor			Non-guarantor
	Company		Subsidiaries			Subsidiaries			Eliminations			Consolidated
ASSETS
Current Assets:
Cash and cash equivalents	$	—	$	310.5		$	67.7		$	—		$	378.2
Short-term investments		—		58.5			0.5			—			59.0
Restricted cash		—		—			2.0			—			2.0
Inventories		—		271.3			63.9			(2.6	)		332.6
Current deferred income taxes		—		19.3			0.9			—			20.2
Prepaid expenses		0.6		33.6			5.2			—			39.4
Other current assets		28.1		49.1			26.3			(83.3	)		20.2
Current assets of discontinued operations		—		1.6			1.3			—			2.9
Total current assets		28.7		743.9			167.8			(85.9	)		854.5
Property and Equipment:
Land		—		7.7			—			—			7.7
Property, buildings and equipment		—		1,044.3			140.9			—			1,185.2
Accumulated depreciation and amortization		—		(728.8	)		(79.0	)		—			(807.8	)
Property and equipment, net		—		323.2			61.9			—			385.1
Favorable leases, net		—		18.2			—			—			18.2
Deferred income taxes		—		18.5			9.0			—			27.5
Goodwill		—		5.9			—			—			5.9
Other assets		1,157.1		405.5			1.3			(1,542.0	)		21.9
Noncurrent assets of discontinued operations		—		—			1.4			—			1.4
Total Assets	$	1,185.8	$	1,515.2		$	241.4		$	(1,627.9	)	$	1,314.5
LIABILITIES AND SHAREOWNERS’ EQUITY
Current Liabilities:
Current maturities of long-term debt	$	—	$	0.4		$	—		$	—		$	0.4
Notes payable		—		—			2.0			—			2.0
Accounts payable		—		159.4			66.0			(56.8	)		168.6
Accrued expenses		51.5		127.4			13.7			(29.1	)		163.5
Current liabilities of discontinued operations		—		3.4			0.6			—			4.0
Total current liabilities		51.5		290.6			82.3			(85.9	)		338.5
Long-term debt		480.4		0.6			6.4			(283.2	)		204.2
Other liabilities		1.9		94.9			12.5			—			109.3
Minority interest		—		—			10.5			—			10.5
Commitments and contingencies
Total shareowners’ equity		652.0		1,129.1			129.7			(1,258.8	)		652.0
Total Liabilities and Shareowners’ Equity	$	1,185.8	$	1,515.2		$	241.4		$	(1,627.9	)	$	1,314.5

79

CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
For the 53 Weeks Ended February 3, 2007
(dollars in millions)

	Parent			Guarantor			Non-Guarantor
	Company			Subsidiaries			Subsidiaries			Eliminations			Consolidated
Operating Activities:
Net earnings	$	122.0		$	151.3		$	67.4		$	(218.7	)	$	122.0
Loss from discontinued operations, net of income taxes and minority interest		—			0.5			2.9			—			3.4
Adjustments for non-cash items included in net earnings:
Loss on impairment of and disposal of assets		—			8.7			1.6			—			10.3
Depreciation and amortization		—			74.1			14.4			—			88.5
Amortization of deferred financing costs		0.9			0.2			—			—			1.1
Share-based compensation expense		—			11.0			1.2			—			12.2
Deferred income taxes		—			(1.4	)		10.5			—			9.1
Minority interest, net of income taxes		—			—			4.6			—			4.6
Income tax benefit of share-based compensation		—			0.6			—			—			0.6
Accretion of investments		—			(3.6	)		—			—			(3.6	)
Changes in working capital:
Inventories		—			(11.5	)		(20.1	)		1.8			(29.8	)
Prepaid expenses and other current assets		(14.2	)		24.0			(32.9	)		14.1			(9.0	)
Accounts payable		—			(14.5	)		(6.2	)		36.3			15.6
Accrued expenses		123.9			(107.2	)		41.2			(52.2	)		5.7
Other assets and liabilities, net		(150.4	)		(67.7	)		2.4			218.7			3.0
Net cash used in discontinued operations		—			(1.2	)		(2.8	)		—			(4.0	)
Cash flow provided by operating activities		82.2			63.3			84.2			—			229.7
Investing Activities:
Capital expenditures		—			(103.8	)		(14.8	)		—			(118.6	)
Proceeds from sale of property and equipment		—			4.6			—			—			4.6
Intangible asset additions		—			(15.5	)		—			—			(15.5	)
Purchases of investments		—			(214.9	)		(0.7	)		—			(215.6	)
Sales and maturities of investments		—			187.0			1.2			—			188.2
Investment in subsidiaries		—			(1.5	)		—			1.5			—
Cash flow used in investing activities		—			(144.1	)		(14.3	)		1.5			(156.9	)
Financing Activities:
Repayment of debt		—			(0.4	)		(2.4	)		—			(2.8	)
Payment of deferred financing costs		—			(0.2	)		—			—			(0.2	)
Issuances of common stock		47.1			—			—			—			47.1
Purchases of common stock		(129.3	)		—			—			—			(129.3	)
Dividends to parent		—			2.3			(2.3	)		—			—
Excess tax benefits from share-based compensation		—			8.0			—			—			8.0
Contribution by / distributions to parent		—			—			1.5			(1.5	)		—
Distributions to minority owners		—			—			(1.5	)		—			(1.5	)
Net cash provided by discontinued operations		—			—			1.2			—			1.2
Cash flow (used in) provided by financing activities		(82.2	)		9.7			(3.5	)		(1.5	)		(77.5	)
Effect of exchange rate changes on cash		—			—			(2.1	)		—			(2.1	)
(Decrease) increase in cash and cash equivalents		—			(71.1	)		64.3			—			(6.8	)
Cash and cash equivalents, beginning of year		—			310.5			67.7			—			378.2
Cash and cash equivalents, end of period	$	—		$	239.4		$	132.0		$	—		$	371.4

80

CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
For the 52 Weeks Ended January 28, 2006
(dollars in millions)

	Parent			Guarantor			Non-Guarantor
	Company			Subsidiaries			Subsidiaries			Eliminations			Consolidated
Operating Activities:
Net earnings	$	66.4		$	91.1		$	44.4		$	(135.5	)	$	66.4
Loss from discontinued operations, net of income taxes and minority interest		—			3.7			2.3			—			6.0
Adjustments for non-cash items included in net earnings:
Cumulative effect of change in accounting principle, net of income taxes and minority interest		—			3.8			0.3			—			4.1
Loss on impairment of and disposal of assets		—			7.9			1.9			—			9.8
Depreciation and amortization		—			80.7			9.7			—			90.4
Amortization of deferred financing costs		0.2			1.0			—			—			1.2
Share-based compensation expense		1.3			—			—			—			1.3
Deferred income taxes		—			11.7			2.0			—			13.7
Minority interest, net of income taxes		—			—			3.0			—			3.0
Income tax benefit of share-based compensation		6.5			—			—			—			6.5
Accretion of investments		—			(1.3	)		—			—			(1.3	)
Changes in working capital:
Inventories		—			5.8			7.9			(0.2	)		13.5
Prepaid expenses other current assets		(11.9	)		(32.1	)		19.6			22.4			(2.0	)
Accounts payable		—			29.4			(2.7	)		(17.7	)		9.0
Accrued expenses		44.3			(23.3	)		(7.0	)		(4.5	)		9.5
Other assets and liabilities, net		(85.2	)		(42.7	)		(1.2	)		135.5			6.4
Net cash used in discontinued operations		—			(8.3	)		(2.3	)		—			(10.6	)
Cash flow provided by operating activities		21.6			127.4			77.9			—			226.9
Investing Activities:
Capital expenditures		—			(59.8	)		(4.5	)		—			(64.3	)
Proceeds from sale of property and equipment		—			1.2			—			—			1.2
Restricted cash		—			—			1.0			—			1.0
Purchases of investments		—			(145.9	)		(0.5	)		—			(146.4	)
Sales and maturities of investments		—			110.0			—			—			110.0
Investment in subsidiaries		—			(1.7	)		—			1.7			—
Dividends from subsidiaries		—			85.1			—			(85.1	)		—
Net cash used in discontinued operations		—			—			(0.1	)		—			(0.1	)
Cash flow used in investing activities		—			(11.1	)		(4.1	)		(83.4	)		(98.6	)
Financing Activities:
Repayment of notes payable		—			—			(1.0	)		—			(1.0	)
Issuance of debt		—			—			1.2			—			1.2
Repayment of debt		—			(0.3	)		(1.2	)		—			(1.5	)
Issuances of common stock		49.6			—			—			—			49.6
Purchases of common stock		(71.2	)		—			—			—			(71.2	)
Contribution by / distributions to parent		—			—			1.7			(1.7	)		—
Dividends to parent		—			—			(85.1	)		85.1			—
Net cash provided by discontinued operations		—			—			0.9			—			0.9
Cash flow (used in) provided by financing activities		(21.6	)		(0.3	)		(83.5	)		83.4			(22.0	)
Effect of exchange rate changes on cash		—			—			0.9			—			0.9
Increase (decrease) in cash and cash equivalents		—			116.0			(8.8	)		—			107.2
Cash and cash equivalents, beginning of year		—			194.5			76.5			—			271.0
Cash and cash equivalents, end of period	$	—		$	310.5		$	67.7		$	—		$	378.2

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CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
For the 52 Weeks Ended January 29, 2005
(dollars in millions)

	Parent			Guarantor			Non-Guarantor
	Company			Subsidiaries			Subsidiaries			Eliminations			Consolidated
Operating Activities:
Net (loss) earnings	$	(2.0	)	$	17.0		$	16.5		$	(33.5	)	$	(2.0	)
Loss from discontinued operations, net of income taxes and minority interest		—			27.4			11.7			—			39.1
Adjustments for non-cash items included in net earnings:
Restructuring charges		—			10.8			—			—			10.8
Loss on impairment of and disposal of assets		—			4.6			2.4			—			7.0
Depreciation and amortization		0.6			82.3			11.7			—			94.6
Amortization of deferred financing costs		—			0.3			0.6			—			0.9
Share-based compensation expense		—			0.7			—			—			0.7
Deferred income taxes		—			(2.3	)		(4.1	)		—			(6.4	)
Minority interest, net of income taxes		—			—			(2.3	)		—			(2.3	)
Changes in working capital:
Inventories		—			31.4			1.3			(1.4	)		31.3
Prepaid expenses and other current assets		(10.2	)		21.3			(7.3	)		5.6			9.4
Accounts payable		—			37.0			(21.3	)		12.9			28.6
Accrued expenses		(0.3	)		47.4			3.9			(17.1	)		33.9
Other assets and liabilities, net		21.7			(60.0	)		1.5			44.5			7.7
Net cash provided by (used in) discontinued operations		—			9.9			(7.7	)		—			2.2
Cash flow provided by operating activities		9.8			227.8			6.9			11.0			255.5
Investing Activities:
Capital expenditures		—			(93.9	)		(8.1	)		—			(102.0	)
Proceeds from sale of property and equipment		—			3.0			—			—			3.0
Restricted cash		—			—			30.5			—			30.5
Purchases of investments		—			(34.3	)		—			—			(34.3	)
Sales and maturities of investments		—			23.0			—			—			23.0
Investment in subsidiaries		—			5.5			—			(5.5	)		—
Net cash used in discontinued operations		—			(2.3	)		(1.2	)		—			(3.5	)
Cash flow (used in) provided by investing activities		—			(99.0	)		21.2			(5.5	)		(83.3	)
Financing Activities:
Repayment of notes payable		—			—			(30.5	)		—			(30.5	)
Issuance of debt		—			—			2.4			—			2.4
Repayment of debt		—			(0.2	)		(1.3	)		—			(1.5	)
Payment of deferred financing costs		—			(1.5	)		1.3			—			(0.2	)
Issuances of common stock		1.6			—			—			—			1.6
Purchases of common stock		(11.4	)		—			—			—			(11.4	)
Contribution by / distributions to parent		—			—			5.5			(5.5	)		—
Contributions from minority owners		—			—			2.1			—			2.1
Net cash provided by discontinued operations		—			—			1.6			—			1.6
Cash flow (used in) provided by financing activities		(9.8	)		(1.7	)		(18.9	)		(5.5	)		(35.9	)
Effect of exchange rate changes on cash		—			—			(2.0	)		—			(2.0	)
Increase in cash and cash equivalents		—			127.1			7.2			—			134.3
Cash and cash equivalents, beginning of year		—			67.4			69.3			—			136.7
Cash and cash equivalents, end of period	$	—		$	194.5		$	76.5		$	—		$	271.0

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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

ITEM 9A. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

As of the end of the period covered by this Form 10-K for fiscal 2006, we carried out an evaluation, under the supervision and with the participation of our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934) are effective and designed to ensure that information required to be disclosed in periodic reports filed with the SEC is recorded, processed, summarized and reported within the time period specified. Our principal executive officer and principal financial officer also concluded that our controls and procedures were effective in ensuring that information required to be disclosed by us in the reports that we file or submit under the Act is accumulated and communicated to management including our principal executive officer and principal financial officer, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

Management’s Annual Report on Internal Control over Financial Reporting and the Report of Independent Registered Public Accounting Firm

Management’s annual report on internal control over financial reporting and the report of independent registered public accounting firm are incorporated by reference to pages 37 and 38 of Item 8 of this Form 10-K.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting during fiscal year 2006 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.

ITEM 9B. OTHER INFORMATION

None.

PART III

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

The Board of Directors has established a standing Audit and Finance Committee which currently consists of Mr. John F. McGovern — Chairman, Mr. Daniel Boggan Jr., Mr. Howard R. Fricke, Mr. Robert F. Moran, Mr. Michael E. Murphy and Mr. David Scott Olivet. The Board has determined that each of the members of the Audit and Finance Committee is an audit committee financial expert (as that term is defined under Item 401(h) of Regulation S-K) and are independent.

Our Code of Ethics, formerly known as the Policy On Business Conduct, is applicable to all associates including our principal executive officer, principal financial officer, principal accounting officer, and persons performing similar functions. Our Code of Ethics is available on our website at www.paylessinfo.com. The charters for the Board of Directors, the Audit and Finance Committee, and the Compensation Nominating and Governance Committee are also available on our investor relations website. The Company intends to satisfy its disclosure requirements under Item 10 of form 8-K, regarding an amendment to or waiver from a provision of its Code of Ethics by posting such information on our website at www.paylessinfo.com.

Directors - The information set forth in the Company’s definitive proxy statement to be filed in connection with its Annual Meeting to be held on May 24, 2007, under the captions “Election of Directors - Directors and Nominees for Director — Directors Subject to Election — Continuing Directors and — Retiring and Retired Directors” and “Additional Information — Section 16(a) Beneficial Ownership Reporting Compliance” is incorporated herein by reference.

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b) Executive Officers - Information regarding the Executive Officers of the Company is as set forth in Item 1 of this report under the caption “Executive Officers of the Company.” The information set forth in the Company’s definitive proxy statement to be filed in connection with its Annual Meeting to be held on May 24, 2007, under the caption “Additional Information — Section 16(a) Beneficial Ownership Reporting Compliance” is incorporated herein by reference.

ITEM 11. EXECUTIVE COMPENSATION

The information set forth in the Company’s definitive proxy statement to be filed in connection with its Annual Meeting to be held on May 24, 2007, under the captions “Committees of the Board — Compensation, Nominating and Governance Committee — Compensation Committees Interlocks and Insider Participation and — Compensation, Nominating and Governance Committee Report,” “2006 Board Compensation,” “Compensation, Discussion and Analysis,” “2006 Summary Compensation Table,” “2006 Grants of Plan Based Awards,” “Outstanding Equity Awards at Fiscal 2006 Year End,” “Options Exercises and Stock Vested During Fiscal 2006,” “Pension Benefits for Fiscal 2006,” “Nonqualified Deferred Compensation,” and “Potential Payments upon Termination or Change in Control” are incorporated herein by reference.

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The information set forth in the Company’s definitive proxy statement to be filed in connection with its Annual Meeting to be held on May 24, 2007, under the caption “Beneficial Stock Ownership of Directors, Nominees, Executive Officers and Persons Owning More Than Five Percent of Common Stock” is incorporated herein by reference.

The following table summarizes information with respect to the Company’s equity compensation plans at February 3, 2007:

					Number of Securities
					Remaining Available for
	Number of Securities		Weighted-Average		Future Issuance Under
	to be Issued Upon		Exercise Price of		Equity Compensation Plans
	Exercise of Outstanding		Outstanding Options,		(Excluding securities
Plan category	Options, Warrants and Rights		Warrants and Rights		Reflected in Column (a)
Equity compensation plans approved by security holders		3,775	$	19.42		2,788	(1)
Equity compensation plans not approved by security holders		720		20.65		—
Total		4,495	$	19.62		2,788

(1) Includes up to 2,455 thousand shares that may be issued under the Company’s 2006 Stock Incentive Plan and up to 333 thousand shares that can be issued under the Company’s Restricted Stock Plan for Non-Management Directors. The amount does not include up to 5,495 thousand shares that may be purchased under the Payless Stock Ownership Plan.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

The information set forth in the Company’s definitive proxy statement to be filed in connection with its Annual Meeting to be held on May 24, 2007 under the caption “Independence of Directors and Nominees for Directors” is incorporated herein by reference.

The Company began a relationship with Celadon Group, Inc. (“Celadon”) in 2002. Mr. Rubel’s father-in-law, Stephen Russell, is Chairman of the Board and Chief Executive Officer of Celadon. Pursuant to a competitive bid process, during 2006 Celadon won the right to be the primary carrier on two of the Company’s transportation lanes. These lanes account for less than two percent of the Company’s outbound line haul budget. The Company regularly competitively bids its line haul routes and as a result, Celadon could gain or lose routes based upon its bids.

In June 2006, the Company entered into a Marketing and License Agreement with Ballet Theatre Foundation Inc., a nonprofit organization, to use the American Ballet Theatre and ABT marks in connection with development, manufacture, marketing

84

promotion, distribution, and sale of certain dance footwear. Mr. Rubel became a Trustee of Ballet Theatre Foundation, Inc., in January 2007.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

The information regarding principal accounting fees and services is incorporated herein by reference to the material under the heading “Principal Accounting Fees and Services” of the Company’s definitive proxy statement to be filed in connection with its Annual Meeting to be held on May 24, 2007.

PART IV

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(a)	Financial Statements and Schedules:
	The financial statements are set forth under Item 8 of this Annual Report on Form 10-K. Other than as set forth below, financial statement schedules have been omitted since they are either not required, not applicable, or the information is otherwise included.

SCHEDULE II-VALUATION AND QUALIFYING ACCOUNTS

	Balance at		Charged to						Balance at
(dollars in millions)	beginning of period		costs and expenses			Deductions			end of period
Year ended January 29, 2005 Allowance for doubtful accounts	$	2.0	$	0.5		$	(1.6	)	$	0.9
Deferred tax valuation allowance		13.5		2.8			(9.9	)		6.4
Sales return reserve		1.3		10.3			(10.4	)		1.2
Year ended January 28, 2006 Allowance for doubtful accounts	$	0.9	$	0.8		$	(0.8	)	$	0.9
Deferred tax valuation allowance		6.4		1.9			(0.5	)		7.8
Sales return reserve		1.2		9.5			(9.3	)		1.4
Year ended February 3, 2007 Allowance for doubtful accounts	$	0.9	$	1.0		$	(1.4	)	$	0.5
Deferred tax valuation allowance		7.8		(1.1	)		—			6.7
Sales return reserve		1.4		10.1			(10.1	)		1.4

(1) With regard to allowances for doubtful accounts, deductions relate to uncollectible receivables that have been written off, net of recoveries. For the deferred tax valuation allowance, deductions relate to deferred tax assets that have been written off. For sales returns, deductions related to actual returns.

(b) Exhibits

Number	Description
3.1	Amended and Restated Certificate of Incorporation of Payless ShoeSource, Inc., a Delaware corporation (the “Company”). (1)
3.2	Amended and Restated Bylaws of the Company. (2)
4.1	Stockholder Protection Rights Agreement, dated as of April 20, 1998, between the Company and UMB Bank, N.A. (1)
4.2	Indenture, dated as of July 28, 2003, among Payless ShoeSource, Inc. and each of the Guarantors named therein and Wells-Fargo Bank Minnesota, National Association as Trustee, related to the 8.25% Senior Subordinated Notes Due 2013. (3)

85

Number	Description
4.3	Exchange and Registration Rights Agreement, Dated July 28, 2003, among Payless ShoeSource, Inc. and each of Guarantors named therein and Goldman Sachs & Co. as representative of the Several Purchasers. (3)
10.1	Amended and Restated Tax Sharing Agreement, dated as of April 2, 1996, by and between The May Department Stores Company and Payless ShoeSource, Inc. (4)
10.2	Sublease, dated as of April 2, 1996, by and between The May Department Stores Company and Payless ShoeSource, Inc. (5)
10.3	Payless ShoeSource, Inc., Stock 1996 Stock Incentive Plan, as amended September 18, 2003. (6)
10.4	Stock Plan for Non-Management Directors, as amended and restated March 29, 2007.*
10.5	Form of Employment Agreement between Payless ShoeSource, Inc., and certain of its executives. (7)
10.6	Payless ShoeSource, Inc. Supplementary Retirement Plan, as amended December 12, 2006*
10.7	Payless ShoeSource, Inc., 401(k) Profit Sharing Plan, as amended effective January 1, 2007.*
10.8	Form of Change of Control Agreement between Payless ShoeSource, Inc. and certain of its executives. (10)
10.9	Form of Directors’ Indemnification Agreement. (7)
10.10	Form of Officers’ Indemnification Agreement. (10)
10.11	Payless ShoeSource, Inc. Deferred Compensation Plan for Non-Management Directors, as amended September 18, 2003. (6)
10.12	The Stock Appreciation and Phantom Stock Unit Plan of Payless ShoeSource, Inc. and its Subsidiaries for Payless ShoeSource International Employees, as amended September 18, 2003. (6)
10.13	Payless ShoeSource, Inc. Stock Ownership Plan, as amended effective January 1, 2007.*
10.14	Assumption Agreement, dated as of May 22, 1998, by and between Payless ShoeSource, Inc. (Missouri) and Payless ShoeSource Holdings, Inc. (1)
10.15	Payless ShoeSource, Inc. Deferred Compensation 401(k) Mirror Plan, as amended September 18, 2003. (6)
10.16	Payless ShoeSource, Inc. Incentive Compensation Plan. (8)
10.17	Loan, Guaranty and Security Agreement by and among Payless ShoeSource Finance, Inc., as Borrower, the Guarantors signatory thereto, the Lenders signatory thereto and Wells Fargo Retail Finance, as Arranger and Administrative Agent, dated as of January 15, 2004. (9)
10.18	Employment Agreement between Payless ShoeSource, Inc. and Matthew E. Rubel accepted and agreed to June 17, 2005. (11)
10.19	Form of Restricted Stock Award Agreement.*
10.20	Form of Stock Settled Stock Appreciation Rights Award Agreement.*
10.21	Payless ShoeSource, Inc. 2006 Stock Incentive Plan, effective May 25, 2006.*
10.22	First Amendment to Loan, Guaranty and Security Agreement dated as of April 28, 2006. (12)
21.1	Subsidiaries of the Company.*
23.1	Consent of Independent Registered Public Accounting Firm*
31.1	Certification Pursuant to Rules 13(a)-14(a) and 15(d)-14(a) under the Securities Exchange Act of 1934, as amended, of the Chief Executive Officer and President.*

86

Number	Description
31.2	Certification Pursuant to Rules 13(a)-14(a) and 15(d)-14(a) under the Securities Exchange Act of 1934, as amended, of the Senior Vice President, Chief Financial Officer and Treasurer.*
32.1	Certification Pursuant to 18 U.S.C. 1350 of the Chief Executive Officer and President.*
32.2	Certification Pursuant to 18 U.S.C. 1350 of the Senior Vice President, Chief Financial Officer and Treasurer.*

*	Filed herewith
1.	Incorporated by reference from the Company’s Current Report on Form 8-K (File Number 1-14770) filed with the SEC on June 3, 1998.
2.	Incorporated by reference from the Company’s Annual Report on Form 10-K (File Number 1-14770) for the fiscal year ended January 30, 1999, filed with the SEC on April 12, 1999.
3.	Incorporated by reference from the Company’s Quarterly Report on Form 10-Q (File Number 1-14770) for the quarter ended August 2, 2003, filed with the SEC on September 12, 2003.
4.	Incorporated by reference from Exhibit 10.1 of the Company’s Form 10-Q (File Number 1-1633) for the quarter ended May 4, 1996.
5.	Incorporated by reference from the Company’s Registration Statement on Form 10 (File Number 1-11633) dated February 23, 1996, as amended through April 15, 1996.
6.	Incorporated by reference from the Company’s Registration Statement on Form S-4 (File Number 333-109388) filed with the SEC on October 2, 2003, as amended.
7.	Incorporated by reference from the Company’s Annual Report on Form 10-K (File Number 1-14770) for the year ended February 1, 2003, filed with the SEC on April 18, 2003.
8.	Incorporated by reference from the Company’s Annual Report on Form 10-K (File Number 1-14770) for the year ended February 2, 2002, filed with the SEC on April 16, 2002.
9.	Incorporated by reference from the Company’s Current Report on Form 8-K (File Number 1-14770) filed with the SEC on January 22, 2004.
10.	Incorporated by reference from the Company’s Annual Report on Form 10-K (File Number 1-14770) for the year ended January 31, 2004, filed with the SEC on April 9, 2004.
11.	Incorporated by reference from the Company’s Current Report on Form 8-K (File Number 1-14770) filed with the SEC on June 22, 2005.
12.	Incorporated by reference from the Company’s Current Report on Form 8-K (File Number 1-14770) filed with the SEC on May 2, 2006.

The Company will furnish to shareowners upon request, and without charge, a copy of the 2006 Annual Report and the 2007 Proxy Statement, portions of which are incorporated by reference in the Form 10-K. The Company will furnish any other Exhibit at cost.

(c) Financial Statement Schedules have been either omitted due to inapplicability or because required information is shown in the Consolidated Financial Statements, Notes thereto, or Item 15(a).

87

SIGNATURES

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

PAYLESS SHOESOURCE, INC.

Date: April 3, 2007	By:	/s/ Ullrich E. Porzig Ullrich E. Porzig
		Senior Vice President — Chief Financial
		Officer and Treasurer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

/s/ Matthew E. Rubel Chief Executive Officer,	Date: April 3, 2007	/s/ Ullrich E. Porzig Senior Vice President — Chief	Date: April 3, 2007
President and Director		Financial Officer and Treasurer
(Principal Executive Officer)		(Principal Financial and Accounting Officer)
/s/ Howard R. Fricke Chairman of the Board and Director	Date: April 3, 2007	/s/ Daniel Boggan Jr. Director	Date: April 3, 2007
/s/ Michael E. Murphy Director	Date: April 3, 2007	/s/ Mylle H. Mangum Director	Date: April 3, 2007
/s/ Robert C. Wheeler Director	Date: April 3, 2007	/s/ John F. McGovern Director	Date: April 3, 2007
/s/ Michael A. Weiss Director	Date: April 3, 2007	/s/ Robert F. Moran Director	Date: April 3, 2007
/s/ Judith K. Hofer Director	Date: April 3, 2007	/s/ David Scott Olivet Director	Date: April 3, 2007

88

EX-10.4

Exhibit 10.4

STOCK PLAN FOR NON-MANAGEMENT DIRECTORS

Effective May 4, 1996

Amended and restated March 29, 2007

STOCK PLAN FOR NON-MANAGEMENT DIRECTORS
OF
PAYLESS SHOESOURCE, INC.

I. GENERAL

     1. Purpose. The purpose of the Plan is to provide certain compensation to eligible directors of the Corporation and to encourage the highest level of performance of non-management directors by providing those directors with a proprietary interest in the Corporation’s success and progress by granting them shares of the Corporation’s common stock or rights to purchase shares of the Corporation’s common stock subject to the terms and conditions set forth below.

     2. Definitions. Whenever used herein, the following terms shall have the meanings set forth below:

          (a) “Award” means an initial or annual grant of equity, as described in Section 6 of Part I of the Plan.

          (b) “Award Agreement” means a document setting forth the terms and conditions applicable to the Award granted to the Participant.

          (c) “Board” means the Board of Directors of the Corporation.

          (d) “Committee” means the Board or such committee as may be designated by the Board from time to time. Any such Committee must be comprised of at least one employee member of the Board and two or more outside directors who are “non-employee directors” within the meaning of Rule 16b-3 under the Exchange Act.

          (e) “Corporation” means Payless ShoeSource, Inc., a Delaware corporation and any successor thereto.

          (f) “Disability” means a medically determinable physical or mental impairment which renders a Participant substantially unable to function as a director of the Corporation.

          (g) “Dividend Equivalent” means an amount equal to the amount payable with respect to a share of Stock after the date an Award is granted.

          (h) “Exchange Act” means the Securities Exchange Act of 1934, as amended. References to a particular section of the Exchange Act include references to successor provisions.

          (i) “Fair Market Value” of Stock means the closing price of the Stock on the New York Stock Exchange Composite Transaction Tape on the date in question (or if the Stock is not then so traded, the closing price of the Stock on the stock exchange or over-the-counter market on which the Stock is principally trading on such date) or, if no sale of the Stock occurred on such exchange on that day, the closing price of the Stock on the last preceding day when the Stock was sold on the exchange. If Stock, as later defined, is no longer traded on the New York Stock Exchange and if there is no public market for the Stock, “Fair Market Value” shall be determined in good faith by the Committee using other reasonable means.

          (j) “Option Award” means an option granted to a Participant pursuant to Section 6 of Part I of the Plan.

          (k) “Participant” means a member of the Board (i) who is not at the time of grant an officer or employee of the Corporation (ii) who has not during the immediately preceding 12 month period been, an officer or employee of the Corporation or any subsidiary of the Corporation and (iii) to whom an Award is made under the Plan.

          (l) “Plan” means the Restricted Stock Plan for Non-Management Directors of Payless ShoeSource, Inc., amended, restated and renamed May 25, 2006 or such other date as approved by the stockholders of the Corporation, as the Stock Plan for Non-Management Directors of Payless ShoeSource, Inc.

          (m) “Restricted Period” means the period from the vesting of the Stock Award or the receipt of shares of Stock upon exercise of an Option Award until the earlier of (i) the cessation of the Participant’s membership on the Board by reason of death or Disability and (ii) the later of (a) the expiration of the six month period immediately following the Award grant or (b) the date the Participant satisfies their stock ownership requirements as set forth in the Stock Ownership Guidelines for Directors, as such guidelines may be amended from time to time.

          (n) “Stock” means the common stock of the Corporation, $.01 par value, or any other equity securities of the Corporation designated by the Committee, including any attached rights.

          (o) “Stock Award” means a grant of Stock or of a right to receive Stock or its cash equivalent (or both).

          (p) “Stock Ownership Guidelines” means the Stock Ownership Guidelines for Directors adopted by the Company and as amended from time to time.

     3. Administration. The Plan shall be administered by the Committee. Subject to all the applicable provisions of the Plan, the Committee is authorized: (i) to

3

exercise all of the powers granted to it under the Plan, (ii) to construe and interpret the Plan, to prescribe, amend and rescind rules and regulations relating to the Plan, (iii) to make all determinations and take all actions necessary or advisable for the Plan’s administration, (iv) to correct any defect, supply any omission and reconcile any inconsistency in the Plan, (v) to authorize any person to execute on behalf of the Corporation, any instrument required to effect the grant of an Award made by the Committee and (vi) to determine whether, to what extent and under what circumstances Awards may be settled or exercised in cash, shares of Stock, other securities, other Awards or other property, or canceled, forfeited or suspended and the method or methods by which Awards may be settled, canceled, forfeited or suspended. The Committee shall act by vote or written consent of a majority of its members. Whenever the Plan authorizes or requires the Committee to take any action, make any determination or decision or form any opinion, then any such action, determination, decision or opinion by or of the Committee shall be conclusive and binding on all persons. The Committee may obtain such advice or assistance as it deems appropriate from persons not serving on the Committee including but not limited to accountants and counsel. The Committee and others to whom the Committee has allocated or delegated authority or duties shall keep a record of all their proceedings and actions and shall maintain all such books of account, records and other data as shall be necessary for the proper administration of the Plan.

     4. Shares of Stock Available Under the Plan. Effective May 25, 2006, if this amended and restated Plan is approved by the stockholders of the Company, the Plan provides that there may be granted under the Plan an aggregate of not more than 350,000 shares of Stock (the Maximum Limit”), subject to adjustment as provided in Section 3 of Part II of the Plan.

     For each Option Award issued, the Maximum Limit shall be decreased based on the term of the grant as follows for each such Option Award granted:

	EXCHANGE RATIO TABLE
Term of Grant	5 year		6 year		7 year		10 year
Option Award		[.549]		[.598]		[.641]		[.751]

Dividends or Dividend Equivalents, if any, shall be paid in shares of Stock, and shall be deducted from the Plan Maximum Limit if such shares are available. If such shares to pay dividends are not available under the Plan Maximum Limit, but are payable, then such dividends will be paid in cash. Amounts paid entirely in cash shall not be counted against the Maximum Limit. Shares of Stock covered by the unexercised or terminated or forfeited portion of any Award that did not result in the delivery of Stock shall be

4

available for further Awards. For Stock Awards, if less than the maximum number of shares issuable are actually issued, such difference shall be available for future Awards.

     Subject to Section 3 or Part II of the Plan, additional rules for determining the number of shares of Stock granted under an Award may be adopted by the Committee, as it deems necessary and appropriate and consistent with the overall limits set forth in the Plan. Shares of Stock granted under the Plan shall be authorized and issued Stock held in the Corporation’s treasury or previously authorized but unissued Stock. If any shares of Stock shall be returned to the Corporation pursuant to the termination provisions described in Sections 7(b) & (g) of Part I of the Plan, or in the instruments evidencing the making of Awards, such shares may again be granted under the Plan.

5. Eligibility.

          The Committee may grant one or more Awards to any Participant designated by it to receive an Award.

6. Awards.

          The Committee may grant any one or more of the following types of Awards, either singly, or in tandem:

a.	Option Award. An Option is a right or rights to purchase a specific number of shares of Stock exercisable at such time or times and subject to such terms and conditions, including vesting schedule, as the Committee may determine and specify in the applicable Award Agreement. Options shall be settled in cash or Stock.
b.	Stock Award. Stock Awards may be granted either alone, in addition to, or in tandem with other Awards granted under the Plan. Stock Awards are subject to such terms and conditions, including vesting schedules, as the Committee may determine and specify in the applicable Award Agreement. Stock Awards shall be settled in Stock.

7. General Terms and Conditions

a.	Term. The term of an Option Award shall not exceed seven years.
b.	Restrictions. Unless otherwise provided under the Plan or by the Committee, during the Restricted Period, no Award shall be sold, exchanged, transferred, assigned, pledged, hypothecated, or otherwise disposed of (other than upon the death of the Participant, by beneficiary designation, by last will and testament or by the laws of descent and

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	distribution)and shall be exercisable and/or subject to receipt during the Restricted Period only by the Participant. Each certificate evidencing shares of Stock granted pursuant to a Stock Award or shares of Stock received upon exercise of an Option shall bear an appropriate legend referring to the terms, conditions and restrictions applicable to such Award. Any attempt to dispose of such shares of Stock in contravention of such terms, conditions and restrictions shall be ineffective. The Corporation itself will hold such shares in custody, until the restrictions thereon shall have lapsed. The Corporation may delay the issuance of shares of Stock covered by any Award and the delivery of a certificate for such shares of Stock until the shares of Stock to be issued in connection with the grant or exercise of an Award, as applicable, are effectively registered under applicable federal securities laws now in force or hereafter amended or until counsel for the Corporation shall have given an opinion, which opinion shall not be unreasonably conditioned or withheld, that such shares of Stock are exempt from registration under applicable federal securities laws now in force or hereafter amended.
c.	Exercise Price. The exercise price of an Option Award shall not be less than 100% of the Fair Market Value of the Stock on the date such Option Award is granted and the exercise opportunity may be capped if the Committee determines appropriate and so specifies in the Award Agreement pertaining thereto.
d.	Repricing Prohibited. There shall be no grant of an Option Award to a Participant in exchange for a Participant’s agreement to cancellation of a higher-priced Option Award that was previously granted to such Participant.
e.	Payment of Taxes Related to Stock and Option Awards. The Corporation shall have the right to require the payment (through withholding from any amount payable from the Corporation to Participant) of any withholding taxes required by federal, state or local law, if at all, in respect of an Award.
f.	Rights of Holders of Stock. A Participant shall have, after a certificate or certificates for the number of shares of Stock granted have been issued in his or her name, absolute ownership of such shares including the right to vote the same, subject, however, to the terms, conditions and restrictions described in the Plan and in the Award Agreement to such Participant. The Corporation will hold all certificates until all restrictions on them have lapsed.

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g.	Death, Disability & Termination. Any provision of Section 7(h) of Part I of the Plan to the contrary notwithstanding, if a Participant who has been a member of the Board continuously since the date as of which an Award was made and such Participant shall cease to be such a member of the Board by reason of death or Disability, then an Option Award granted to such Participant may be exercised to the extent exercisable on the date of death or Disability, within the earlier of (x) 360 days after the death or Disability of such person and (y) the date on which the Option expires by its terms, by the estate of such person, or by any person or persons who acquired the right to exercise such Option Award by beneficiary designation, will or by the laws of descent and distribution. Unless the Committee determines otherwise, a Stock Award Agreement shall provide for the forfeiture of the non-vested shares of Stock underlying such Stock Award upon the Participant ceasing to be a Participant for any reason, including death or Disability.
h.	Terms of Award Agreement. After the Committee determines that it will offer an Option Award or Stock Award, it will advise the Participant in writing or electronically, by means of an Award Agreement, of the terms, conditions and restrictions, including vesting, if any, related to the Award grant, including the number of shares of Stock that the Participant shall be entitled to receive or purchase, the price to be paid, if any, and, if applicable, the time within which the Participant must accept the Award grant. The Award grant shall be accepted by execution of an Award Agreement in the manner determined by the Committee. Unless the Committee determines otherwise, the Award Agreement shall provide for the forfeiture of the non-vested shares of Stock underlying such Stock Award and for any such shares of Stock that remain non-vested at the time the Participant ceases to be a Participant, the cessation of Participant status shall cause an immediate sale of such non-vested shares of Stock to the Corporation at the original price per share of Stock, if any, paid by the Participant.
i.	No Future Entitlements. No Participant shall have any claim or right to be granted an Award under this Plan. Having received an Award under this Plan shall not give a Participant any right to receive any other Award under this Plan and the Committee may determine that any or all Participant(s) are not eligible to receive an Award under this Plan for an indefinite period or for a specified year or years.

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j. Other. The Committee may establish such other terms and conditions for an Award as it deems appropriate.

II. MISCELLANEOUS

     1. Effective Date. The Plan became effective on May 4, 1996, was first amended on April 20, 1998 and if so approved by the stockholders of the Corporation, is amended and restated effective on May 25, 2006.

     2. Duration of Plan. Unless terminated pursuant to Section 5 of Part II, the Plan shall remain in effect.

     3. Changes in Capital Structure. In the event of any change in the outstanding shares of Stock by reason of a stock dividend greater than 5% of the Stock price, stock split or reverse stock split, recapitalization, merger or consolidation (whether or not the Company is a surviving Company), reorganization, combination, exchange or reclassification of shares, spin-off or other similar corporate changes or an extraordinary dividend payable in cash or property, (i) the number of shares of Stock (or other securities) then remaining subject to this Plan, including those that are then covered by outstanding Awards, and the maximum number of shares of Stock that may be issued, or with respect to which Awards may be granted, to any single Participant or in the aggregate pursuant to this Plan, (ii) the price or exercise price for each share or right then covered by an outstanding Award and (iii) the terms and conditions of each other outstanding Award may be proportionally adjusted as the Committee deems equitable in its absolute discretion to prevent dilution or enlargement of the rights of a Participant. Any adjustment made by the Committee under this Section shall be final, binding and conclusive on all persons..

     4 Expenses of Plan. The expenses of the Plan shall be borne by the Corporation.

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     5. Amendment or Termination. The Corporation may at any time amend, suspend or terminate the Plan, in whole or in part, and the Committee may, subject to the Plan, at any time alter or amend any or all Award Agreements to the extent permitted by applicable law and the Plan; provided that no such action shall impair the rights of any holder of an Award without the holder’s consent. For purposes of the Plan, any action of the Committee that alters or affects the tax treatment of any Award shall not be considered to materially impair any rights of any holder. Notwithstanding the foregoing, neither the Corporation nor the Committee shall (except pursuant to Section 3 of Part II) amend the Plan or any Award Agreement, without the approval of the stockholders of the Company to (i) increase the number of shares of Stock available for Awards as set forth in Section 4 of Part I or (ii) decrease the exercise price of any Award or (iii) make any other amendments to the Plan or Award Agreement which would require stockholder approval under the General Corporation Law of the State of Delaware, New York Stock Exchange Rules or such other rules as may govern the trading or quotation of the Company’s Stock or Rule 16b-3 of the Securities Exchange Act of 1934, as amended.

     6. Nothing in this Plan shall be deemed to create any obligation on the part of the Board to nominate any director for reelection as a director by the shareholders of the Corporation.

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EX-10.6

EXHIBIT - - 10.6

PAYLESS SHOESOURCE, INC.

SUPPLEMENTARY RETIREMENT PLAN

As Amended December 12, 2006

TABLE OF CONTENTS

Section 1. Definitions	1
1.1 Act	1
1.2 Actuarial Equivalent	1
1.3 Annual Compensation	1
1.4 Annual Estimated Social Security Benefits	1
1.5 Annual Minimum Benefit Amount	2
1.6 Annual Retirement Income	2
1.7 Annual Retirement Benefits Offset	2
1.8 Average Annual Compensation	3
1.9 Associate	3
1.10 CEO	3
1.11 Committee	4
1.12 Company	4
1.13 Compensation	4
1.14 Competing Business	4
1.15 Effective Date	4
1.16 Employer	4
1.17 Gender	4
1.18 May	4
1.19 May Profit Sharing Plan	4
1.20 May Retirement Plan	5
1.21 Member	5
1.22 Payless	5
1.23 Payless Profit Sharing Plan	5

1.24 Retirement Date	5
1.25 Plan Service	5
1.26 Termination Without Cause	5
1.27 Total Disability	5
Section 2. Membership	6
2.1 Eligibility for Membership	6
2.2 Eligibility for Benefits	6
Section 3. Benefits	6
3.1 Normal Retirement	6
3.2 Early Retirement	6
3.3 Cessation of Benefits	11
3.4 Form of Benefit	11
3.5 Standard Payment Period	12
3.6 Limitation on Payments	12
3.7 Indirect Payment of Benefits	13
3.8 Termination and Rehire	13
3.9 Withholding	14
Section 4. Administration of the Plan	14
4.1 The Committee	14
4.2 Delegation of Duties	14
4.3 Authority	14
Section 5. Certain Rights and Obligations	14

5.1 Rights of Members, Members’ Spouses and Beneficiaries	14
5.2 Employer-Associate Relationship	14
5.3 Unfunded Nature of Plan	14
Section 6. Non-Alienation of Benefits	15
6.1 Provisions with Respect to Assignment and Levy	15
6.2 Alternate Application	15
Section 7. Amendment and Termination	15
7.1 Company’s Rights	15
7.2 Rights to Terminate	15
Section 8. Construction	16

Payless ShoeSource, Inc. Supplementary Retirement Plan

This document constitutes and sets forth the terms of the Payless ShoeSource, Inc. Supplementary Retirement Plan (hereinafter referred to as the “Plan”), effective as of the date Payless ShoeSource, Inc. was “spun-off” from and ceased to be a subsidiary of The May Department Stores Company, May 4, 1996 (the “Effective Date”). The Plan was amended December 12, 2006 to clarify under Section 1.13, the type of cash incentives that will be deemed “compensation” for purposes of the Plan. Capitalized terms, not otherwise defined herein, which are defined in the Payless Profit Sharing Plan shall have the meanings set forth in such plan.

Section 1. Definitions.

1.1 Act means the Social Security Act as in effect from time to time.

1.2 Actuarial Equivalent means a benefit of equivalent value when computed on the basis of the actuarial principles and tables adopted or otherwise approved by the Committee.

1.3 Annual Compensation means an Associate’s Compensation during a fiscal year of the Company, on an accrual basis, and shall include all of the Associate’s Compensation accrued for services during such fiscal year, regardless of when such Compensation is paid or credited.

1.4 Annual Estimated Social Security Benefits means:

     (a) the estimated initial annual amount of the Primary Insurance Amount or the Disability Insurance Benefit (as such terms are defined in the Act), whichever is applicable, determined by the Committee from available records and such other information as the Committee may request the Member to furnish, to which the Member would be entitled under the Act as in effect at the beginning of the calendar year in which cessation of employment occurs assuming the Member is not thereafter in employment covered under the Act. The estimated Primary Insurance Amount shall be applicable under this Plan in all cases except as hereinafter provided in certain cases of Total Disability and shall be adjusted in the manner provided in the Act as of the date of retirement if such retirement occurs on or after the Member’s 62nd birthday or as if the Member’s age at retirement were 62 if such retirement occurs before the Member’s 62nd birthday. The estimated Disability Insurance Benefit shall be applicable to a Member who sustains Total Disability and qualifies for LTD Plan benefits which are reduced on account of Disability Insurance Benefits under the Act; and

     (b) the estimated initial annual amount of benefit to which the Member would be entitled under any public pension or welfare system of any country other than the United States of America which is similar to the Primary Insurance Amount or the

Disability Insurance benefit under the Act, as determined by the Committee in its sole and absolute discretion.

1.5 Annual Minimum Benefit Amount means:

     (a) for all years in which the Member participated in the Payless Profit Sharing Plan or the May Profit Sharing Plan, the amount of the Company contribution and forfeitures which would have been allocated to the Member’s Company Accounts in the May and Payless Profit Sharing Plans but for the limitation on annual additions imposed by Section 415(c)(1) and Section 415(c)(2) of the Internal Revenue Code (the “Code”), and the limitation under Code Section 401(a)(17) on the amount of such Member’s Compensation which may be taken into account in determining (i) the Member’s basic contributions under the May Profit Sharing Plan and (ii) the Member’s Allocation Pay Amount under the Payless Profit Sharing Plan. The Minimum Benefit Amount with respect to the Payless Profit Sharing Plan shall be determined as if the Company Contribution for the applicable year or years was invested in the investment fund(s) in which the Company Contribution actually allocated for the Member was invested. (The amount determined under this paragraph shall be converted to an annual benefit which would be produced if the amount determined were paid in the form of an Actuarially Equivalent immediate life annuity with appropriate adjustments to the amount on account of investment experience actually experienced by the Profit Sharing Plan); and

     (b) the difference between the annual amount of Retirement Pension, if any, to which the Member is entitled under the May Retirement Plan paid in the form of an immediate life annuity and the annual amount of such Retirement Pension which would be payable to the Member but for (i) the limitation on benefits under Section 415(b) of the Code, (ii) the limitation under Code Section 401(a) (17) on the amount of such Member’s Compensation which may be taken into account in determining such Member’s annual amount of Retirement Pension, and (iii) the limitation under Code Section 415(e) on the benefit payable to a Member who participates in both a defined benefit plan and a defined contribution plan, to the extent applicable.

1.6 Annual Retirement Income means the amount determined by multiplying two percent (2%) of the Member’s Average Annual Compensation by the number of years and fractions thereof (to the closest one-twelfth) of Plan Service, up to a maximum of twenty-five (25) years of Plan Service, completed by the Member on his actual Retirement Date.

1.7 Annual Retirement Benefits Offset means, unless otherwise provided in the employment agreement between the Member and the Company, the total of the following annual amounts:

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     (a) the annual amount of Retirement Pension that would be produced if the benefits payable under the May Retirement Plan were paid to the Member in the form of an immediate life annuity,

     (b) the annual amount of Retirement Pension that would be produced under any other retirement plan to which the Company or a related entity contributes and which credits employment included in Plan Service if the benefits thereunder were payable in the form of an Actuarially Equivalent immediate life annuity,

     (c) the annual amount of benefits that would be produced if the amount payable from the Member’s Company Accounts under the Payless Profit Sharing Plan (including Company Accounts which were Employer or Company Accounts under the May Profit Sharing Plan or Plans merged into the May Profit Sharing Plan) were paid in the form of an Actuarially Equivalent immediate life annuity, assuming that:

(i)

for each calendar year that the Member was eligible to participate as a Member of the May Profit Sharing Plan and for such period of time that the Member is eligible to share in Company matching contributions under the Payless Profit Sharing Plan, the Company Contribution and forfeitures allocated to the Member’s Company Accounts were and are deemed to be in an amount equal to the product of the May or Company matching rate (as applicable) actually applicable to such year or period of time multiplied by the maximum basic contributions under the May or Payless Profit Sharing Plan(s) which could have been contributed by the Member for such calendar year or other period of time,

(ii)

appropriate adjustments on account of investment experience were made to such amount based on the actual investment experience of the May Profit Sharing Plan, as the Committee shall determine;

     (d) the May Retirement Plan and May Profit Sharing Plan offsets set forth in this Section 1.7 shall apply only if the period of membership in those Plans is included in Plan Service under this Plan.

1.8 Average Annual Compensation means the average of the three highest amounts of Annual Compensation of the Member accrued with respect to three (not necessarily consecutive) of the most recent five fiscal years of the Company ending before the Member’s actual Retirement Date.

1.9 Associate means any associate of an Employer under the Payless Profit Sharing Plan.

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1.10	CEO means the Company’s Chief Executive Officer as of February 15, 2001, and any successive Chief Executive Officer of the Company to whom the Board grants the benefits specifically set forth in this Plan for the CEO.
1.11	Committee means the committee established by Section 4 of this Plan.

1.12 Company means Payless ShoeSource, Inc., a Delaware corporation, and any other organization which may be a successor to it.

1.13 Compensation means, unless otherwise provided in the employment agreement between the Associate and the Company, the total compensation from an Employer (or, for the period prior to the date Payless ceases to be a subsidiary of May, from an Employer or from any member of the controlled group of corporations determined in accordance with Section 414(b) of the Code or is a trade or business under common control in accordance with Section 414(c) of the Code, which includes an Employer) with respect to an Associate for services rendered prior to the Associate’s actual Retirement Date, including all regular pay, commissions, overtime pay, cash incentives (excluding cash long-term incentive payments beginning with the 2005-2007 performance period but including for those Members who were Members as of December 12, 2006, any earned cash long-term incentive payment for the 2004-2006 performance period. The amount included for the 2004-2006 performance period, if any, is to be allocated to the third year of the performance period) , prize awards, amounts which an Associate elected to have the Employer contribute directly to the May or Payless Profit Sharing Plans on the Associate’s behalf in accordance with Section 4.01(b) of each such Plan, amounts not otherwise includable in the Associate’s taxable income pursuant to Section 125 of the Code, and amounts subject to the Payless ShoeSource, Inc. Deferred Compensation Plan or the Payless ShoeSource, Inc. Deferred Compensation 401(k) Mirror Plan. Compensation shall not include a pension, retirement allowance, severance pay, retainer or fee under contract, any special payments, cash or otherwise, relating to the spinoff of Payless or distributions from the Profit Sharing Plan.

1.14 Competing Business means any single (i) retail department store; (ii) discount department store; (iii) catalog showroom store; (iv) specialty store; (v) furniture store; (vi) shoe store; (vii) clothing store; or a group of any of the type of stores referred to in (i) through (vii) hereof, which such store or group of stores had, in its fiscal year ending within the twelve month period immediately preceding the date of such Member’s Retirement Date, a gross sales volume, including sales in leased or licensed departments, in excess of $25,000,000.

1.15 Effective Date means May 4, 1996. The effective date of this amendment and restatement is the effective date of the Merger.

1.16 Employer means an employer designated as an Employer under the Payless Profit Sharing Plan.

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1.17 Gender. Wherever applicable, the masculine pronoun as used herein shall include the feminine pronoun.

1.18 May means The May Department Stores Company.

1.19 May Profit Sharing Plan means The May Department Stores Company Profit Sharing Plan.

1.20 May Retirement Plan means The May Department Stores Company Retirement Plan.

1.21 (a) Member means any person included in the membership of the Plan as provided in Section 2.

        (b) Retired Member means a Member who retires after the Effective Date and becomes entitled to a supplementary retirement benefit under this Plan in accordance with its provisions.

1.22 Payless means Payless ShoeSource, Inc., a Delaware corporation.

1.23 Payless Profit Sharing Plan means the Payless ShoeSource, Inc. 401(k) Profit Sharing Plan, as amended from time to time, and any other successor retirement plan which may be designated by the Committee, including the Payless ShoeSource, Inc. Profit Sharing Plan for Puerto Rico Associates.

1.24 Plan Service means Years of Service determined using the elapsed time method. Plan Members shall receive a Year of Plan Service on each anniversary date of their commencement of employment with an Employer, subject to any limitations or restrictions as may be imposed in connection with such Employer’s adoption of the Plan.

1.25 Retirement Date means the last day of the month in which a Member retires under the Payless Profit Sharing Plan or an earlier date set forth in Section 3.2 of this Plan under which a Member is eligible for benefits hereunder.

1.26 Termination Without Cause means the involuntary termination of Member’s employment for any other reason than specified in Section 3.2(d) and (e).

1.27 Total Disability means a disability qualifying a Member for benefits under the Payless ShoeSource, Inc. Long-Term Disability Plan.

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Section 2. Membership.

2.1 Eligibility for Membership. Each Associate who is a member of The May Department Stores Company Supplementary Retirement Plan on the day Payless ceased to be a subsidiary of May shall become a Member of the Plan as of that date. Each other Associate of an Employer who has Compensation from an Employer in any later calendar year completed prior to his Retirement Date equal to at least twice the amount of “wages” which are subject to the payment of F.I.C.A. tax by the Associate in such year shall become a Member as of the January 1 thereafter. The Committee, in its discretion, may permit any other Associate to become a Member if the Committee determines that the Associate’s Compensation from an Employer in any calendar year does not adequately reflect the Associate’s full Compensation for such year.

2.2 Eligibility for Benefits. A Member shall become entitled to benefits under the Plan only if, and to the extent that, the Plan so provides. The fact that an Associate becomes a Member shall not, by itself, entitle the Associate to any benefit under the Plan.

Section 3. Benefits.

3.1 Normal Retirement.

     (a) Subject to the remaining provisions of this Section 3, the annual supplementary retirement benefit payable to a Member who retires on or after attaining age 65 shall be equal to the excess, if any, of:

(i)	such Members Annual Retirement Income, over
(ii)	the sum of:

X	his Annual Estimated Social Security Benefits, and
X	his Annual Retirement Benefits Offset.

     (b) If the benefit payable under subsection (a) above is less than the Annual Minimum Benefit Amount computed pursuant to Section 1.5, the Member shall receive the Annual Minimum Benefit Amount.

3.2 Early Retirement.

     (a)(i) A Member may retire early under this Plan at any time after attaining age 55 and completing 5 years of Plan Service. Subject to the remaining provisions of this Section 3, the annual supplementary retirement benefit determined under Sections 3.1(a) and 3.1(b) above, payable to a Member who retires prior to attaining age 65 shall be first computed on the basis provided by Section 3.1(a), taking into account only years of Plan

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Service and Average Annual Compensation to the Member’s Retirement Date or, if applicable, on the basis provided by Section 3.1(b), which amount shall be reduced as follows:

Age at Retirement	Reduction in Payment
65 or older	No reduction
64	2.0% of Average Annual Compensation
63	4.0% of Average Annual Compensation
62	6.0% of Average Annual Compensation
61	6.5% of Average Annual Compensation
60	7.0% of Average Annual Compensation
59	7.5% of Average Annual Compensation
58	8.0% of Average Annual Compensation
57	8.5% of Average Annual Compensation
56	9.0% of Average Annual Compensation
55	9.5% of Average Annual Compensation
54	10% of Average Annual Compensation
53	10.5% of Average Annual Compensation
52	11% of Average Annual Compensation
51	11.5% of Average Annual Compensation

     (a)(ii) The CEO shall be eligible for benefits under the Plan upon an involuntary Termination without Cause (as defined in the CEO’s employment agreement with the Company). If Terminated Without Cause prior to attaining age 65, the benefits payable to the CEO shall first be computed on the basis provided by Section 3.1(a), taking into account only years of Plan Service and Average Annual Compensation to the Member’s Retirement Date or, if applicable, on the basis provided by Section 3.1(b), which amount shall be reduced as specified in the chart provided under Section 3.2(a)(i).

     (a)(iii) The CEO shall be eligible for benefits under the Plan upon Total Disability. If the CEO experiences Total Disability prior to attaining age 65, the benefits payable to the CEO shall first be computed on the basis provided by Section 3.1(a) taking into account only years of Plan Service and Average Annual Compensation to the Member’s Retirement Date or, if applicable, on the basis provided by Section 3.1(b), which amount shall be reduced as specified in the chart provided under Section 3.2(a)(i).

     (b) Notwithstanding the other provisions of this Section 3.2, if a Member’s retirement occurs prior to his 62nd birthday, then during the period between his Retirement Date and the Member’s 62nd birthday only, in the calculation of the Member’s supplementary retirement benefit, such Member’s supplementary retirement benefit shall not be reduced by his Annual Estimated Social Security Benefits.

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     (c) Notwithstanding anything else to the contrary provided in this Section 3.2 or otherwise in the Plan, if, during the five-year period following the occurrence of a Change in Control of the Company, the Company or an Employer terminates a Member’s employment, who is not the CEO, other than as a Termination For Cause and such Member had attained age 50 on the date on which the Change in Control occurred, then such Member’s annual supplementary retirement benefit shall be computed and paid to such Member as if such Member had retired at age 55 with at least five years of service on the date of termination with benefits to be determined as if such Member had been employed through age 55 at a level of Compensation equal to the Member’s Average Annual Compensation. Notwithstanding anything to the contrary provided in this Section 3.2, or otherwise in the Plan, the CEO shall be eligible (prior to age 55) for benefits under the Plan immediately upon a Change of Control of the Company and benefits shall be determined in accordance with this Section 3.2(c). For the purposes stated in this Section 3.2(c), the Average Annual Compensation of the specified Member shall be deemed to be the greater of his Average Annual Compensation determined (i) as of the date of the Change in Control or (ii) as of the date of termination of employment.

     (d) A “Change in Control of the Company” shall be deemed to have occurred if:

(i) Any individual, entity or group (within the meaning of Section 13(d)(3) or 14(d)(2) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) (a “Person”) acquires beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Exchange Act) of 20% or more of either (A) the then-outstanding shares of common stock of the Company (the “Outstanding Company Common Stock”) or (B) the combined voting power of the then-outstanding voting securities of the Company entitled to vote generally in the election of directors (the “Outstanding Company Voting Securities”); provided, however, that, for purposes of this Section 3.2(d), none of the following shall constitute a Change of Control: (i) any acquisition directly from the Company of 30% or less of Outstanding Company Common Stock or Outstanding Company Voting Securities provided that at least a majority of the members of the board of directors of the Company following such acquisition were members of the Incumbent Board at the time of the Board’s approval of such acquisition, (ii) any acquisition by the Company, (iii) any acquisition by any employee benefit plan (or related trust) sponsored or maintained by the Company or any affiliated company, or (iv) any acquisition by the Company which, by reducing the number of shares of Outstanding Company Common Stock or Outstanding Company Voting Securities, increases the proportionate number of shares of Outstanding Company Common Stock or Outstanding Company Voting Securities beneficially

8

	owned by any Person to 20% or more of the Outstanding Company Common Stock or Outstanding Company Voting Securities; provided, however, that, if such Person shall thereafter become the beneficial owner of any additional shares of Outstanding Company Common Stock or Outstanding Company Voting Securities and beneficially owns 20% or more of either the Outstanding Company Common Stock or the Outstanding Company Voting Securities, then such additional acquisition shall constitute a Change of Control; or
(ii)	Individuals who, as of the date hereof, constitute the Board (the “Incumbent Board”) cease for any reason to constitute at least a majority of the Board; provided, however, that any individual becoming a director subsequent to the date hereof whose election, or nomination for election by the Company’s stockholders, was approved by a vote of at least a majority of the directors then comprising the Incumbent Board shall be considered as though such individual were a member of the Incumbent Board, but excluding, for this purpose, any such individual whose initial assumption of office occurs as a result of an actual or threatened election contest with respect to the election or removal of directors or other actual or threatened solicitation of proxies or consents by or on behalf of a Person other than the Board;
(iii)	A reorganization, merger, consolidation or sale or other disposition of all or substantially all of the assets of the Company (a “Business Combination”) is consummated, in each case, unless, immediately following such Business Combination, (A), more than 50%, respectively, of the then-outstanding shares of common stock and the combined voting power of the then-outstanding voting securities entitled to vote generally in the election of directors, as the case may be, of (x) the corporation resulting from such Business Combination or (y) a corporation that, as a result of such transaction, owns the Company or all or substantially all of the Company’s assets either directly or through one or more subsidiaries, is represented by the Outstanding Company Common Stock and the Outstanding Company Voting Securities (or, if applicable, is represented by shares into which Outstanding Company Common Stock or Outstanding Company Voting Securities were converted pursuant to such Business Combination) in substantially the same proportions as their ownership immediately prior to such Business Combination of the Outstanding Company Common Stock and the Outstanding Company Voting Securities, as the case may be, (B) no Person (excluding any corporation resulting from such Business

9

Combination or any employee benefit plan (or related trust) of the Company or such corporation resulting from such Business Combination) beneficially owns, directly or indirectly, 20% or more of, respectively, the then-outstanding shares of common stock of the corporation resulting from such Business Combination or the combined voting power of the then-outstanding voting securities of such corporation, except to the extent that such ownership existed prior to the Business Combination, and (C) at least a majority of the members of the board of directors of the corporation resulting from such Business Combination were members of the Incumbent Board at the time of the execution of the initial agreement or of the action of the Board providing for such Business Combination; or

(iv)

The stockholders of the Company approve of a complete liquidation or dissolution of the Company

     (e) “Termination for Cause” by the Company or by an Employer of the Company means termination upon:

(i)

the willful and continued failure by the Member to substantially perform his duties with the Company or an Employer (other than any such failure resulting from disability or any such actual or anticipated failure after the Member notifies the Company or an Employer of termination for good reason) after a written demand for substantial performance is delivered to the Member by the Company or Employer, which demand specifically identifies the manner in which the Company or Employer believes the Member has not substantially performed his duties, or

(ii)

the willful engaging by the Member in conduct that is demonstrably and materially injurious to the Company or Employer, monetarily or otherwise.

provided, however, that a termination shall not be deemed a Termination for Cause if the Member’s employment agreement with the Company provides a definition of “cause” under which “cause” has not occurred.

For the purposes of this subparagraph, “good reason” means, without the Member’s express written consent, the occurrence of any of the following circumstances during the one-year period following a Change in Control of the Company, unless such circumstances are fully corrected (effective retroactive to and including the date the circumstances first occurred) within 30 days of the Company or Employer receiving notice of the Member’s termination:

10

(A)

a reduction by the Company or Employer or a subsidiary, as appropriate, in the Member’s annual base salary, bonus opportunity or benefits as the same may be increased from time to time except for across-the-board salary, bonus opportunity or benefit reductions similarly affecting all management personnel of the Company, Employer and/or subsidiaries (and all management personnel of any person in control of the Company or Employer and of all persons, firms, corporations and partnerships and other entities controlled by such person); or

(B)

the relocation of the Company’s or Employer’s (or subsidiary’s) offices at which the Member is principally employed to a location more than 35 miles from such location. or the Company’s or Employer’s (or subsidiary’s) requiring the Member to be based anywhere other than the Company’s or Employer’s (or subsidiary’s) offices at such location.

provided, however, that “good reason” shall also have the meaning specified in the employment agreement between the Member and the Company.

3.3 Cessation of Benefits. Subject to the provisions of Sections 3.4, 3.5 and 3.6, all payments of supplementary retirement benefits hereunder shall cease upon the death of the Member.

3.4 Form of Benefit. Subject to subsection (b) below, the standard form of the supplementary retirement benefit payable hereunder shall be an immediate life annuity; provided, however, that one of the following optional forms of payment may also be elected:

(a)	100% Joint Annuity. This option is an actuarially reduced benefit payable to a Member during his life and, after his death, payable for life to such person he shall have designated as his contingent annuitant.
(b)	50% Joint and Survivor Annuity. This option is an actuarially reduced benefit payable to a Member during his life and, after his death, a benefit at one-half the rate of such actuarially reduced benefit payable for life to such person as he shall have designated as his contingent annuitant. Unless the Member’s spouse consents to another optional form of payment, this will be the standard form of payment for a Member who is married at Retirement Date. The Member’s spouse will be the contingent annuitant.
(c)	Period Certain Annuity (10 years). This option is an actuarially reduced benefit payable to a Member during his life with periodic payments certain terminating at the end of ten years, with provision that if the Member dies before receiving all the periodic payments for such ten year period, (i)

11

periodic payments for the remainder of such period shall be paid to a designated beneficiary, and (ii) if there is no such designated beneficiary, to his estate.

(d)

Period Certain Annuity. (15 years). This option is an actuarially reduced benefit payable to a Member during his life with periodic payments certain terminating at the end of fifteen years, with provision that if the Member dies before receiving all the periodic payments for such fifteen year period, (i) periodic payments for the remainder of such period shall be paid to a designated beneficiary, and (ii) if there is no such designated beneficiary, to his estate.

The supplementary retirement benefit payable under an optional form shall be the Actuarial Equivalent of the supplementary retirement benefit otherwise payable in the form of an immediate life annuity.

3.5 Standard Payment Period. Supplementary retirement benefit payments shall be made in monthly installments, except that the Committee may, in its discretion at any time and from time to time prior or subsequent to retirement, direct that such payments be made other than at monthly intervals, or direct that either a lump sum settlement or a different form of payment be made equal to the Actuarial Equivalent of the benefit or remainder thereof otherwise payable.

3.6 Limitation on Payments.

     (a) It is recognized that a Member’s duties during the period of employment with the Company or an Employer entail the receipt of confidential information concerning not only the current operations and procedures of the Company or an Employer but also its short-range and long-range plans. If (A) the Member during any portion of the period of two (2) years following his retirement (1) has an aggregate investment (as determined from time to time) in a Competing Business equal to at least the greater of (i) $100,000, (ii) 1% in value of such Competing Business or (iii) such greater amount as the Committee may establish on a case by case basis or (2) personally renders services to a Competing Business in any manner, including without limitation, as owner, partner, director, trustee, officer, employee, consultant or advisor thereof, and (B) the Committee determines, in its discretion, that such investment or rendering of personal services is contrary to the best interests of the Company, then all rights to receive any benefits under the Plan shall immediately cease if the Member does not reduce such aggregate investment to an amount permitted hereunder or cease rendering such personal services, within 60 days of receipt of written notice of such determination from the Committee. The term “value” as used herein shall mean the net worth of such Competing Business, as disclosed by the balance sheet of such Competing Business, as of the close of the last preceding fiscal year; provided, however, that with respect to an investment in stock or other securities of a Competing Business, if such stock or other securities are part of a class of stock or other securities listed on any stock exchange, the term “value” shall mean the market value of such class of stock or other securities of such Competing Business, as of the date of any such determination by the Committee.

12

     (b) Any and all rights to benefits payable to or for the account of a Member shall at all times be subject to termination (i) if the Committee shall find such Member guilty of dishonesty or any other unlawful act causing injury or harm to the Company or an Employer or their employees or customers, or (ii) if such Member voluntarily terminates his employment without the written consent of the Company or his Employer or in violation of a written contract of employment.

     (c) Notwithstanding any other provisions of the Plan, in the event that the aggregate amount of benefits paid under this Plan in any benefit year (the period commencing on July 1 of any year and ending on the following June 30), after taking into account the tax effect on the Company or an Employer, shall exceed five percent (5%) of the average consolidated net earnings of the Company as shown in the Company’s annual report to shareowners for the three (3) most recent consecutive fiscal years, ending prior to the conclusion of the benefit year, then all benefits otherwise payable hereunder during the next following benefit year shall be reduced or if necessary terminated. Such reduction shall be made by reducing the benefits otherwise payable during such next following benefit year in the same proportion that the benefits for the immediately preceding benefit year (before the imposition of the limitations provided for by this paragraph) would have had to have been reduced so that no excess would have occurred during such immediately preceding benefit year.

     (d) Notwithstanding anything provided in this Section 3.6 or otherwise in the Plan, to the contrary, the terms of subsections (a), (b) and (c) of this Section 3.6 shall cease to apply and shall be null and void immediately upon the occurrence of a Change in Control of the Company, as defined in Section 3.2(d) of the Plan, or as otherwise provided in the employment agreement between the Member and the Company.

3.7 Indirect Payment of Benefits. If any retired Member or his beneficiary is, in the judgment of the Committee, legally, physically or mentally incapable or incompetent, payment may be made to the guardian or other legal representative of such retired Member or beneficiary or, if there be none, to such other person or institution who or which, in the opinion of the Committee, based on information furnished to the Committee, is then maintaining or has custody of such retired Member or beneficiary. Such payment shall constitute a full discharge with respect thereto.

3.8 Termination and Rehire. Except as provided in Section 3.2(a)(ii), 3.2(a)(iii) and 3.2(c), in the event a Member’s employment is terminated prior to eligibility for early retirement, as described in Section 3.2, or in the event that a Member dies prior to the date as of which supplementary retirement benefits hereunder would otherwise commence, then no benefits shall be payable under this Plan. If a terminated Member is rehired under circumstances which result in reinstatement of membership under the Payless Profit Sharing Plan, reinstatement of membership under this Plan will occur at the same time. Such reinstatement will result in cessation of payment of benefits under this Plan. Upon the subsequent retirement of a Member whose benefits had ceased by reason of this Section 3.8, supplementary retirement benefits shall again be payable based upon such adjustments in amounts as the Committee may deem equitable.

13

3.9 Withholding. The Employer shall withhold from amounts otherwise payable under this Plan any amounts required to be withheld under federal, state or local law or regulations, such amounts to be remitted on a timely basis to the appropriate governmental authorities.

Section 4. Administration of the Plan.

4.1 The Committee. Except as otherwise provided herein, the Plan shall be administered by the Committee constituted under the Payless Profit Sharing Plan.

4.2 Delegation of Duties. In the administration of the Plan, the Committee may, from time to time, appoint agents and delegate to such agents and to the Administrative Subcommittee such duties as it considers appropriate and to the extent that such duties have been so delegated, the Administrative Subcommittee or agent, as the case may be, shall be exclusively responsible for the proper discharge of such duties. The Committee, the Administrative Subcommittee or any agent may from time to time consult with counsel who may be counsel to the Company.

4.3 Authority. Any decision or action of the Committee (or, with respect to any duty delegated to it, any decision or action of the Administrative Subcommittee or of a duly appointed agent) in respect of any question arising out of or in connection with the administration, interpretation and application of the Plan and the rules and regulations thereunder shall be in its absolute discretion and shall be final, conclusive and binding upon all persons having any interest in the Plan.

Section 5. Certain Rights and Obligations.

5.1 Rights of Members, Members’ Spouses and Beneficiaries. The rights of the Members, their spouses, their beneficiaries and other persons are hereby expressly limited as set forth herein and shall be determined solely in accordance with the provisions of the Plan.

5.2 Employer-Associate Relationship. The establishment of the Plan shall not be construed as conferring any legal or other rights upon any Associate or any other person for a continuation of employment or as interfering with or affecting in any manner the right of the Company or any Employer to discharge any Associate or otherwise act with relation to such Associate. The Company or an Employer may take action (including discharge) with respect to any Associate or other person and may treat him without regard to the effect which such action or treatment might have upon him under the Plan.

5.3 Unfunded Nature of Plan. The Plan shall be unfunded. Neither an Employer nor the Committee shall be required to segregate any assets in connection with benefits provided by the Plan. Neither the Company, an Employer nor the Committee shall be deemed to be a trustee of any amounts to be paid under the Plan. Any liability of the Company or an Employer to any person with respect to benefits payable under the Plan shall be based solely upon such contractual obligations, if any, as shall be created by the Plan and shall be only a claim against the general assets of the Company or the Employer, and no such liability shall be deemed to be secured by any pledge or any other encumbrance on any specific property of the Company or any Employer.

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Section 6. Non-Alienation of Benefits.

6.1 Provisions with Respect to Assignment and Levy. No benefit payable under the Plan shall be subject in any manner to anticipation, alienation, sale, transfer, assignment, pledge, encumbrance, levy or charge, and any attempt so to anticipate, alienate, sell, transfer, assign, pledge, encumber, levy upon or charge the same shall be void; nor shall any such benefit be in any manner liable for or, subject to the debts, contracts, liabilities, engagements or torts of the person entitled to such benefit, except as specifically provided herein.

6.2 Alternate Application. If any Member, Member’s spouse or beneficiary under the Plan becomes bankrupt or attempts to anticipate, alienate, sell, transfer, assign, pledge, encumber or charge any benefit under the Plan, except as specifically provided herein, or any benefit shall be levied upon, garnished or attached, then such benefit shall, in the discretion of the Committee, cease, and in that event the Committee may hold or apply the same or any part thereof to or for the benefit of such Member, Member’s spouse or beneficiary, children or other dependents, or any of them, or in such other manner and in such proportion as the Committee may deem proper.

Section 7. Amendment and Termination.

7.1 Company’s Rights. The Company reserves the right at any time and from time to time in its sole discretion to modify or amend in whole or in part any or all of the provisions of the Plan, provided that no amendment shall reduce any supplementary retirement benefit with respect to a Member who had already retired and no amendment shall reduce the amount of any supplementary retirement benefit with respect to a Member who, at the time of amendment, was eligible for retirement under the terms of the Plan, to a level below that determined as if retirement were effective at the time of amendment.

Notwithstanding anything provided to the contrary in this Section 7.1 or the next Section 7.2, following a Change in Control of the Company the Plan may not be amended or terminated in a manner that would adversely affect the rights of any Member to his vested annual supplementary retirement benefits. Without limiting the generality of the foregoing, Section 3.2(c) through (e) may not be amended or deleted following a Change of Control of the Company.

7.2 Rights to Terminate. Except as provided in the previous Section 7.1, the Company reserves the right at any time and from time to time in its sole discretion to terminate the Plan, in whole or in part. In the event the Plan is terminated, the Employer shall be under no further obligation to provide benefits under the Plan, except to the extent of any supplementary retirement benefit with respect to a Member who had already retired and to the extent of any supplementary retirement benefit with respect to a Member who, at the time of termination, was eligible for retirement under the terms of the Plan, including Sections 3.2(a)(i), 3.2(a)(ii), 3.2(a)(iii) and 3.2(c), determined as if retirement were effective at the time of Plan termination. If the Plan is partially terminated, the preceding sentence shall apply to Members in the class with respect to which the Plan is terminated.

15

Section 8. Construction.

The provisions of the Plan shall be construed, regulated, administered and enforced according to the laws of the State of Kansas.

16

EX-10.7

EXHIBIT 10.7

PAYLESS SHOESOURCE, INC. 401(k)
PROFIT SHARING PLAN

As Amended Effective January 1, 2007, or as otherwise specified

TABLE OF CONTENTS

	PAGE
SECTION 1 - Definitions		2
1.01 Accounts		2
1.02 Administrative Delegate		2
1.03 After-Tax Contributions		2
1.04 Allocation Pay Amount		2
1.05 Associate		2
1.06 Authorized Leave of Absence		3
1.07 Before-Tax Contributions		3
1.08 Beneficiary		3
1.09 Board		3
1.10 Code		3
1.11 Committee		3
1.12 Company		3
1.13 Company Accounts		3
1.14 Company Matching Contributions		3
1.15 Company Profit Sharing Contributions		3
1.16 Effective Date		3
1.17 Employer		3
1.18 ERISA		4
1.19 Fiduciary		4
1.20 Fiscal Year		4
1.21 Group		4
1.22 Hour of Service		4
1.23 Investment Fund		4
1.24 May Plan		4
1.25 Member		4
1.26 Member Accounts		4
1.27 Member After-Tax Accounts		5
1.28 Member Before-Tax Accounts		5
1.29 Member Contributions		5
1.30 Member Rollover Contribution Accounts		5
1.31 Military Service		5
1.32 Net Profits		5
1.33 Pay		5
1.34 Pooled Investment Account		6
1.35 Plan		6
1.36 Plan Year		6
1.37 Prior Plan		6
1.38 Qualified Domestic Relations Order		6
1.39 Retirement		6
1.40 Rollover Contributions		6
1.41 Social Security Wage Base		6
1.42 Total and Permanent Disability or Disability		6
1.43 Transferred Accounts		6
1.44 Trust Agreement		6
1.45 Trust Fund		6
1.46 Trustee		6
1.47 Unit		7
1.48 Unit Value		7
1.49 Valuation Date		7
1.50 Year of Service		7

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	PAGE
1.51 Vesting Service		7
SECTION 2 - Membership		9
2.01 Conditions of Eligibility		9
SECTION 3 - Company Contributions		11
3.01 Amount of Company Profit Sharing Contribution		11
3.02 Amount of Company Matching Contribution		11
3.03 Allocation of Company Contributions		11
3.04 Profit Sharing Allocation Formula		11
3.05 Investment of the Company Contribution		12
3.06 Return of Company Contributions		12
SECTION 4 - Member Contributions		13
4.01 Procedure for Making Contributions		13
4.02 Limitations On And Distributions On Before-Tax Contributions For Highly Compensated Employees		15
4.03 Distributions of Excess Deferrals		17
4.04 Limitations On And Distributions Of After-Tax Employee Contributions And Matching Contributions For Highly Compensated Employees		17
4.05 Definitions and Special Rules		19
SECTION 5 - Investment Provisions		20
5.01 Investment Funds		20
5.02 Investment Direction		20
SECTION 6 - Accounts		22
6.01 Member Accounts		22
6.02 Company Accounts		22
6.03 Maintenance of Accounts		22
6.04 Valuation of Accounts		22
6.05 Member Statements		22
6.06 Shares of Payless ShoeSource, Inc. in the Payless Common Stock Fund		22
6.07 Vesting in Member and Company Accounts		23
SECTION 7 - Expenses		27
7.01 Administrative Expenses		27
SECTION 8 - Withdrawals During Employment		28
8.01 Withdrawals Prohibited Unless Specifically Authorized		28
8.02 Authorized Withdrawals		28
SECTION 9 - Benefits Upon Retirement, Death, Disability or Termination of Employment		30
9.01 Benefits		30
9.02 Beneficiary		30
SECTION 10 - Payment of Benefits		31
10.01 Time of Payment		31
10.02 Form of Payment		32
10.03 Indirect Payment of Benefits		32
10.04 Inability to Find Member		32
10.05 Commencement of Benefit Distribution to Members		33
10.06 Commencement of Benefit Distribution to Beneficiary		36
10.07 Commencement of Benefit Distribution to Alternate Payee		36

ii

	PAGE
SECTION 11 - Permitted Rollover of Plan Distributions		37
11.01 Rollover to Other Plans		37
11.02      Rollover from Other Plans		37
11.03      Definitions		38
SECTION 12 - Loans		39
12.01      Availability of Loans		39
12.02      Amount of Loans		39
12.03      Terms of Loans		39
SECTION 13 - Limit on Contributions to the Plan		41
13.01      Limit on Contributions		41
13.02      Adjustment for Excessive Annual Additions		41
SECTION 14 - Administration of the Plan		43
14.01      Plan Administrator		43
14.02      Delegation of Authority		43
14.03      Committee and Subcommittees		43
14.04      Accounts and Reports		44
14.05      Non-Discrimination		44
SECTION 15 - Management of the Trust Fund		46
15.01      Use of the Trust Fund		46
15.02      Trustees		46
15.03      Investments and Reinvestments		46
SECTION 16 - Certain Rights and Obligations of Employers and Members		48
16.01      Disclaimer of Employer Liability		48
16.02      Employer-Associate Relationship		48
16.03      Binding Effect		48
16.04      Corporate Action		48
16.05      Claim and Appeal Procedure		48
SECTION 17 - Non-Alienation of Benefits		50
17.01      Provisions with Respect to Assignment and Levy		50
17.02      Alternate Application		50
SECTION 18 - Amendments		51
18.01      Company’s Rights		51
18.02      Procedure to Amend		51
18.03      Provision Against Diversion		51
SECTION 19 - Termination		52
19.01      Right to Terminate		52
19.02      Withdrawal of an Employer		52
19.03      Distribution in Event of Termination of Trust		52
19.04      Administration in Event of Continuance of Trust		52
19.05      Merger, Consolidation or Transfer		52
SECTION 20 - Construction		53
20.01      Applicable Law		53
20.02      Gender and Number		53

iii

	PAGE
SECTION 21 - Top-Heavy Requirements		54
21.01      Generally		54
21.02      Minimum Allocations		54
21.03      Participants Under Defined Benefit Plans		54
21.04      Determination of Top Heaviness		54
21.05      Calculation of Top-Heavy Ratios		55
21.06      Cumulative Accounts and Cumulative Accrued Benefits		55
21.07      Other Definitions		56

iv

PAYLESS SHOESOURCE, INC.
401(k) PROFIT SHARING PLAN

INTRODUCTION

     Effective April 1, 1996, Payless ShoeSource, Inc. withdrew from and ceased to be a participating Employer in The May Department Stores Company Profit Sharing Plan (the “May Plan”), and established the Payless ShoeSource, Inc. Profit Sharing Plan (the “Plan”). Effective January 1, 1997, a portion of the Plan covering Associates of Payless ShoeSource of Puerto Rico, Inc. was spun off. As of August 1, 1997, Payless amended and restated the Plan, primarily to establish a company matching contribution based on Members’ contributions effective January 1, 1998, to institute automatic enrollment in before-tax contributions by Members, and to comply with certain changes in the law. On June 1, 1998, Payless restructured its corporate organization into a holding company structure with Payless ShoeSource, Inc., a Delaware corporation, as the parent corporation and the named Company for this Plan. Effective March 20, 2000, the Company amended and restated the Plan, primarily to include provisions for loans and the acceptance of rollover contributions from other qualified plans, a change to daily valuation and other miscellaneous changes.

     Effective January 1, 2002, the Company amended and restated the Plan to effect the adoption of mandatory and certain permissive provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001 (“EGTRRA”). The EGTRRA amendments to the Plan are intended to be made in good faith compliance with the requirements of EGTRRA and are to be construed in accordance with EGTRRA and guidance issued thereunder. While the EGTRRA amendments are generally effective January 1, 2002, some of the amendments are effective May 1, 2002, as indicated below. In addition, effective May 1, 2002, the Plan was amended to permit Full Time Associates to participate in the Plan upon the completion of 90 days of employment service with a participating Employer or other member of the Group. Effective January 1, 2003 the Company again amended and restated the Plan to reflect the terms of the final Treasury Regulations governing required minimum distributions. Effective March 28, 2005, the Company amended the Plan to reduce the limit for certain mandatory distributions as described in IRS notice 2005-5. Other amendments made herein are effective on the dates as specified. The Plan was further amended as specified to provide for a guaranteed minimum Company Matching Contribution. Additional amendments were made effective January 1, 2006 to permit Full-Time Associates to make elective contributions to the Plan after completing 60 days of employment and to be eligible to receive the Company Matching Contribution after completing 180 days of employment. The hardship provisions of the Plan were also amended to expand the definition of a “hardship”, consistent with Treasury regulations. The Plan was further amended effective January 1, 2007 to provide for Part-Time Associates to be eligible to participate in the Plan upon turning age 21 and completing a full year of employment and to remove the re-employment provision specified under Section 2.02.

     The terms and provisions of this new plan are as follows:

1

SECTION 1

Definitions

     1.01 Accounts means the Company Accounts and Member Accounts established under Section 6.

     1.02 Administrative Delegate means one or more persons or institutions to which the Committee has delegated certain administrative functions pursuant to a written agreement.

     1.03 After-Tax Contributions means Member Contributions which are not Before-Tax Contributions and which are made by the Member in accordance with Section 4.01(a).

     1.04 Allocation Pay Amount means with respect to each eligible Member, (a) one (1) times the amount of Pay as defined in Section 1.33 up to the Social Security Wage Base (“SSWB”) for the Plan Year, plus (b) two (2) times the amount of such Pay in excess of the SSWB for the Plan Year. Notwithstanding any provision of this Section 1.04 or of Section 3.03 to the contrary, in no event shall the percentage of Members’ Pay to be allocated for any year below the SSWB be less than fifty percent (50%) of the percentage of Pay allocated with respect to Members’ Pay in excess of the SSWB, nor may the latter percentage of Pay (above the SSWB) exceed the former percentage of Pay (below the SSWB) by more than 5.7% (or such other percentage as may be the maximum permitted differential under Code Section 401(1) from time to time).

     In determining each eligible Member’s Allocation Pay Amount, only Pay received during the part of the Plan Year the Member is eligible for the Company Contribution feature of the Plan, pursuant to Section 2, shall be considered, and the SSWB to be applied for such Member shall be proportionally prorated if such eligibility is for less than a full Plan Year.

     Notwithstanding the foregoing, with respect to any Plan Year for which applying the definition of Allocation Pay Amount set forth above would cause the allocation made pursuant to Section 3.03 to violate the permitted disparity limitations of Treas. Reg. Section 1.401(l)-2, Allocation Pay Amount shall be adjusted to permit Section 3.03 to operate in compliance with the limitations of Treas. Reg. Section 1.401(l)-2.

     1.05 Associate means any person who is classified as an employee by an Employer and who receives Pay from an Employer. The term Associate also may include, based upon the express written determination of the Company or the Committee, a U.S. citizen employed, at the request of the Company, by a member of the Group (defined in Section 1.21) to the extent such employee otherwise qualifies for membership under Section 2, in which case such Group member shall be deemed to be an “Employer” hereunder, as to such person or persons only. The term “Associate” shall not include (i) any person covered under a collective bargaining agreement unless and until the Employer and the collective bargaining representatives so agree, (ii) any non-resident alien, and (iii) any “leased employee” within the meaning of Code Section 414(n)(2).

2

     1.06 Authorized Leave of Absence means any leave of absence authorized by the Employer under rules established by the Employer.

     1.07 Before-Tax Contributions means contributions which the Member elects (in accordance with Section 4.01(b)) to have the Employer make directly to the Plan on behalf of the Member, which election shall constitute an election under Code Section 401(k)(2)(A). The “Member’s Before-Tax Contributions” shall refer to Before-Tax Contributions made to the Plan by the Employer on behalf of the Member.

     1.08 Beneficiary means the person or persons entitled under Section 9.02 to receive any payments payable under this Plan on account of a Member’s death.

     1.09 Board means the Board of Directors of the Company.

     1.10 Code means the Internal Revenue Code of 1986, as amended from time to time.

     1.11 Committee means the Profit Sharing Committee comprised of three or more members as determined and appointed from time to time by the Board.

     1.12 Company means Payless ShoeSource, Inc., a Delaware corporation, and any other organization which may be a successor to it.

     1.13 Company Accounts means accounts reflecting the portion of each Member’s interest in the Investment Funds which are attributable to Company Matching Contributions (“Company Matching Accounts”) and to Company Profit Sharing Contributions (“Company Profit Sharing Accounts”) and to any contributions made by an Employer under prior plans, as well as to any income and/or earnings attributable to such Company Contributions and prior plan contributions.

     1.14 Company Matching Contributions means contributions made by the Company or an Employer, based on a Member’s Before-Tax and/or After-Tax Contributions, pursuant to Section 3.02.

     1.15 Company Profit Sharing Contributions means discretionary contributions made by the Company or an Employer, based on Net Profits, pursuant to Section 3.03.

     1.16 Effective Date originally meant April 1, 1996. However, the effective date of this amendment and restatement of the Plan shall be March 20, 2000, unless otherwise specified herein.

     1.17 Employer means the Company and, if authorized by the Company to participate herein, any subsidiary of the Company or any affiliated corporation, partnership or sole proprietorship which elects to participate herein.

3

     1.18 ERISA means the Employee Retirement Income Security Act of 1974, as amended from time to time.

     1.19 Fiduciary means the Employer, the Trustee, each of the members of the Committee described in Section 14, and any investment manager designated pursuant to Section 15.

     1.20 Fiscal Year means the Company’s Fiscal Year.

     1.21 Group means the Company and any other company which is related to the Company as a member of a controlled group of corporations in accordance with Code Section 414(b), as a trade or business under common control in accordance with Code Section 414(c) or as an affiliated service group in accordance with Code Section 414(m) or the regulations under Code Section 414(o). For the purposes of the Plan, for determining whether or not a person is an employee of the Group and the period of employment of such person, each such other company shall be included in the “Group” only for such period or periods during which such other company is a member with the Company of a controlled group or under common control.

     1.22 Hour of Service means any hour for which an Associate (including a leased employee) is directly or indirectly compensated, or entitled to compensation, by the Employer or by any member of the Group, whether or not such Group member has adopted the Plan, for any of the following:

(a) the performance of duties during the applicable computation period;

(b) a period during which no duties are performed (irrespective of whether the employment relationship has terminated) due to vacation, holiday, illness, incapacity (including disability), layoff, jury duty, Military Service, or Authorized Leave of Absence;

(c) a period for which back pay is awarded or agreed to, provided that no Hour of Service has been credited under subsection (a) or (b) with respect to the same period.

     Hours of Service and applicable computation periods shall be determined in accordance with the requirements of 29 C.F.R. Section 2530.200b.

     1.23 Investment Fund means any fund for investment of contributions as described in Section 5.01.

     1.24 May Plan means The May Department Stores Company Profit Sharing Plan.

     1.25 Member means any person included in the membership of this Plan as provided in Section 2.

     1.26 Member Accounts means the Member Before-Tax Accounts, the Member After-Tax Accounts and the Member Rollover Contribution Accounts. To the extent an Associate

4

makes a Rollover Contribution pursuant to Section 11.02 and the Associate is otherwise eligible but has not yet completed the participation requirements of Section 2.01, such contribution shall also be a Member Account.

     1.27 Member After-Tax Accounts means the Member Accounts with respect to a Member’s After-Tax Contributions.

     1.28 Member Before-Tax Accounts means the Member Accounts with respect to a Member’s Before-Tax Contributions.

     1.29 Member Contributions means the Member’s Before-Tax Contributions and After-Tax Contributions.

     1.30 Member Rollover Contribution Accounts means the Member Accounts with respect to an Associate’s or Member’s Rollover Contributions.

     1.31 Military Service means effective December 13, 1996, any period of obligatory military service with the Armed Forces of the United States of America, or voluntary service in lieu of such obligatory service, provided that the Associate returns to active employment with the Employer within the period during which the Employer would be required to re-employ the Associate under Federal law. Notwithstanding any provision of this Plan to the contrary, contributions, benefits, loan repayment and service credit with respect to qualified Military Service will be provided in accordance with Code Section 414(u).

     1.32 Net Profits means the consolidated net profits of the Company for any given Fiscal Year, determined by generally accepted accounting principles except that (i) no deduction or provision shall be made for any federal, state or other taxes measured by net income, nor for any contributions to the Trust or to any other pension or profit sharing plan, and (ii) there shall be excluded any proceeds from life insurance of which the Company is beneficiary (whether paid in a single sum or otherwise) and any gains or losses on the sale of capital assets. Such term shall also mean any accumulated and undistributed Net Profits (as defined in the preceding sentence) earned in prior Fiscal Years to the extent that such accumulated and undistributed Net Profits constitute surplus of the Company and its subsidiaries available for contributions hereunder.

     1.33 Pay means the aggregate of (i) all regular pay, commissions, overtime pay, cash incentives, prizes and cash awards, plus (ii) amounts which the Associate elects to have the Employer contribute directly to the Plan on the Associate’s behalf in accordance with Section 4.01(b). Pay shall include any amounts not otherwise includable in the Member’s taxable income pursuant to Code Section 125. Pay shall not include amounts for a pension, a retirement allowance, a retainer or a fee under contract, deferred compensation (including amounts deferred under the Deferred Compensation Plan of The May Department Stores Company and the Deferred Compensation Plan of Payless ShoeSource, Inc.), severance pay, distributions from this Plan, amounts earned before an individual becomes a Member, or items of extraordinary income including but not limited to amounts resulting from the exercise of stock options, spinoff cash, spinoff stock and restricted stock awards. Pay in excess of $200,000 shall be disregarded,

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although such amount shall be adjusted at the same time and in such manner as permitted under Code Section 415(d).

     1.34 Pooled Investment Account means an account established pursuant to an administrative services agreement between the Company and the Trustee.

     1.35 Plan means this Payless ShoeSource Inc. 401(k) Profit Sharing Plan.

     1.36 Plan Year means a calendar year ending each December 31.

     1.37 Prior Plan means either The May Department Stores Company Profit Sharing Plan, the Volume Shoe Corporation Profit Sharing Plan, or such other qualified plan as may be so designated by the Committee.

     1.38 Qualified Domestic Relations Order means a “qualified domestic relations order” as that term is defined in Code Section 414(p), provided that such order was entered on or after January 1, 1985.

     1.39 Retirement means a Member’s termination of employment on or after age 55 and after completing at least five (5) Years of Service or attaining the fifth anniversary of participation, as of which date the Member’s benefit shall be nonforfeitable.

     1.40 Rollover Contributions means contributions which the Associate or Member, as applicable, elects to make in accordance with Section 11.02.

     1.41 Social Security Wage Base means, with respect to each Plan Year, the maximum amount of wages which are subject to tax in such year under the Federal Old Age, Survivors and Disability Insurance System.

     1.42 Total and Permanent Disability or Disability means the qualification for disability under Title 11 of the Federal Social Security Act.

     1.43 Transferred Accounts means Member and Company Accounts transferred from the May Plan.

     1.44 Trust Agreement means the agreement or agreements provided for in Section 14, as amended from time to time.

     1.45 Trust Fund means all the assets of the Investment Funds and any other assets which are held in one or more trusts by the Trustee or Trustees for the purposes of this Plan.

     1.46 Trustee means the corporation(s), person or persons which may at any time be acting as Trustee or Trustees under the Trust Agreement.

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     1.47 Unit means one of the units representing an interest in an Investment Fund as provided in Section 6.03.

     1.48 Unit Value means the value of each Unit in an Investment Fund as of the Valuation Date as determined pursuant to Section 6.04.

     1.49 Valuation Date means any day that the New York Stock Exchange is open for business or any other date chosen by the Committee. Prior to March 31, 2000, Valuation Date means the last business day of each calendar month and any other date chosen to perform a valuation.

     1.50 Year of Service for purposes of determining eligibility under Section 2 means a year of employment during which the Associate has been paid for not less than 1,000 Hours of Service for an Employer or any other member of the Group. An Associate shall be credited with a year of employment on each anniversary date of his commencement of employment with an Employer during which he earns not less than 1,000 Hours of Service for an Employer or any other member of the Group. Periods of temporary illness, temporary layoff, Military Service, and Authorized Leaves of Absence shall not be deemed as breaking continuity of employment and shall be counted in determining Years of Service. The term “Year of Service” shall also include an employment year during which, except to the extent otherwise provided in Treasury Regulations, a “leased employee” within the meaning of Code Section 414(n) has been paid for not less than 1,000 Hours of Service for the Employer even though during such period the leased employee was not an Associate as defined in Section 1.05. The term “Year of Service” shall include any period required to be included by the Family and Medical Leave Act of 1993.

     The extent to which service with another organization, part or all of whose business operations are acquired by the Company (or by an Employer), shall be credited as “Years of Service” hereunder or as “Vesting Service” under Section 1.51 shall be determined by the Company or by the Committee on a case-by-case basis.

     1.51 Vesting Service for purposes of determining a Member’s vested interest under Section 6.07 is based on “elapsed time” and is to be determined in accordance with the following definitions:

(a) “Employment Commencement Date” means the date upon which an Associate first performs an Hour of Service.

(b) “Hour of Service” means an hour for which an Associate is paid or entitled to payment for the performance of duties for the Employer or any other member of the Group.

(c) “Period of Service” means a period beginning on the Associate’s Employment Commencement Date (or Reemployment Commencement Date, as the case may be) and ending on his Severance from Service Date.

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(d) “Severance from Service Date” means the earlier to occur of:

(i) the last date upon which an Associate terminates employment with the Employer or any other member of the Group (either voluntarily or involuntarily), retires or dies; or

(ii) the first anniversary of the date upon which the Associate was first absent from service with the Employer (with or without pay) for any other reason (i.e., vacation, sickness, disability, leave of absence or layoff).

     Notwithstanding the foregoing, the Severance from Service Date of an Associate who is absent from service with the Employer beyond the first anniversary of the first day of such absence on account of maternity or paternity (as described in Code Sections 410(a)(5)(E) or 411(a)(6)(E)) shall be the second anniversary of the first day of such absence; and the period of time between such first and second anniversaries shall not be treated as a Period of Service or as a Period of Severance.

(e) “Period of Severance” means a period beginning on an Associate’s Severance from Service Date and ending upon the Associate’s Reemployment Commencement Date.

(f) “Reemployment Commencement Date” means the first date, following a Severance from Service Date, upon which the Associate performs an Hour of Service for the Employer or any other member of the Group.

(g) “Service Spanning Rules.” In determining whether or not an Associate has completed a twelve month Period of Service for purposes of vesting, the following Periods of Severance shall be treated as Periods of Service:

(i) If an Associate terminates employment with the Employer (either voluntarily or involuntarily) or retires, and then performs an Hour of Service within the twelve month period beginning on the Severance from Service Date, such Period of Severance shall be treated as a Period of Service; and

(ii) If an Associate terminates employment with the Employer (either voluntarily or involuntarily) or retires during an absence from service of twelve months or less for any reason other than a termination or retirement, and then performs an Hour of Service within a period of twelve months from the date the Employee was first absent from service, the Period of Severance shall be treated as a Period of Service.

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SECTION 2

Membership

2.01 Conditions of Eligibility.

(a) Each Associate who on April 30, 2002 was a Member of or is eligible to be a Member of the Plan shall continue to be a Member of this Plan entitled to make Member Contributions pursuant to Section 4 and eligible to share in Company Contributions pursuant to Section 3.

(b) Each other Associate shall be eligible to become a Member of the Plan when the Associate attains age 21 and meets such other eligibility criteria for Part-Time and Full-Time Associates as set forth below. Once determined eligible, membership commences as of the first day of the month coincident with or following the date the Associate has met the applicable eligibility requirements. Such Associate shall be eligible:

(i) to make Member Contributions pursuant to Section 4;

(ii) to share in Company Matching Contributions pursuant to Section 3.02;

(iii) to share in Company Profit Sharing Contributions, if any, pursuant to Section 3.01.

     Effective January 1 2006, a Full Time Associate shall be eligible to make Member Contributions pursuant to Section 4 as of the first day of the month coincident with or following the date he has completed 60 days of employment with the Employer and attained age 21. Further, a Full-Time Associate shall be eligible to receive a Company Matching Contribution coincident with or following the date he has completed 180 days of service with the Company and satisfied the requirements of Section 3.03. For the purposes of the preceding sentence, a “Full Time Associate” is an Associate classified on the Employer’s records as a Full Time Associate. In many locations, this means the Associate is normally scheduled to work 32 or more hours per week. However, the Associate’s classification on the Employer’s records, and not the actual number of hours worked in any period, determines Full Time status. Effective January 1, 2007, a Part Time Associate shall be eligible to make Member Contributions pursuant to Section 4 as of the first day of the month coincident with or following the date he has completed one full year of employment. Prior to the effective date of January 1, 2007, Part Time Associates must have completed one full Year of Service to be eligible to make Member Contributions.

(c) Each Member shall be deemed to have elected to make a three percent (3%) Before-Tax Contribution pursuant to Section 4.01(b), commencing with the first paycheck issued with respect to the first payroll period beginning on or after the first day of the month coincident with or following the date the Employer determines he met the foregoing eligibility requirements. Notwithstanding this “deemed” election, an Associate

9

or Member may elect pursuant to procedures established by the Committee to not make, or to suspend making, said three percent (3%) automatic Before-Tax Contribution, or pursuant to Section 4.01(a) or (b) to make an After-Tax or a Before-Tax Contribution of an amount other than three percent (3%).

(d) Associates employed by the Company’s Puerto Rican Subsidiaries are not eligible for membership hereunder. If any such Associate has Accounts in this Plan, such Accounts shall continue to be revalued as of each succeeding Valuation Date pursuant to Section 6.04.

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SECTION 3

Company Contributions

     3.01 Amount of Company Profit Sharing Contribution. The Company or an Employer may contribute to the Trust, as of the end of each Plan Year, a percentage of the Company’s Net Profits as a Company Profit Sharing Contribution. The amount of such contribution, if any, shall be determined by the Board of Directors in its discretion. Any such contribution shall be made as soon as practicable after the close of the Company’s Fiscal Year. All such contributions advanced to the Plan by the Company shall be reimbursed to the Company by the Employer.

     3.02 Amount of Company Matching Contribution. The Company shall, in its discretion, contribute to the Trust, as of the end of each Plan Year, a total combined amount as to this Plan and the Payless ShoeSource, Inc. Profit Sharing Plan for Puerto Rico Associates (“Puerto Rico Plan”) equal to 2 1/2% of its Net Profits, until determined otherwise by the Board of Directors, in the form of a Company Matching Contribution. Effective beginning with the 2006 Plan Year, the Board has determined that a minimum guaranteed Company Matching Contribution of $.25 per $1.00 of Member Contributions up to 5% of Pay will be contributed each Plan Year by the Company. Such Company Matching Contributions may be made by an Employer, rather than by the Company, as to that Employer’s participating Associates. The total amount of such contribution shall be allocated in proportion to the amount that each Member’s Contributions under Sections 4.01(a) and (b) for such Plan Year, up to a total of 5% of such Member’s Pay, bears to the total amount of all Member Contributions up to 5% of such Members’ Pay. Such Company Matching Contribution shall be determined and paid to the Trustee as soon as practicable after the close of each Fiscal Year.

     3.03 Allocation of Company Contributions. The Company Contributions shall be allocated only to the Company Accounts of Members who are employed by the Employer on the last day of the Plan Year and on behalf of Members whose employment has terminated during the Plan Year by reason of Retirement, death or Disability. Company Profit Sharing Contributions shall be credited to eligible Members’ Company Profit Sharing Contribution Accounts. Company Profit Sharing Contributions allocated prior to or as of July 31, 1997 shall be fully vested; Company Profit Sharing Contributions allocated thereafter shall be subject to the vesting provisions of Section 6.07. Company Matching Contributions shall be subject to the vesting provisions of Section 6.07 and to the withdrawal penalty provisions of Section 8.02(a). No Company Matching Contribution shall be made with respect to a Member Before-Tax Contribution in excess of the Code Section 402(g) and 414(v) limit, as revised from time to time.

     3.04 Profit Sharing Allocation Formula. The Company Profit Sharing Contribution, if any, shall be allocated to all Members eligible to share in the contribution according to the ratio that each Member’s Allocation Pay Amount for the Plan Year bears to the total Allocation Pay Amount for all eligible Members for the Plan Year. For this purpose the term eligible Members includes Members in both the Puerto Rico Plan and this Plan.

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     3.05 Investment of the Company Contribution. The amounts allocated to each Member pursuant to Section 3.03 shall be credited to his Company Accounts and invested in one or more of the Investment Funds described in Section 5.01 and in the percentages designated by the Member in the investment election filed pursuant to Section 5.02 effective at the time the amount is allocated.

     3.06 Return of Company Contributions.

(a) If, after the Company Contribution has been made and allocated, it should appear that, through oversight or a mistake of fact or law, a Member (or an Associate who should have been considered a Member) who should have been entitled to share in such contribution, receives no allocation or receives an allocation which was less than he should have received, the Company may, at its election and in lieu of reallocating such contribution, make a special make-up contribution for the Company Account of such Member in an amount sufficient to provide for him the same addition to his Company Account as he should have received. Similarly, if a Member received an allocation which was more than he should have received (or an Associate was inappropriately included in the Plan), the Company, at its election, may reallocate such contribution, offset other Company contributions against such allocation, or use such allocation to pay Plan expenses.

(b) Each contribution made to the Trust shall be made on the condition that it is currently deductible by the Company or Employer under Code Section 404 for the taxable year with respect to which the contribution is made. If a contribution subsequently is determined, whether in whole or in part, not to be currently deductible as provided in the preceding sentence, then, within one year of the date of disallowance of the deduction of such Company Contribution, an amount equal to the disallowed deduction shall be returned to the Company or Employer.

(c) Earnings attributable to a contribution that is returned pursuant to Subsection (a) or (b) above shall not be withdrawn, but losses attributable thereto shall reduce the amount returned to the Company and/or Employer.

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SECTION 4

Member Contributions

4.01 Procedure for Making Contributions.

(a) After-Tax Contributions. Subject to the limitations set forth in Sections 4.02, 4.03 and 4.04, each Member may contribute to the Plan an amount (in whole percentage points) equal to not less than 1% nor more than 15% (effective May 1, 2002, 75%) of his Pay as he shall have designated pursuant to procedures established by the Company (which may establish lower permissible After-Tax Contributions for Highly Compensated Employees); provided, however, that a Member shall not contribute, or elect to have contributed on his behalf, amounts with respect to Pay received by him after the close of the calendar year during which his employment terminates and further provided that any Before-Tax Contributions made on behalf of the Member shall reduce, by the percentage which he elects to have contributed pursuant to Section 4.01(b)(i), the percentage of Pay that the Member may contribute pursuant to this Section 4.01(a).

(b) Before-Tax Contributions.

(i) Subject to the limitations set forth below, each Member may elect that his Employer shall contribute directly to the Trust Fund an amount equal to a whole percentage of his Pay, not less than 1% nor greater than such percentage as may be determined from time to time by the Company which amount shall be his Before-Tax Contribution. The maximum Before-Tax Contribution by a Member determined to be a Highly Compensated Employee under Section 4.02, for the Plan Year in question, may be further restricted or limited by the Company or Committee from time to time.

(ii) Pursuant to Section 2.01(c), each eligible Member shall be deemed to have elected to make a three percent (3%) Before-Tax Contribution, unless the Member elects otherwise in accordance with procedures established by the Committee.

(c) Notwithstanding any election in accordance with Section 4.01(b), if the Committee at any time determines that all or any portion of the Member’s Before-Tax Contributions should be treated as After-Tax Contributions in order for the Before-Tax Contribution provisions of the Plan to qualify as a “qualified cash or deferred arrangement” for purposes of Code Section 401(k), or if the Actual Deferral Percentage standards set forth in Code Section 401(k)(3) are not met at the end of the Plan Year, then the Committee, in its sole and absolute discretion,

(i) may, in accordance with Section 4.02 below, limit the amount which shall be contributed by the Employer as Before-Tax Contributions after the date of such determination on behalf of all or any portion of the Members and,

13

(ii) may, except with respect to situations in which Section 4.01(h) applies, (and prior to March 15 of the calendar year following the Plan Year in which such contributions are made) declare all or such portion of the Before-Tax Contributions theretofore or thereafter made on behalf of all or a portion of the Members to be After-Tax Contributions. Effective January 1, 1997, if Before-Tax Contributions are made to another plan or plans, this Plan and such other plans must be aggregated for purposes of Section 410(b) of the Code (other than the average benefit percentage test).

(d) The Employer shall (i) deduct a Member’s After-Tax Contributions from the Pay of the Member in such installments as the Employer may deem appropriate, (ii) contribute a Member’s Before-Tax Contributions on behalf of the Member, and (iii) reduce the Pay that is paid to the Member directly in cash by an amount equal to the Member’s Before-Tax Contributions in such installments as the Employer shall deem appropriate. The amounts so deducted and so contributed shall be paid by the Employer to the Trustee not later than 15 days following the end of the month with respect to which such amounts are to be so deducted and contributed or within such shorter period of time as may be designated under the Code, ERISA or related regulations. The Employer may, from time to time, make estimated contribution payments to the Trustee during each month.

(e) Effective with the first payroll period beginning in any calendar month, or as of such other effective time as may be determined by the Committee, a Member may elect to change the rate of his After-Tax Contributions to any other rate permitted by Subsection (a) of this Section 4.01 and may elect to change the amount to be contributed by the Employer directly to the Trust Fund as Before-Tax Contributions to an amount equal to an amount permitted by Subsection (b) of this Section 4.01 with respect to such contributions to be made after the effective date of the election, pursuant to procedures established by the Committee.

(f) Not later than 15 days prior to the beginning of a payroll period of a Member, or not later than such other date as may be determined by the Committee, such Member may elect, pursuant to procedures established by the Committee, (i) to suspend making After-Tax Contributions and (ii) that the Employer should suspend making Before-Tax Contributions on his behalf, all as of the beginning of such payroll period. Not later than 15 days prior to the beginning of a payroll period of a Member, or not later than such other date as may be determined by the Committee, such Member may elect (i) to resume making After-Tax Contributions and, (ii) that the Employer shall resume making Before-Tax Contributions on his behalf, by indicating any amount of contributions permitted under Subsection (a) and designating an amount equal to any amount of Pay as Before-Tax Contributions that is permitted under Subsection (b) hereof.

(g) Contributions pursuant to this Section 4.01 shall be credited to Member Accounts.

(h) Notwithstanding any election in accordance with Subsection (b), the total amount of a Member’s Before-Tax Contributions and other contributions made by the Member

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under Code Section 401(k) to another plan qualified under Code Section 401(a) for any calendar year shall not exceed $11,000 (as adjusted from time to time by the Secretary of the Treasury or his delegate, pursuant to Code Section 415(d)). If any Member may reach the $11,000 limit (as adjusted) the Committee can direct that all or any portion of such Member’s Contributions during such year shall be After-Tax Contributions regardless of such Member’s elections pursuant to Sections 4.01(a) and 4.01(b). Effective May 1, 2002, all employees who are eligible to make elective deferrals under this Plan and who have attained age 50 before the close of the Plan Year shall be eligible to make catch-up contributions in accordance with, and subject to the limitations of, section 414(v) of the Code. Such catch-up contributions shall not be taken into account for purposes of the provisions of the Plan implementing the required limitations of sections 402(g) and 415 of the Code. The Plan shall not be treated as failing to satisfy the provisions of the Plan implementing the requirements of sections 401(k)(3), 401(k)(11), 401(k)(12), 410(b), or 416 of the Code, as applicable, by reason of the making of such catch-up contributions.

(i) The Committee shall provide each new Member a notice that explains the procedure for making Before-Tax Contributions under Sections 4.01(b) and 2.01(c), including the Member’s right to elect to make no Before-Tax Contribution from his or her Pay and the manner in which the amount of such contributions may be changed. In addition, the Committee shall provide an annual notice to each Member indicating his or her Before-Tax Contributions as a percentage of Pay, describing the right to alter and the procedure for changing such percentage, and explaining the timing for implementation of any such change.

     4.02 Limitations On And Distributions Of Before-Tax Contributions For Highly Compensated Employees.

The Committee is authorized to reduce to the extent necessary the maximum contributions under Section 4.01(b) for Highly Compensated Employees prior to the close of the Plan Year if the Committee reasonably believes that such reduction is necessary to prevent the Plan from failing both tests in Code Section 401(k)(3). Such adjustments shall be made in accordance with rules prescribed by the Committee. The Committee may implement rules limiting contributions under Section 4.01(b) which may be made on behalf of some or all Highly Compensated Employees so that the limits of Section 401(k)(3) or 401(m)(2) of the Code are satisfied. If for any Plan Year the Plan satisfies neither of the tests set forth in Code Section 401(k)(3), the Trustee shall be directed by the Committee to return to each Highly Compensated Employee his or her portion of the excess contributions (plus the income or less the loss allocable to such excess contributions) for such Plan Year within 12 months after the last day of such Plan Year. A Highly Compensated Employee shall forfeit any Matching Contributions which were contributed on account of any portion of the excess contributions even if such Matching Contributions are vested. Each Highly Compensated Employee’s portion of the excess contributions for a Plan Year shall be determined under a two step process. First, the aggregate amount of excess contributions shall be calculated. This shall be done by reducing the actual deferral percentages of those Highly Compensated Employees with the highest actual deferral

15

percentages to the extent necessary but not below the next highest level of actual deferral percentages. This process shall be repeated, to the extent necessary, until the actual deferral percentage for the group of Highly Compensated Employees satisfies one of the tests set forth in Code Section 401(k)(3). The aggregate amount of excess contributions shall be equal to the sum of all such reductions. Second, the aggregate amount of excess contributions to be returned shall be allocated by reducing the Before-Tax Contributions of those Highly Compensated Employees with the highest amount of Before-Tax Contributions to the extent necessary but not below the next highest amount of Before-Tax Contributions. This process shall be repeated, to the extent necessary, until all excess contributions to be returned shall be allocated among the Highly Compensated Employees. The income or loss allocable to a Highly Compensated Employee’s portion of the excess contribution will be determined under such reasonable method as the Committee shall establish, provided the method does not discriminate in favor of Highly Compensated Employees, is used consistently for all Members and for all corrective distributions under the Plan for the Plan Year, and is used by the Plan for allocating income to Members’ accounts.

(a) Coordination With Distributions Of Elective Deferrals. If the Plan is required to distribute both elective deferrals and excess contributions for a Plan Year, the Plan shall:

(i) calculate and distribute the elective deferrals before determining the excess contributions to be distributed to Highly Compensated Employees;

(ii) calculate the actual deferral percentage including the amount of excess elective deferrals distributed pursuant to (i) above; and

(iii) distribute excess contributions to Members by reducing the excess contributions distributed to a Member by the amount of excess elective deferrals distributed to such Member.

(b) Election To Make Additional Contributions. Notwithstanding the above, in accordance with Treasury Regulation Section 1.401(k)-2(a)(6), the Company may elect, in lieu of all or a portion of the corrective distribution described above in this Section, to make additional qualified nonelective contributions or qualified matching contributions which are treated as elective deferrals under the Plan and that, in combination with the elective deferrals, satisfy the actual deferral percentage test. Any such additional qualified nonelective contributions will be credited to a Member Before-Tax Account and shall be allocated to each Member who is not a Highly Compensated Employee in an amount as determined by the Company and will be contributed as a percentage of such Member’s Pay for the Plan Year. Any such additional qualified matching contributions will be credited to a Member Before-Tax Account and shall be allocated to each Member who is not a Highly Compensated Employee and will be contributed as a percentage of the amount contributed by such Member under Section 4.01(b).

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(c) Testing Year. The actual deferral percentage of Non-Highly Compensated Employees shall be determined as of the Plan Year preceding the Plan Year for which the Plan must satisfy one of the tests in Code Section 401(k)(3).

4.03 Distributions of Excess Deferrals.

     If a Member’s elective deferrals for any calendar year exceed $10,500 (or such higher amount prescribed under Section 402(g) of the Code), then the Member may file an election form prescribed by the Committee with the Employer/Company designating in writing the amount of the Member’s Excess Before-Tax Deferrals to be distributed from this Plan. Any such election form must be filed with the Committee no later than the first March 1 following the close of such calendar year in order for the Committee to act on it. If such an election form is timely filed, the Trustee shall distribute to the Member the amount of such Excess Before-Tax Deferrals which the Member has allocated to this Plan together with any income or less any loss allocable to such amount on or before the first April 15 following the close of such calendar year. In the case of a Highly Compensated Employee, any matching contributions which were contributed on account of the Excess Before-Tax Deferrals being distributed will be forfeited, even if such matching contributions are vested. For purposes of this Section 4.03, the income or loss allocable to such Excess Before-Tax Deferrals will be determined under such reasonable method as the Committee shall establish, provided the method does not discriminate in favor of Highly Compensated Employees, is used consistently for all Members and for all corrective distributions under the Plan for the Plan Year, and is used by the Plan for allocating income to Members’ accounts.

     4.04 Limitations On And Distributions Of After-Tax Employee Contributions And Matching Contributions For Highly Compensated Employees.

The Committee is authorized to reduce to the extent necessary the maximum amount of Employer Matching Contributions under Section 3.02 and Employee After-Tax Contributions contributed on behalf of any Highly Compensated Employee prior to the close of the Plan Year if the Committee reasonably believes that such adjustment is necessary to prevent the Plan from failing both tests in Code Section 401(m)(2). Such reduction shall be made in accordance with rules prescribed by the Committee. Notwithstanding anything herein to the contrary, the tests in Code Section 401(m)(2) shall be treated as satisfied with respect to such Matching Contributions and After-Tax Contributions to the Plan, or a portion of the Plan, if the Plan or such portion is a collectively bargained plan that automatically satisfies Code Section 410(b), in accordance with Treasury Regulation Sections 1.401(m)-1(b)(2) and 1.410(b)-2(b)(7). If for any Plan Year the Plan fails to satisfy either of the tests set forth in Code Section 401(m)(2), the Trustee shall be directed by the Committee to distribute to each Highly Compensated Employee his or her vested portion (and forfeit the nonvested portion) of the excess aggregate contributions (plus the income or less the losses allocable to such excess

17

aggregate contributions) for such Plan Year, within 12 months after the last day of such Plan Year. Each Highly Compensated Employee’s portion of the excess aggregate contributions for a Plan Year shall be determined under a two step process. First, the aggregate amount of excess aggregate contributions shall be calculated. This shall be done by reducing the actual contribution percentages of those Highly Compensated Employees with the highest actual contribution percentages to the extent necessary but not below the next highest level of actual contribution percentages. This process shall be repeated, to the extent necessary, until the actual contribution percentage for the group of Highly Compensated Employees satisfies one of the tests set forth in Code Section 401(m)(2). The aggregate amount of excess aggregate contributions shall be equal to the sum of all such reductions. Second, the aggregate amount of excess aggregate contributions to be distributed or forfeited shall be allocated by first reducing any After-Tax Contributions and then any Matching Contributions made by or on behalf of Highly Compensated Employees with the highest total amount of After-Tax Contributions and Matching Contributions to the extent necessary but not below the next highest total amount of After-Tax Contributions and Matching Contributions. This process shall be repeated, to the extent necessary, until all excess aggregate contributions to be distributed or forfeited shall be allocated among the Highly Compensated Employees. A Highly Compensated Employee whose After-Tax Contributions are determined to be excess aggregate contributions shall forfeit any Matching Contributions which were contributed on account of such After-Tax Contributions, even if such Matching Contributions are vested. The income or loss allocable to a Highly Compensated Employee’s portion of the excess aggregate contributions will be determined under such reasonable method as the Committee shall establish, provided the method does not discriminate in favor of Highly Compensated Employees, is used consistently for all Members and for all corrective distributions under the Plan for the Plan Year, and is used by the Plan for allocating income to Members’ accounts.

(a) Election To Make Additional Contributions. Notwithstanding the above, in accordance with Treasury Regulation Section 1.401(m)-2(a)(6), the Company may elect, in lieu of all or a portion of the distribution described above, to either (i) make an additional qualified nonelective contribution that, in combination with Matching Contributions and After-Tax Contributions for the Plan Year, satisfies the actual contribution percentage test or (ii) recharacterize elective contributions as Matching Contributions. Any such additional qualified nonelective contributions will be credited to a Member Before-Tax Account and shall be allocated to each Member who is not a Highly Compensated Employee in an amount as determined by the Company and will be contributed as a percentage of such Member’s Pay for the Plan Year.

(b) The actual contribution percentage of Non-Highly Compensated Employees shall be determined as of the Plan Year preceding the Plan Year for which the Plan must satisfy one of the tests in Code Section 401(m)(2).

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     4.05 Definitions and Special Rules.

(a) Repeal of Multiple Use Test.

     The Multiple use test described in Treasury Regulation section 1.401(m)-2 shall not apply for Plan Years beginning after December 31, 2001.

(b) Special Definitions.

     All terms used in this Section 4 shall have the meaning given such terms in Code Sections 401(k) and 401(m) and the regulations thereunder.

(c) Special Rule For Early Participation. If the Company applies Code Section 410(b)(4)(B) in determining whether the Plan satisfies Code Section 410(b) by excluding from consideration eligible Associates who have not met minimum age and service requirements, the Company may exclude from consideration all Non-Highly Compensated Employees who have not met the minimum age and service requirements of Code Section 410(a)(1)(A) for purposes of satisfying the tests in Code Sections 401(k)(3) and 401(m)(2).

(d) Highly Compensated Employee In Two Or More Qualified Plans. The actual contribution percentage and the actual deferral percentage of a Highly Compensated Employee who is eligible to participate in two or more qualified plans which have (i) cash or deferred arrangements or (ii) Matching Contributions or After-Tax Contributions features maintained by the Employer or a member of the Group, shall be calculated by treating all such cash or deferred arrangements in which the Highly Compensated Employee is eligible to participate as one cash or deferred arrangement for purposes of calculating the actual deferral percentage for such Highly Compensated Employee and all such features in which the Highly Compensated Employee is eligible to participate as one feature for purposes of calculating the actual contribution percentage for such Highly Compensated Employee with respect to years ending within the same calendar year.

(e) Plan Restructuring. The Plan may be aggregated with another plan or other plans or disaggregated under Section 1.401(k)-1(b)(4) and Section 1.401(m)- 1(b)(4) of the Treasury Regulations for any Plan Year in order to pass the actual contribution percentage and actual deferral percentage tests set forth in this Section.”

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SECTION 5

Investment Provisions

5.01 Investment Funds.

(a) There shall be established as part of the Trust Fund a reasonable range of investment options. The Committee may from time to time, in its discretion, change, delete or add Investment Funds available within the Trust Fund; provided that unless and until the Plan is amended accordingly, the Plan shall continue to provide a Payless Common Stock Fund as an investment option.

(b) Income from and proceeds of sales of investments in each Investment Fund shall be reinvested in the same Investment Fund. Any income or other taxes payable with respect to a Fund shall be charged to such Fund.

(c) A Trustee may, from time to time, make temporary investments in short term obligations of the United States Government, commercial paper, or other investments of a short term nature, pending investment in an Investment Fund.

5.02 Investment Direction.

(a) A Member may elect that his Member Contributions be invested in 1% increments totaling 100% in one or more of the Investment Funds. Such election must be made pursuant to procedures prescribed by the Committee. Such election shall be effective until and unless a Member makes a different election for any period, but only as provided for under Subsection 5.02(b) and Subsection 5.02(c). If the Member fails to file a timely initial investment election, he shall be deemed to have elected to have 100% of his Member Contributions invested in the stable, fixed income investment as may be determined by the Committee. Until such time as the Committee determines otherwise and so notifies Members, a Member’s share of any Company Contributions, when allocated as of Plan Year-end, shall be invested in the same Investment Funds in the same proportions as the Member has elected in connection with investment of his Member Contributions at the time the Company Contribution is contributed to the Trust.

(b) A Member may change his election with respect to future Member and Company Contributions effective pursuant to procedures prescribed by the Committee and may not change his election in any other manner except as provided in Subsection 5.02(c).

(c) Effective as of the date determined by the Committee, and pursuant to procedures prescribed by the Committee, a Member may elect to have any or all of the value in any of the Investment Funds which are credited to his Member and/or Company Accounts transferred and invested in any one or more of the Investment Funds.

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(d) Notwithstanding this Section 5.02, effective March 20, 2000, during the black out period as determined by the Committee and the Trustee established to change to daily valuation or a change in recordkeepers, no investment transfers or changes may be made by a Member unless provided in Section 6.06. Notwithstanding anything to the contrary, no loans, withdrawals or distributions shall be made during any such blackout period except as provided by the Committee.

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SECTION 6

Accounts

     6.01 Member Accounts. The Committee shall maintain or cause to be maintained for each Member under each Investment Fund in which his Member Contributions are invested separate Member Accounts which shall reflect the portion of his interest in such Investment Fund which is attributable to his contributions. The Member’s After-Tax Contributions shall be credited to a separate Member After-Tax Account. The Member’s Before-Tax Contributions shall be credited to a separate Member Before-Tax Account. The Member’s or Associate’s Rollover Contribution shall be credited to a separate Member Rollover Contribution Account.

     6.02 Company Accounts. The Committee shall maintain or cause to be maintained for each Member under each Investment Fund in which his Company Contributions are invested separate Company Accounts which shall reflect the portion of his interest in such Investment Fund which is attributable to Company Contributions, as well as to contributions made by an Employer under prior plans and to any income or earnings attributable to such Company Contributions and prior plan contributions. The Member’s Company Matching Contributions shall be credited to a separate Company Matching Contribution Account. The Member’s Company Profit Sharing Contribution, if any, shall be credited to a separate Company Profit Sharing Contribution Account.

     6.03 Maintenance of Accounts. For the purposes of maintaining Accounts pursuant to this Section 6, each Investment Fund shall be divided into Units, and the Interest of each Member in such Investment Fund shall be evidenced by the number of Units in such Investment Fund credited to his Accounts.

     6.04 Valuation of Accounts. As of each Valuation Date the Committee shall determine the value of a Unit in each Account by dividing the current market value of all property in each such Account as of such Valuation Date (after deducting any expenses or other amounts including withdrawals properly chargeable against such Account) by the number of Units then outstanding to the credit of all Members in each such Account.

     6.05 Member Statements. The Committee shall furnish or cause to be furnished to each Member a statement of his Company and Member Accounts, at least once each year, or more frequently if required by applicable law.

     6.06 Shares of Payless ShoeSource, Inc. (“Payless Stock”) in the Payless Common Stock Fund.

(a) Each Member (or beneficiary of a deceased Member) who has Accounts invested in the Payless Common Stock Fund shall, as a named fiduciary within the meaning of Section 403(a)(1) of ERISA, have the right to direct the Trustee with respect to the vote of the number of shares of Payless Stock attributable to Units credited to him in the Payless Common Stock Fund as of the latest practicable Valuation Date prior to or

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contemporaneous with the record date set by the Company for each meeting of shareowners of the Company. For such purpose the Trustee shall furnish to each such Member prior to each such meeting the proxy statement for such meeting, together with a form to be returned to the Trustee on which may be set forth the Member’s instructions as to the manner of voting such shares of stock. Upon receipt of such instructions, the Trustee shall vote such shares in accordance therewith. If a Member’s instructions are not received by the Trustee in a timely manner, the Trustee shall vote such Member’s shares in the same proportion as the shares of Common Stock for which instructions were actually timely received from Members. The Trustee shall not divulge the instructions of any Member.

(b) Each Member (or beneficiary of a deceased Member) who has Accounts invested in the Payless Common Stock Fund shall, as a named fiduciary within the meaning of Section 403(a)(1) of ERISA, have the right with respect to the number of shares of Payless Stock attributable to Units credited to him in the Payless Common Stock Fund as of the latest practicable Valuation Date, to direct the Trustee in writing as to the manner in which to respond to a tender or exchange offer with respect to Payless Stock, and the Trustee shall respond in accordance with the instructions so received. The Trustee shall utilize its best efforts to timely distribute or cause to be distributed to each Member such information as will be distributed to shareowners of the Company in connection with any such tender or exchange offer, together with a form requesting instructions on whether or not such shares will be tendered or exchanged. If the Trustee shall not receive timely direction from a Member as to the manner in which to respond to such a tender or exchange offer, the Trustee shall not tender or exchange any shares of Payless Stock with respect to which such Member has the right of direction. Tenders as a result of a self-tender offer by the Company shall continue notwithstanding any investment change blackout. The Trustee shall not divulge the instructions of any member. The proceeds from the tender or exchange of shares attributable to Units in Payless Common Stock Investment Fund accounts of Members shall be transferred to one of the Investment Funds described in Section 5.01 pursuant to a procedure established by the Committee.

6.07 Vesting in Member and Company Accounts.

(a) Vesting Schedule. A Member shall have a fully vested interest at all times (i) in his Member Accounts and (ii) in his Company Profit Sharing Contribution Account balance determined as of July 31, 1997. A Member who has completed at least two full Years of Service as of August 1, 1997 also shall be fully vested at all times (i) in his Company Matching Contribution Account and (ii) in his Company Profit Sharing Contribution Account determined at any time after July 31, 1997. The Company Matching Contribution Account of a Member who is not or was not credited with at least two Years of Service as of August 1, 1997 and his Company Profit Sharing Contribution Account attributable to Company Profit Sharing Contributions, if any, based on such Member’s eligibility for such contributions after August 1, 1997, shall vest according to the following schedule:

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Vesting Service	Vested Interest
Fewer than 2 years	0%
2 years	25%
3 years	50%
4 years	75%
5 years or more	100%

     Notwithstanding the foregoing, a Member’s interest in his Company Matching Contribution Account and his Company Profit Sharing Contribution Account shall become fully vested if the Member terminates employment on account of Retirement, death or Disability.

(b) Cash-out Distributions to Partially Vested Members and Restoration of Forfeitures. If, pursuant to Section 10.01, a partially-vested Member receives a cash-out distribution before he incurs a Forfeiture Break in Service (as defined in Subsection (e) below), the cash-out distribution will result in an immediate forfeiture of the nonvested portion(s) of the Member’s Company Matching and Company Profit Sharing Contribution Account(s). See Subsection (e) below. A partially-vested Member is a Member whose Vested Interest, determined under Section 6.07(a), in either his Company Matching Contribution Account or his Company Profit Sharing Contribution Account, or both, is less than 100%. A cash-out distribution is a distribution of the entire vested portion of the Member’s Account(s).

(i) A partially-vested Member who is reemployed by an Employer after receiving a cash-out distribution of the vested portion of his Account(s) shall have such forfeited amount restored, unless the Member no longer has a right to restoration under this subparagraph (i). The amount restored by the Plan Administrator shall be the same dollar amount as the dollar amount of his Account(s) on the Valuation Date immediately preceding the date of the cash-out distribution, unadjusted for any gains or losses occurring subsequent to that Valuation Date but reduced by the amount of the prior cash-out distribution. Restoration of the Member’s Account balance(s) includes restoration of all Code Section 411(d)(6) protected benefits with respect to the restored Account(s) in accordance with applicable Treasury regulations. The Plan Administrator will not restore a reemployed Member’s Account balance(s) under this subparagraph (i) if the Member has incurred a Forfeiture Break in Service (as defined in Subsection (d) below).

(ii) If restoration of the Member’s Account(s) is permitted under subparagraph (i) above, the Plan Administrator will restore the Member’s Account(s) on the same day as the date of allocation of the Company Contribution for the Plan Year during which such Member was reemployed by an Employer. To restore

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the Member’s Account(s), the Plan Administrator, to the extent necessary, will allocate to the Member’s Account(s):

(A) first, the amount, if any, of Member forfeitures otherwise available for allocation under Subsection (f) below;

(B) second, deductible Employer contributions for the Plan Year to the extent made under a discretionary formula; and

(C) third, as otherwise permitted by law.

The Plan Administrator will not take into account any allocation under this Subsection (b) in applying the limitation on allocations under Section 13.

(iii) The deemed cash-out rule applies to a 0% vested Member. A 0% vested Member is a Member whose Account(s) derived from Employer contributions is (are) entirely forfeitable at the time of his termination of employment. Under the deemed cash-out rule, the Plan Administrator will treat the 0% vested Member as having received a cash-out distribution on the date of the Member’s termination of employment or, if the Member’s Account(s) is (are) entitled to an allocation of Employer contributions for the Plan Year in which he terminates employment, on the last day of that Plan Year.

(c) Determination of Vesting Service. For purposes of determining a Member’s Vested Interest in his Company Contributions Account(s) under Subsection (a) above, a Member shall be credited with that number of years of Vesting Service determined by adding together all of the Associate’s Periods of Service, whether or not consecutive. Notwithstanding the foregoing, Vesting Service shall not include any Period of Service before the Plan Year in which an Associate attains age eighteen (18). Only whole years of service shall be taken into account for purposes of applying the schedule set forth in Subsection (a) above, and, for purposes of determining a Member’s number of whole years of service, non-successive Periods of Service must be aggregated, with 365 days of service being deemed to constitute one year. For purposes of determining a Member’s Period of Service, the Service Spanning rules described in Section 1.51(g) shall apply.

(d) Forfeiture Break in Service. For purposes of this Section 6.07, a “Break in Service” is a Period of Severance of at least 365 consecutive days. A “Forfeiture Break in Service” occurs when a Member or former Member incurs 5 consecutive Breaks in Service.

(e) Forfeiture Occurs. A Member’s forfeiture, if any, of his Account balance(s) derived from Company contributions occurs under the Plan on the earlier of:

(i) the last day of the last pay period ending within the Plan Year in which the Member first incurs a Forfeiture Break in Service; or

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(ii) the date the Member receives a cash-out distribution.

     The Plan Administrator shall determine the percentage of a Member’s Account(s) forfeiture, if any, under this Subsection (e) solely by reference to the vesting schedule of Section 6.07(a). As of the last day of each Plan Year, the total amount of forfeitures which occurred during such Plan Year shall be calculated and such amount shall be applied (i) to restore under (b) above any amounts previously forfeited from rehired Members’ Accounts, (ii) to pay Administrative Expenses under Section 7.01 and (iii) the balance, if any, shall be added to and allocated with the Company Matching Contribution for that Plan Year.

(f) Former May Plan Members. The provisions of this Subsection (f) apply to a Member who previously was employed by the Employer, when it was part of the Group which included The May Department Stores Company, and who at the termination of his employment had Company Accounts in the May Plan which were forfeited as a result of termination of employment. If such Member has not incurred five consecutive Breaks in Service as defined in Section 6.07(b), the value of the Member’s Company Account forfeited under the May Plan will be restored under this Plan (in the manner described in Subsection (b) above) and will be 100% vested.

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SECTION 7

Expenses

     7.01 Administrative Expenses. To the extent permitted by applicable law, the costs and expenses for administering this Plan, consisting of Trustee fees and expenses, Investment Manager fees and expenses, fees and expenses of outside experts, expenses of maintaining records under Section 6 of the Plan, and all other administrative expenses of the Plan, shall be paid out of the Trust Fund unless the Company elects to pay them with its own funds. Costs incident to the purchase and sale of securities, such as brokerage fees, commissions and stock transfer fees, are not regarded as administrative expenses and shall be borne by the appropriate Investment Fund as determined by the Trustee or Committee.

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SECTION 8

Withdrawals During Employment

     8.01 Withdrawals Prohibited Unless Specifically Authorized. No withdrawal from the Plan shall be permitted prior to a Member’s termination of employment, except as provided in Section 8.02.

     8.02 Authorized Withdrawals.

     (a) Prior to his termination of employment, a Member may elect to withdraw, in cash, any or all of the value in his Member After-Tax Accounts. However, in the event a Member elects to withdraw all or a portion of his After-Tax Contributions made after August 1, 1997, such Member shall forfeit his right to fifty percent (50%) of the Company Matching Contribution, if any, otherwise allocable in connection with his Member Contributions for the Plan Year in which the withdrawal occurs.

     (b) Prior to his termination of employment, a Member may elect to withdraw, in the event of a “hardship”, an amount in cash up to (i) the total amount of the Before-Tax Contributions made to the Trust on his behalf, or (ii) the value in his Member Before-Tax Account, whichever is less. In any event the amount withdrawn may not be greater than the amount determined by the Committee as being required to meet the immediate financial need created by the “hardship” and not reasonably available from other resources of the Member, whichever amount is less. The term “hardship” means a heavy financial hardship in light of immediate and heavy financial needs as determined by the Committee in accordance with Internal Revenue Service regulations. The amount of an immediate and heavy financial need may include any amounts necessary to pay any federal, state or local taxes or penalties reasonably anticipated to result from the distribution. The determination shall be made in a nondiscriminatory manner. Hardship shall include but not be limited to the following:

(i)   Medical expenses described in Code Section 213(d) previously incurred by the Member, the Member’s spouse, or any of the Member’s dependents (as defined in Code Section 125) or necessary for these persons to obtain medical care described in Section 213(d);

(ii) Purchase (excluding mortgage payments) of a principal residence for the Member;

(iii) Payment of tuition, related educational fees, and room and board expenses for the next 12 months of post-secondary education for the Member, his or her spouse, children, or dependents (as defined in Code Section 152);

(iv) The need to prevent the eviction of the Member from his or her principal residence or foreclosure on the mortgage of the Member’s principal residence.

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(v) (Effective January 1, 2006). Payments for burial or funeral expenses for a Member’s deceased parent, spouse, children or dependents (as defined in Section 152 of the Code and effective January 1, 2006), without regard to Section 152(d)(1)(B).

(vi) (Effective January 1, 2006). Expenses for the repair of damage to Member’s principal residence that would qualify for the casualty deduction under Section 165 of the Code (determined without regard to whether the loss exceeds 10% of adjusted gross income).

          The Committee may adopt written guidelines which identify additional circumstances constituting hardship and which provide procedures to be followed in the administration of hardship withdrawal requests, which guidelines are hereby incorporated herein.

          In addition, such hardship must be one which in the judgment of the Committee, based on the Member’s representations, cannot be relieved (1) through reimbursement or compensation by insurance or otherwise, (2) by reasonable liquidation of the Member’s assets to the extent such liquidation would not itself cause an immediate and heavy financial need, (3) by cessation of Member Contributions under the Plan, (4) by other distributions or loans from employee benefit plans, including this Plan, maintained by the Company or any other employer or (5) by borrowing from commercial sources on reasonable commercial terms. The Member shall be required to submit documentation, to be determined by the Committee, with his hardship withdrawal request to enable the Committee to make a judgment regarding the validity of such hardship withdrawal request. For any Member who has attained age 59 1/2, the “hardship” requirement shall be deemed waived.

     (c) A Member who was a Participant in or eligible to be a Participant in the Volume Shoe Corporation Profit Sharing Plan (the “Volume Plan”) as of December 31, 1988 and who had an account balance in the Volume Plan attributable to Employer Contributions made to the Volume Plan before July 31, 1976 and which account became a Company Account under The May Department Stores Company Profit Sharing Plan and which has been transferred to this Plan, shall be entitled to withdraw the market value of such account balance determined (and frozen) as of December 31, 1988.

     (d) Associates with Member Rollover Contribution Accounts may elect to withdraw their Member Rollover Contribution Accounts prior to termination of employment.

     (e) A withdrawal election shall be made pursuant to application procedures established by the Committee. Contribution totals and Account values shall be determined as of the Valuation Date coinciding with or next following the filing of the withdrawal election. If the Member Accounts from which withdrawal is made are in more than one Investment Fund, the withdrawal shall be pro rata from each such Investment Fund except in the case the Member is subject to Section 16 of the Securities Exchange Act of 1934 or has been designated as a “Designated Insider,” in which case such Member’s withdrawal will be taken first from such Member’s Investment Funds other than the Payless Common Stock Fund.

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SECTION 9

Benefits Upon Retirement, Death, Disability or Termination of Employment

     9.01 Benefits. Upon a Member’s Retirement, death, Disability, or other termination of employment, the value of his Member Accounts and of his vested Company Accounts shall be determined as of the Valuation Date prior to the date the distribution is calculated. A temporary Authorized Leave of Absence for Military Service or for other purposes approved by the Employer shall not, while any such Authorized Leave of Absence is validly in effect, be regarded as a termination of employment.

     9.02 Beneficiary. Any benefits payable on account of a Member’s death shall be paid to such Member’s spouse. If such Member has no spouse or if such Member’s spouse shall have consented to the naming of another beneficiary, such benefits shall be paid to the person or persons (including, without limitation, estates, trust, or other entities) last named as beneficiary by such Member on an appropriate form filed with the Committee. A spouse’s consent shall acknowledge the effect of the consent and be in writing, witnessed by a Plan representative or notary public. A spouse’s consent shall be irrevocable. If no beneficiary has been so named or the named beneficiary does not survive the Member, any payment to be made under this Plan on account of a Member’s death shall be paid to such Member’s spouse, or, if he has no spouse, to such Member’s estate. Whenever permitted by the Code or regulations thereunder, the Committee may waive the requirements that a spouse’s consent be obtained. Such waiver may be on a case by case basis or by categories.

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SECTION 10

Payment of Benefits

10.01 Time of Payment.

(a) All amounts distributable to a Member or Beneficiary pursuant to Section 9 shall, unless the Member makes an approved election pursuant to Section 10.01(b) or 10.01(c), be paid in a lump sum payment to be made as soon as practicable after the Valuation Date as of which the Account values are determined pursuant to Section 9.01; provided, however, that any additional amounts which may be allocated to a Member’s Company Accounts resulting from a Company Contribution in respect of the calendar year in which employment terminates shall be paid as soon as practicable after such contribution.

     Notwithstanding any provision of this Section 10 to the contrary, if the present value of the nonforfeitable accrued benefit of a Member, including Company Contributions, Member Contributions, Rollover Contributions and earnings thereon (but excluding accumulated deductible employee contributions, if any) exceeds $1,000, no partial or total distribution shall be made unless the Member has consented thereto in writing in the manner required by law.

(b) A Member who was a Member of the May Plan as of June 30, 1990 may elect that all Transferred Accounts distributable to him pursuant to Section 9 shall be paid in annual installments over a period not to exceed ten years beginning with the Valuation Date as of which the lump sum payment would otherwise be made. In the event of the death of a Member prior to the expiration of such period, all amounts which have not been distributed to him shall be paid in a lump sum to his designated Beneficiary or his estate if there is no designated Beneficiary. Subject to the foregoing, each such installment shall be paid as of a Valuation Date and, until all the Accounts of the Member have been fully distributed, they shall continue to be revalued as of each succeeding Valuation Date pursuant to Section 6.04.

     Notwithstanding the paragraph above, a Member who as of December 31, 1988 was or was entitled to be a Participant in the Volume Shoe Corporation Profit Sharing Plan may elect that all Transferred Accounts distributable to him pursuant to Section 9 be paid in the form of equal monthly installments over a period not to exceed 120 months. Such payments shall otherwise be made in accordance with the foregoing portion of this Subsection 10.01(b).

(c) A Member who is entitled to receive a distribution in excess of $1,000 may elect to defer such distribution to the required minimum distribution age, as determined by law from time to time. An election to defer distribution shall conform to such requirements as to form, content, manner, and timing as shall be determined by the Committee and which requirements shall be applied in a manner which does not discriminate in favor of Members who are highly compensated employees (within the meaning of Code Section

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414(q)). All Accounts of a Member who elects to defer his distribution shall continue to be revalued as of each succeeding Valuation Date pursuant to Section 6.04. A deferred distribution shall be paid when such Member attains the required minimum distribution age or at such earlier or later time as shall be determined by the Committee as permitted by law. In the event of the death of a Member prior to distribution of the deferred amounts, all amounts shall be distributed in a lump sum to his designated Beneficiary or to his estate if there is no designated Beneficiary. The value for payment shall be determined as of the Valuation Date coincident with or next following such Member’s birthday coincident with the Member’s required minimum distribution age or such other payment date determined by the Committee.

     10.02 Form of Payment. All distributions shall be made in the form of cash, except that distributions from the Payless Common Stock Fund shall be made in the form of full shares of Payless Common Stock, as applicable (with payment in cash for a fraction of a share) or in cash if elected by the Member or Beneficiary. The rights extended to a Member hereunder shall also apply to any Beneficiary or alternate payee of such Member.

     10.03 Indirect Payment of Benefits. If any Member or Beneficiary has been adjudged to be legally, physically or mentally incapable or incompetent, payment may be made to the legal guardian or other legal representative of such Member or Beneficiary as determined by the Committee. Such payments shall constitute a full discharge with respect thereto.

     10.04 Inability to Find Member. If a Member or Beneficiary or other person to whom a benefit payment is due cannot be found during the three years subsequent to the date a distribution was required to be made under this Plan, the Accounts shall be forfeited at the end of such three-year period. The value of such Accounts as of the date the distribution was required to be made shall be restored if such Member or Beneficiary or other person makes a claim.

10.05 Required Minimum Distributions.

          Notwithstanding anything to the contrary contained in the Plan, the entire interest of a Member will be distributed in accordance with Code Section 401(a)(9) and the regulations thereunder beginning no later than the Member’s Required Beginning Date. The provisions of this Section will apply for purposes of determining required minimum distributions for calendar years beginning with the 2003 calendar year. Notwithstanding the other provisions of this Section, distributions may be made under a designation made before January 1, 1984, in accordance with section 242(b)(2) of the Tax Equity and Fiscal Responsibility Act (TEFRA) and the provisions of the Plan that relate to section 242(b)(2) of TEFRA.

     (a) If the Member dies before distributions begin, the Member’s entire interest will be distributed, or begin to be distributed, no later than as follows:

     (1) If the Member’s surviving spouse is the Member’s sole designated beneficiary, then distributions to the surviving spouse will begin by December 31 of the calendar year immediately following the calendar year in which the Member

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died, or by December 31 of the calendar year in which the Member would have attained age 70¹/2, if later.

     (2) If the Member’s surviving spouse is not the Member’s sole designated beneficiary, then distributions to the designated beneficiary will begin by December 31 of the calendar year immediately following the calendar year in which the Member died.

     (3) If there is no designated beneficiary as of September 30 of the year following the year of the Member’s death, the Member’s entire interest will be distributed by December 31 of the calendar year containing the fifth anniversary of the Member’s death.

     (4) If the Member’s surviving spouse is the Member’s sole designated beneficiary and the surviving spouse dies after the Member but before distributions to the surviving spouse begin, this subsection, other than subsection (a)(1), will apply as if the surviving spouse were the Member.

For purposes of this subsection, unless subsection (a)(4) applies, distributions are considered to begin on the Member’s Required Beginning Date. If subsection (a)(4) applies, distributions are considered to begin on the date distributions are required to begin to the surviving spouse under subsection (a)(1). To the extent the Plan provides for distributions in the form of annuities, if distributions under an annuity purchased from an insurance company irrevocably commence to the Member before the Member’s Required Beginning Date (or to the Member’s surviving spouse before the date distributions are required to begin to the surviving spouse under subsection (a)(1)), the date distributions are considered to begin is the date distributions actually commence.

     (b) Unless the Member’s interest is distributed in the form of an annuity purchased from an insurance company or in a single sum on or before the Required Beginning Date, as of the first distribution calendar year distributions will be made in accordance with subsections (c) and (d). To the extent the Plan provides for distributions in the form of annuities, if the Member’s interest is distributed in the form of an annuity purchased from an insurance company, distributions thereunder will be made in accordance with the requirements of Code Section 401(a)(9) and the Treasury regulations.

     (c) During the Member’s lifetime, the minimum amount that will be distributed for each distribution calendar year is the lesser of:

     (1) the quotient obtained by dividing the Member’s account balance by the distribution period in the Uniform Lifetime Table set forth in section 1.401(a)(9)-9 of the Treasury regulations, using the Member’s age as of the Member’s birthday in the distribution calendar year; or

33

     (2) if the Member’s sole designated beneficiary for the distribution calendar year is the Member’s spouse, the quotient obtained by dividing the Member’s account balance by the number in the Joint and Last Survivor Table set forth in section 1.401(a)(9)-9 of the Treasury regulations, using the Member’s and spouse’s attained ages as of the Member’s and spouse’s birthdays in the distribution calendar year.

Required minimum distributions will be determined beginning with the first distribution calendar year and up to and including the distribution calendar year that includes the Member’s date of death.

     (d) If the Member dies on or after the date distributions begin and there is a designated beneficiary, the minimum amount that will be distributed for each distribution calendar year after the year of the Member’s death is the quotient obtained by dividing the Member’s account balance by the longer of the remaining life expectancy of the Member or the remaining life expectancy of the Member’s designated Beneficiary, determined as follows:

     (1) The Member’s remaining life expectancy is calculated using the age of the Member in the year of death, reduced by one for each subsequent year.

     (2) If the Member’s surviving spouse is the Member’s sole designated beneficiary, the remaining life expectancy of the surviving spouse is calculated for each distribution calendar year after the year of the Member’s death using the surviving spouse’s age as of the spouse’s birthday in that year. For distribution calendar years after the year of the surviving spouse’s death, the remaining life expectancy of the surviving spouse is calculated using the age of the surviving spouse as of the spouse’s birthday in the calendar year of the spouse’s death, reduced by one for each subsequent calendar year.

     (3) If the Member’s surviving spouse is not the Member’s sole designated beneficiary, the designated beneficiary’s remaining life expectancy is calculated using the age of the beneficiary in the year following the year of the Member’s death, reduced by one for each subsequent year.

If the Member dies on or after the date distributions begin and there is no designated beneficiary as of September 30 of the year after the year of the Member’s death, the minimum amount that will be distributed for each distribution calendar year after the year of the Member’s death is the quotient obtained by dividing the Member’s account balance by the Member’s remaining life expectancy calculated using the age of the Member in the year of death, reduced by one for each subsequent year.

     (e) If the Member dies before the date distributions begin and there is a designated beneficiary, the minimum amount that will be distributed for each distribution calendar year after the year of the Member’s death is the quotient obtained by dividing the

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Member’s account balance by the remaining life expectancy of the Member’s designated beneficiary, determined as provided in subsection (d). If the Member dies before the date distributions begin and there is no designated beneficiary as of September 30 of the year following the year of the Member’s death, distribution of the Member’s entire interest will be completed by December 31 of the calendar year containing the fifth anniversary of the Member’s death. If the Member dies before the date distributions begin, the Member’s surviving spouse is the Member’s sole designated beneficiary, and the surviving spouse dies before distributions are required to begin to the surviving spouse under subsection (a)(1), this Section will apply as if the surviving spouse were the Member.

     (f) The following definitions shall apply for purposes of this Section:

     (1) Designated beneficiary shall mean the individual who is designated as the beneficiary under the terms of the Plan and is the designated beneficiary under Code Section 401(a)(9) and section 1.401(a)(9)-1, Q&A-4 of the Treasury regulations.

     (2) A distribution calendar year is a calendar year for which a minimum distribution is required. For distributions beginning before the Member’s death, the first distribution calendar year is the calendar year immediately preceding the calendar year which contains the Member’s Required Beginning Date. For distributions beginning after the Member’s death, the first distribution calendar year is the calendar year in which distributions are required to begin under subsection (a). The required minimum distribution for the Member’s first distribution calendar year will be made on or before the Member’s Required Beginning Date. The required minimum distribution for other distribution calendar years, including the required minimum distribution for the distribution calendar year in which the Member’s Required Beginning Date occurs, will be made on or before December 31 of that distribution calendar year.

     (3) Life expectancy means an individual’s life expectancy as computed by use of the Single Life Table in section 1.401(a)(9)-9 of the Treasury regulations.

     (4) The Member’s account balance is the account balance as of the last valuation date in the calendar year immediately preceding the distribution calendar year (valuation calendar year) increased by the amount of any contributions made and allocated or forfeitures allocated to the account balance as of dates in the valuation calendar year after the valuation date and decreased by distributions made in the valuation calendar year after the valuation date. The account balance for the valuation calendar year includes any amounts rolled over or transferred to the Plan either in the valuation calendar year or in the distribution calendar year if distributed or transferred in the valuation calendar year.

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     (5) Required Beginning Date means the first day of April following the calendar year in which the Member attains age 70¹/2 or, if later, the calendar year in which the Member retires. In the case of a Member who is a “five percent owner” as defined in Section 21.07(f)(3), Required Beginning Date means the first day of April following the calendar year in which the Member attains age 70¹/2.

     10.06 Commencement of Benefit Distribution to Beneficiary. Distributions to the Beneficiary entitled under Section 9.02 to receive any payments payable under this Plan on account of a Member’s death shall be made in a lump sum payment not later than December 31 of the calendar year following the calendar year in which the Member died.

     10.07 Commencement of Benefit Distribution to Alternate Payee. Distributions to an alternate payee entitled under Section 16.01 to receive any payments payable under this Plan pursuant to the terms of a Qualified Domestic Relations Order shall be made in accordance with the terms of such Qualified Domestic Relations Order and this Plan on or after the date on which the Member has attained his “earliest retirement age” (as defined under Code Section 414(p)) under the Plan. Notwithstanding the foregoing, distribution to an alternate payee may be made prior to the Member’s attainment of his earliest retirement age if, but only if: (1) the Qualified Domestic Relations Order specifies distribution at that time or permits an agreement between the Plan and the alternate payee to authorize an earlier distribution; (2) the distribution is a single sum distribution of the alternate payee’s entire benefit entitlement under the Plan; and (3) in the event the present value of the alternate payee’s benefits under the Plan exceeds $1,000, the alternate payee consents to any distribution occurring prior to the Member’s attainment of earliest retirement age.

     Nothing in this Section 10.07 shall be construed to permit a Member to (1) receive a distribution at a time not otherwise permitted under the Plan, (2) permit the alternate payee to receive a form of payment not otherwise permitted under the Plan, or (3) cause his Plan accounts to be valued or otherwise determined in a manner not otherwise permitted under the Plan.

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SECTION 11

Permitted Rollover of Plan Distributions

     11.01 Rollover to Other Plans. Notwithstanding any provision of the Plan to the contrary that would otherwise limit a distributee’s election under this Section, a distributee may elect, at the time and pursuant to procedures prescribed by the Committee, to have any portion of an eligible rollover distribution paid directly to an eligible retirement plan specified by the distributee in a direct rollover. Such distribution may commence no less than thirty (30) days nor more than ninety (90) after any notice required under Treas. Reg. Section 1.411(a)-11(c) (or its successor) and explanation of his right to rollover his distribution and tax explanation in accordance with Internal Revenue Rules are given to a Member or other distributee, provided that the Member has been clearly informed that he has a right to a period of at least thirty (30) days after receiving said notice to consider the decision as to whether to elect a distribution or, if applicable, a distribution option, and the Member nevertheless affirmatively elects distribution preceding the expiration of thirty (30) days. A portion of the distribution shall not fail to be an eligible rollover distribution merely because the portion consists of after-tax Member contributions which are not includible in gross income. However, such portion may be transferred only to an individual retirement account or annuity described in Sections 408(a) or (b) of the Code, or a qualified defined contribution plan described in Sections 401(a) or 403(a) of the Code that agrees to separately account for amounts so transferred, including separately accounting for the portion of such distribution which is includible in gross income and the portion of such distribution which is not so includible.

     11.02 Rollover from Other Plans. An Associate eligible to participate in the Plan, regardless of whether he has satisfied the participation requirements of Section 2.01, may transfer to the Plan an Eligible Rollover Distribution provided that such distribution is from an Eligible Retirement Plan other than an individual retirement account described in Code Section 408(a) or an individual retirement annuity described in Code Section 408(b); and, provided further, that this Plan shall not accept the portion of any eligible rollover distribution that is not includible in gross income. If such transfer is not a direct transfer, such a transfer may be made only if the following conditions are met:

(a) the transfer occurs on or before the 60^th day following the Associate’s receipt of the distribution from the Eligible Retirement Plan; and

(b) The amount transferred is equal to any portion of the distribution the Associate received from the Eligible Retirement Plan, not in excess of the fair market value of all property received in such a distribution reduced by employee contributions, as defined in Code Section 402(a)(5)(E).

The Committee shall develop such procedures, and may require such information, from a Member desiring to make such a transfer, as it deems necessary or desirable to determine that the proposed transfer will meet the requirements of the Section. Upon approval by the Committee or its Administrative Delegate, the amount

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transferred shall be deposited in the Trust Fund and shall be credited to the Member’s account. Such rollover amount shall be one hundred percent (100%) vested in the Member, shall share in the income allocations in accordance with Section 5, but shall not share in the Company Profit Sharing Contributions, the Company Matching Contributions or the forfeiture allocations. Upon termination of employment, the total amount of the rollover contribution shall be distributed in accordance with the terms of the Plan.

Upon such a transfer by an Associate who is otherwise eligible to participate in the Plan but who has not yet completed the participation requirement of Section 2.01, his rollover amount shall represent his sole interest in the Plan until he becomes a Member.

     11.03 Definitions. The following definitions shall apply for the purposes of this Section 11:

(a) Eligible Rollover Distribution. An eligible rollover distribution is any distribution of all or any portion of the balance to the credit of the distributee, except that an eligible rollover distribution does not include: any distribution that is one of a series of substantially equal periodic payments (not less frequently than annually) made for the life (or life expectancy) of the distributee or the joint lives (or joint life expectancies) of the distributee and the distributee’s beneficiary or for a specified period of ten years or more; any distribution to the extent such distribution is required under Code Section 401(a)(9) and any hardship distribution.

(b) Eligible Retirement Plan. An eligible retirement plan is an individual retirement account described in Code Section 408(a), an individual retirement annuity described in Code Section 408(b), an annuity plan described in Code Section 403(a), an annuity contract described in Code Section 403(b), an eligible plan described in Code Section 457(b) maintained by a state, a political subdivision of a state, or any instrumentality of a state or political subdivision of a state, or a qualified trust described in Code Section 401(a), which accepts or will make, as applicable, an Eligible Rollover Distribution. This definition shall also apply to an Eligible Rollover Distribution to a Member’s surviving spouse, or a former spouse who is an alternate payee under a Qualified Domestic Relations Order.

(c) Distributee. A distributee includes a Member or former Member. In addition, the Member or former Member’s surviving spouse and the Member’s or former Member’s spouse or former spouse who is the alternate payee under a qualified domestic relations order, as defined in Code Section 414(p), are distributees with regard to the interest of the spouse or former spouse.

(d) Direct Transfer. A direct transfer is a payment by the Plan to the eligible retirement plan specified by the distributee as described in Code Section 401(a)(31).

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SECTION 12

Loans

     12.01 Availability of Loans. Loans shall be permitted under this Plan as established by the policy of the Committee. Any such loan shall be subject to such conditions and limitations as the Committee deems necessary for administrative convenience and to preserve the tax-qualified status of the Plan. Loans are available to Associates who have a Member Rollover Contribution Account.

     12.02 Amount of Loans. No loan to any Associate, Member or Beneficiary may be made to the extent that such loan, when added to the outstanding balance of all other loans to the Associate, Member or Beneficiary, would exceed the lesser of (a) $50,000 reduced by the excess (if any) of the highest outstanding balance of loans during the one-year period ending on the day before the loan is made, over the outstanding balance of loans from the Plan on the date the loan is made, or (b) one-half the present value of the nonforfeitable accrued benefit of the Participant. For the purpose of the above limitation, all loans from all plans of the Employer and other members of a group of employers described in Code Sections 414(b), 414(c), 414(m) and 414(o) are aggregated. Furthermore, any loan shall by its terms require that repayment (principal and interest) be amortized in level payments, not less frequently than quarterly, over a period not extending beyond four and one-half years from the date of the loan. If such loan is used to acquire a dwelling unit which within a reasonable time (determined at the time the loan is made) will be used as the principal residence of the Participant, the repayment period shall not extend beyond twenty nine and one-half years from the date of the loan. An assignment or pledge of any portion of the Participant’s interest in the Plan and a loan, pledge, or assignment with respect to any insurance contract purchased under the Plan will be treated as a loan under this paragraph.

     12.03 Terms of Loans.

(a) Loans shall be made available to all Associates, Members and Beneficiaries on a reasonably equivalent basis.

(b) Loans shall not be made available to Highly Compensated Employees (as defined in Code Section 414(q)) in an amount greater than the amount made available to other Employees.

(c) Loans must be adequately secured using not more than fifty percent (50%) of the Member’s Vested Account balance, and bear a reasonable interest rate as determined from time to time by the Committee.

(d) An Associate or Member loan for less than $1,000 is not permitted; provided, however, that if such Associate or Member also receives a loan from the Puerto Rico Plan, such minimum amount limitation shall not apply.

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(e) In the event of a default, foreclosure on the note and attachment of security will not occur until a distributable event occurs under the Plan with respect to the Member.

(f) No loans will be made to any Associate or Member who on any day during the Company’s applicable fiscal year is a beneficial owner of more than five percent (5%) of the outstanding stock of the Company.

(g) All loans shall be made pursuant to a written Member loan program incorporated herein by reference.

(h) Loans are available from the following accounts, and will be withdrawn from the Members accounts in the following hierarchy:

(a) Member Accounts
(b) Vested Company Accounts
(c) Member Rollover Contribution Accounts

(i) Loans will be taken and repaid from and to the Investment Funds on a pro rata basis, except in the case the Member is subject to Section 16 of the Securities Exchange Act of 1934 or has been designated as a “Designated Insider,” in which case such Member’s loan will be taken first from such Member’s Investment Funds other than the Payless Common Stock Fund.

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SECTION 13

Limit on Contributions to the Plan

     This Section 13 is intended to conform the Plan to the requirements of Code Section 415 and limits the contributions that can be made by and for an individual under the Plan.

     13.01 Limit on Contributions. Notwithstanding any provision of the Plan to the contrary:

(a) The amounts allocated to a Participant during the Limitation Year under the Plan and allocated to the Participant under any other defined contribution plan to which the Employer or any other member of the Group has contributed shall be proportionately reduced, to the extent necessary, so that the Annual Addition does not exceed the least of:

(1)	$40,000; or
(2)	100% of the Participant’s remuneration from the Employer or any member of the Group during the Limitation Year; or
(3)	such other limits set forth in Code Section 415.

The amount set forth in subparagraph (1) above shall automatically be adjusted to reflect adjustments made by applicable law. Remuneration for purposes of this Section means remuneration as defined in Treasury Regulation Section 1.415-2(d)(10) and, effective January 1, 1998, shall also include the deferrals described in Code Section 415(c)(3)(D)(including effective January 1, 2001, elective amounts not included in gross income by reason of Code Section 132(f)(4)).

(b) For purposes of this Section, Limitation Year means the 12 month period commencing on January 1 and ending on December 31.

(c) For purposes of this Section, Annual Additions means the sum for the Limitation Year of Employer contributions, Employee contributions (determined without regard to any rollover contributions as defined in Code Sections 402(a)(5), 403(a)(4), 403(b)(8) and 408(d)(3), without regard to catch-up contributions under Code Section 414(v) and without regard to Employee contributions to a simplified employee pension plan which are excludible from gross income under 408(k)(6) of the Code) and forfeitures.

13.02 Adjustment for Excessive Annual Additions.

(a) If, as a result of the allocation of forfeitures, a reasonable error in estimating a Member’s Pay or other facts and circumstances to which Treasury Regulation Section 1.415-6(b)(6) shall be applicable, the “annual additions” under this Plan would cause the maximum “annual additions” to be exceeded for any Member, the Committee shall (1)

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return any Member Contributions credited for the “limitation year” to the extent that the return would reduce the “excess amount” in the Member’s Accounts, (2) hold any “excess amount” remaining after the return of any member Contributions in a “Section 415 suspense account”, (3) use the “Section 415 suspense account” in the next “limitation year” (and succeeding “limitation years” if necessary) to reduce either Company Contributions for that Member if that Member is covered by the Plan as of the end of the “limitation year” or if such Member is not covered by the Plan at the end of the “limitation year” to reduce Company Contributions for all Members in the Plan, before any Company Contributions or Member Contributions which would constitute “annual additions” are made to the Plan for such “limitation year,” (4) reduce Company Contributions for such “limitation year” by the amount of the “Section 415 suspense account” allocated and reallocated during such “limitation year.” For purposes of (3) above, the Plan may not distribute “excess amounts” to Members or former Members.

(b) For purposes of this Section, “excess amount” for any Member for a “limitation year” shall mean the excess, if any, of (1) the “annual additions” which would be credited to his account under the terms of the Plan without regard to the limitations of Code Section 415 over (2) the maximum “annual additions” determined pursuant to Section 13.01(a).

(c) For purposes of this Section, “Section 415 suspense account” shall mean an unallocated account equal to the sum of “excess amount” for all Members in the Plan during the “limitation year.” The “Section 415 suspense account” shall not share in any earnings or losses of the Trust Fund.

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SECTION 14

Administration of the Plan

     14.01 Plan Administrator. The Company shall be the Plan Administrator of the Plan for purposes of ERISA and shall be a “named fiduciary” as determined in ERISA Section 402(a)(2).

     14.02 Delegation of Authority.

     (a) Authority to administer the Plan has been delegated to the Committee and the Administrative Subcommittee, if any, in accordance with Sections 1.42 (Total and Permanent Disability), 4.01 (Member Contributions), 6.01 (Member Accounts), 6.02 (Company Accounts), 6.05 (Member Statements), 8.02 (Authorized Withdrawals), 13.02 (Adjustment for Excessive Annual Additions), 20.02 (Withdrawal of an Employer) and this Section 14.

     (b) Authority with respect to the Investment Funds of the Plan has been delegated to the Trustee in accordance with Sections 7.01 (Administrative Expenses), 5.01(c) (Investment Funds), 15 (Management of the Trust Fund) and 6.06 (shares of Payless ShoeSource, Inc. (Payless Stock) in the Payless Common Stock Fund).

     (c) Authority to direct the investment of the Plan’s funds has been delegated to the Investment Subcommittee, if any, in accordance with Section 15.03(b), (c) and (d) (Investments and Reinvestments).

     (d) The Committee shall also have the authority and discretion to engage an Administrative Delegate who shall perform, without discretionary authority or control, administrative functions within the frame work of policies, interpretations, rules practices and procedures made by the Committee or other Plan Fiduciary. Any action made or taken by the Administrative Delegate may be appealed by an affected Member to the Committee in accordance with the claims review procedure in Section 16.05. Any decisions which call for interpretations of the Plan provisions not previously made by the Committee shall be made only by the Committee. The Administrative Delegate shall not be considered a fiduciary with respect to the services it provides.

     14.03 Committee and Subcommittees.

     (a) The Committee may appoint two subcommittees (an “Administrative Subcommittee” and an “Investment Subcommittee”), each Subcommittee to consist of at least three persons, who need not be members of the Board. The Committee and each Subcommittee, if appointed, shall elect from its members a Chairman and a Secretary, and may appoint one or more Assistant Secretaries who may, but need not be, members of the Committee or such Subcommittee, and may employ such agents, such legal counsel and such clerical, medical, accounting, actuarial and other services as it may from time to time deem advisable to assist in the

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administration of the Plan. The Committee and each Subcommittee may, from time to time, appoint agents and delegate to such agents such duties as it considers appropriate and to the extent that such duties have been so delegated, the agent shall be exclusively responsible for the proper discharge of such duties.

     (b) The Administrative Subcommittee shall have the general responsibility for the administration of the Plan and the carrying out of its provisions, and shall have general powers with respect to Plan administration, including, but not limited to, the powers listed in this Section 14.03. The Administrative Subcommittee shall have the discretionary authority to interpret and construe the Plan, the power to establish rules for the administration of the Plan and the transaction of its business, the power to remedy and resolve inconsistencies and omissions, and the power to determine all questions which arise in the administration, interpretation, or application of the Plan, including but not limited to questions regarding the eligibility, status, Account value and any rights of any Member, Beneficiary, and any other person hereunder.

     (c) The Investment Subcommittee shall have the powers provided for in Section 15.03(b).

     (d) The Committee and each Subcommittee shall act by a majority of its members and the action of such majority expressed by a vote at a meeting, or in writing without a meeting, shall constitute the action of the Committee or such Subcommittee. All decisions, determinations, actions or interpretations with respect to the Plan by the Committee or either Subcommittee and the individual committee or subcommittee members shall be in the Committee’s, Subcommittee’s or individual member’s sole discretion. The decision, determination, action or interpretation of the Committee or either Subcommittee and the respective individual members of the Committee or Subcommittee in respect to all matters within the scope of its authority shall be conclusive and binding on all persons. No member of the Committee or either Subcommittee shall have any liability to any person for any action or omission except each for his own individual willful misconduct. If a Subcommittee is not appointed, the Committee shall exercise such Subcommittee’s authority and perform its duties as described herein.

     (e) Nothing in this Section 14 or in any other provision of the Plan shall be deemed to relieve any person who is a fiduciary under the Plan for purposes of ERISA from any responsibility or liability for any responsibility, obligation or duty which Part 4 of Title I of ERISA shall impose upon such person with respect to this Plan.

     14.04 Accounts and Reports. The Committee shall maintain or cause to be maintained accounts reflecting the fiscal transactions of the Plan and shall keep in convenient form such data as may be necessary for the administration of the Plan. The Committee shall prepare annually a report showing in reasonable detail the assets and liabilities of the Plan and setting forth a brief account of the operation of the Plan for the preceding year.

     14.05 Non-Discrimination. Neither the Committee nor either Subcommittee shall exercise its discretion in such a way as to result in discrimination in favor of officers, shareholders or highly compensated employees (within the meaning of Code Section 414(q)).

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SECTION 15

Management of the Trust Fund

     15.01 Use of the Trust Fund. All assets of the Plan shall be held as a Trust Fund in one or more trusts and shall be used to provide the benefits of this Plan. No part of the corpus or income shall be used for, or diverted to, purposes other than for the exclusive benefit of Members and their Beneficiaries under this Plan and administrative expenses of this Plan.

     15.02 Trustees. The Trust Fund may, at the direction of the Company, be divided into one or more separate trusts, each of which may have a separate Trustee appointed from time to time by the Company and subject to removal by the Company. The Trustee or Trustees of each trust shall have complete authority and discretion with respect to the investment and reinvestment of the assets of each trust, subject, however, to (i) the provisions in the Trust Agreements between the Trustee or Trustees and the Company, and (ii) the provisions of this Plan. Any or all of such separate trusts shall be referred to collectively from time to time as the Trust Fund. Any division of the Trust Fund into one or more separate trusts shall be at the direction of the Company.

     15.03 Investments and Reinvestments. The investment and reinvestment of the assets of the Trust Fund shall be in accordance with the following:

     (a) The Company shall have the authority to instruct the Trustee or Trustees to accept and follow the instructions of any designated investment manager (within the meaning of ERISA Section 3(38)) with respect to the investment and reinvestment of the assets constituting a money market or stable value fund, a fixed income fund, a common stock fund, or any other Investment Funds the Company may designate.

     (b) The Investment Subcommittee shall have the powers, with respect to investment and reinvestment of the assets constituting the Investment Funds, to promulgate limitations, restrictions, rules or guidelines with respect to the investment policies and classes of investments in which the assets of the Investment Funds may be invested or reinvested by the Trustee or Trustees, including any such investments made pursuant to the instructions of any investment manager. In the event an investment manager designated pursuant to Section 15.03(a) resigns or otherwise is unable to act, the Investment Subcommittee shall have such power and authority as otherwise would be exercisable by such Investment Manager.

     (c) In the event that the assets of the Trust Fund shall be divided into one or more separate trusts pursuant to the authority provided for in Section 15.02, then the powers of the Investment Subcommittee as provided for in Section 15.03(b) may be exercised with respect to one or more of such trusts within the discretion of the Investment Subcommittee.

     (d) The powers of the Investment Subcommittee as provided in Section 15.03(b) may be exercised at any time or from time to time by the Investment Subcommittee within the discretion of the Investment Subcommittee and shall be pursuant to a written agreement between

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the Investment Subcommittee and the Trustee or Trustees or, if an investment manager has been appointed, between the Investment Subcommittee and the investment manager.

     (e) The Trust Agreement between the Company and the Trustee or Trustees implementing the Plan shall contain provisions effectuating the provisions of this Section 15 of the Plan.

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SECTION 16

Certain Rights and Obligations of Employers and Members

     16.01 Disclaimer of Employer Liability.

     (a) No liability shall attach to any Employer with respect to a benefit or claim hereunder and Members and their Beneficiaries, and all persons claiming under or through them, shall have recourse only to the Trust Fund for payment of any benefit hereunder.

     (b) The rights of the Members, their Beneficiaries and other persons are hereby expressly limited and shall be only in accordance with the provisions of the Plan. Nothing contained herein shall be deemed to give a Member any interest in any specific property of the Trust or any interest other than a right to receive payments pursuant to the provisions of the Plan.

     16.02 Employer-Associate Relationship. Neither the establishment of this Plan nor its communication through a Summary Plan Description (or otherwise) shall be construed as conferring any legal or other rights upon any Associate or any other person to continue in employment or as interfering with or affecting in any manner the right of an Employer to discharge any Associate or otherwise act with relation to him. Each Employer may take any action (including discharge) with respect to any Associate or other person and may treat him without regard to the effect which such action or treatment might have upon him as a Member of this Plan.

     16.03 Binding Effect. Each Member, by executing an enrollment form, beneficiary designation and otherwise agreeing to participate in the Plan agrees for himself, his beneficiary(ies), heirs, successors and assigns to be bound by all of the provisions of the Plan.

     16.04 Corporate Action. With respect to any action permitted or required by the Plan, the Company may act through its appropriate officers.

     16.05 Claim and Appeal Procedure. A Member or beneficiary may file with the Committee or its designee at any time a written claim in connection either with a benefit payable hereunder or otherwise. The Committee or its designee, normally within 90 days after receipt of a written claim, shall render a written decision on the claim, unless an additional 90 days is required by special circumstances which shall be explained to the claimant. If the claim is denied, either in whole or in part, the decision shall include the reason or reasons for the denial; a specific reference to the Plan provision or provisions which are the basis for the denial; a description of any additional material or information necessary for the claimant to perfect the claim; an explanation as to why the information or material is necessary; and an explanation of the Plan’s entire claim procedure. The claimant may file with the Committee, within 60 days after receiving the written decision from the Committee, a written notice of request for review of the Committee’s decision. The review shall be made by a committee of up to three individuals (which may include members of the Committee) appointed by the Company or by the Committee. Said committee shall render a written decision on the claim containing the specific reasons for

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their decision, including a reference to the Plan’s provisions, normally within 60 days after receipt of the request for review, unless an additional 60 days is required by special circumstances which shall be explained to the claimant. If a Member or beneficiary does not file written notice of a claim with the Committee or its designee at the times set forth above, he shall have waived any right to a benefit other than as originally proposed by the Company or the Committee.

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SECTION 17

Non-Alienation of Benefits

     17.01 Provisions with Respect to Assignment and Levy. No benefit payable under this Plan shall be subject in any manner to anticipation, alienation, sale, transfer, assignment, pledge, encumbrance, levy or charge, and any attempt so to anticipate, alienate, sell, transfer, assign, encumber, levy upon or charge the same shall be void; nor shall any such benefit be in any manner liable for or subject to the debts, contracts, liabilities, engagements or torts of the person entitled to such benefit, except as specifically provided herein. Notwithstanding the foregoing, the creation, assignment, or recognition of a right to any benefit payable to an alternate payee with respect to a Qualified Domestic Relations Order shall not be treated as an assignment or alienation prohibited by this Section. Any other provision of the Plan to the contrary notwithstanding, if a Qualified Domestic Relations order requires the distribution of all or part of a Member’s benefits under the Plan, the establishment or acknowledgment of the alternate payee’s right to benefits under the Plan in accordance with the terms of such Qualified Domestic Relations Order shall in all events be deemed to be consistent with the terms of the Plan.

          Notwithstanding the above a Member’s benefit will be offset against any amount he or she is ordered or required to pay to the Plan pursuant to an order or requirement which arises under a judgment of conviction for a crime involving the Plan, under a civil judgment entered by a court in an action involving a fiduciary breach, or pursuant to a settlement agreement between the Participant and the Department of Labor or the Pension Benefit Guaranty Corporation. Any such offset shall be made pursuant to Section 206(d) of ERISA.

     17.02 Alternate Application. If a Member or Beneficiary under this Plan becomes bankrupt or attempts to anticipate, alienate, sell, transfer, assign, pledge, encumber or charge any benefit under this Plan, except as specifically provided herein, or if any benefit shall, in the discretion of the Committee, cease, and in that event the Committee may hold or apply the same or any part thereof to or for the benefit of such Member or Beneficiary, his spouse, children or other dependents, or any of them, or in such other manner and in such proportion as the Committee may deem proper.

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SECTION 18

Amendments

     18.01 Company’s Rights. The Company reserves the right at any time and from time to time in its sole discretion to alter, amend, or modify, in whole or in part, any or all of the provisions of this Plan, provided, however, no such alteration, amendment or modification shall be made which shall decrease the accrued benefit of any Member. Anything in this Plan to the contrary notwithstanding, the Company in its sole discretion may make any modifications or amendments, additions or deletions in or to this Plan as to benefits or otherwise and retroactively if necessary, and regardless of the effect thereof on the rights of any particular Member or Beneficiary, which it deems appropriate and/or necessary in order to comply with or satisfy any conditions of any law or regulation relating to the qualification of this Plan and the trust or trusts created pursuant hereto and to keep this Plan and said trusts qualified under Code Section 401(a) and to have the trust or trusts declared exempt from taxation under Code Section 501(a).

     18.02 Procedure to Amend. This Plan may be amended by action of the Company’s Board of Directors and evidenced by a written amendment signed by the Company’s Secretary or by any other person so authorized by or pursuant to authority of the Board of Directors.

     18.03 Provision Against Diversion. No part of the assets of the Trust Fund shall, by reason of any modification or amendment or otherwise, be used for, or diverted to, purposes other than for the exclusive benefit of Members and their Beneficiaries under this Plan and administrative expenses of this Plan.

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SECTION 19

Termination

     19.01 Right to Terminate. The Company reserves the right to terminate this Plan, in whole or in part, at any time and, if this Plan shall be terminated either in its entirety or with respect to any Employer included hereunder, the provisions of Section 19.03 shall apply and the Accounts of affected Members shall become (or remain) fully vested and nonforfeitable.

     19.02 Withdrawal of an Employer. If an Employer shall cease to be a participating Employer in this Plan, the Trust Fund and the Accounts of the Members of the withdrawing Employer and their Beneficiaries shall be revalued as if such withdrawal date were a Valuation Date. The Committee shall then direct the Trustee either to distribute the Accounts of the Members of the withdrawing Employer as of the date of such withdrawal on the same basis as if the Plan had been terminated pursuant to Section 19.03 or to deposit in a trust established by the withdrawing Employer pursuant to a plan substantially similar to this Plan assets equal in value to the assets of the Trust Fund allocable to the Accounts of the Members of the withdrawing Employer.

     19.03 Distribution in Event of Termination of Trust. If this Plan is terminated at any time including a partial termination as defined in Code Section 411(d)(3), or if contributions are completely discontinued and the Company determines that the trust shall be terminated, in whole or in part, the Trust Fund and all Accounts shall be revalued as if the termination date were a Valuation Date and the affected Members’ Accounts shall be distributed in accordance with Section 10.

     19.04 Administration in Event of Continuance of Trust. If this Plan shall be terminated in whole or in part or contributions completely discontinued but the Company determines that the trust shall be continued pursuant to the terms of the Trust Agreement, the trust shall continue to be administered as though the Plan were otherwise in effect. Upon the subsequent termination of the trust, in whole or in part, the provisions of Section 19.03 shall apply.

     19.05 Merger, Consolidation or Transfer. In the case of any merger or consolidation with, or transfer of Plan assets or liabilities to, any other plan, each Member shall be entitled to receive a benefit immediately after the merger, consolidation or transfer (if the transferee plan then terminated) which is equal to or greater than the benefit he would have been entitled to receive immediately before the merger, consolidation or transfer (if the Plan had then terminated).

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SECTION 20

Construction

     20.01 Applicable Law. The provisions of this Plan except as otherwise governed by ERISA shall be construed, regulated, administered and enforced according to the laws of the State of Kansas and, whenever possible, to be in conformity with the applicable requirements of ERISA and the Internal Revenue Code.

     20.02 Gender and Number. Wherever applicable, the masculine pronoun as used herein shall include the feminine pronoun and the singular pronoun shall include the plural.

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SECTION 21

Top-Heavy Requirements

     21.01 Generally. For any Plan Year in which the Plan is a Top-Heavy Plan, the provisions of Sections 21.02 and 21.03 shall automatically take effect in accordance with Code Section 416.

     21.02 Minimum Allocations.

(a) Minimum Employer Allocations and allocations of Plan forfeitures for a Member who is not a Key Employee shall be required under the Plan for the Plan Year as set forth in Section 21.02 (b) and(c).

(b) The amount of the minimum allocation shall be the lesser of the following, percentages of Pay: (i) four percent (4%) or, (ii) the highest percentage at which such allocations are made under the Plan for the Plan Year on behalf of a Key Employee. For purposes of this paragraph (b), all defined contribution plans required to be included in an Aggregation Group shall be treated as one plan. This paragraph (b) shall not apply if the Plan is required to be included in an Aggregation Group and the Plan enables a defined benefit plan required to be included in the Aggregation Group to meet the requirement of Code Sections 401(a)(4) or 410. For purposes of this paragraph (b), the calculation of the percentage at which allocations are made for a Key Employee shall be based only on his Pay not in excess of $200,000, such amount to be adjusted periodically for increases in the cost of living in accordance with Code Section 401(a)(17). The minimum allocation described in this paragraph (b) shall be in addition to (and shall not be reduced by) any Member Contributions under Section 4 (whether Before-Tax or After-Tax) and any allocation of forfeitures, if any, to which a Member may be entitled.

(c) For purposes of this Section 21.02, the term “Member” shall be deemed to refer to all Members who have not separated from service at the end of the Plan Year including, without limitation, individuals who declined to make contributions to the Plan.

     21.03 Participants Under Defined Benefit Plans. If any Member other than a Key Employee is also a participant under a defined benefit plan of an Employer which is a Top-Heavy Plan, then Section 21.03(a) shall not apply and the required minimum annual contribution for such Member under this Plan shall be 7 percent (7 %) of such Member’s Pay. Such contribution shall be made without regard to the amount of contribution, if any, made to the Plan on behalf of Employees.

     21.04 Determination of Top Heaviness.

(a) The determination of whether a plan is Top-Heavy shall be made in accordance with paragraphs (b) through (d) of this Section 21.04.

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(b) If the Plan is not required to be included in an Aggregated Group with other plans, then it shall be Top-Heavy only if when considered by itself, it is a Top-Heavy Plan and it is not included in a permissive Aggregation Group that is not a Top-Heavy Group.

(c) If the Plan is required to be included in an Aggregation Group with other plans, it shall be Top-Heavy only if the Aggregation Group, including any permissively aggregated plans, is Top-Heavy.

(d) If a plan is not a Top-Heavy Plan and is not required to be included in an Aggregation Group, then it shall not be Top-Heavy even if it is permissively aggregated in an Aggregation Group which is a Top-Heavy Group.

     21.05 Calculation of Top-Heavy Ratios. A plan shall be Top-Heavy and an Aggregation Group shall be a Top-Heavy Group with respect to any Plan Year as of the Determination Date if the sum as of the Determination Date of the Cumulative Accrued Benefits and the Cumulative Accounts of Employees who are Key Employees for the Plan Year exceeds 60 percent (60%) of a similar sum determined for all Employees, excluding former Key Employees.

     21.06 Cumulative Accounts and Cumulative Accrued Benefits.

(a) The Cumulative Accounts and Cumulative Accrued Benefits for any Employee shall be determined in accordance with paragraphs (b) through (e) of this Section 21.06.

(b) Cumulative Account shall mean the sum of the amount of an Employee’s accounts under a defined contribution plan (for an unaggregated plan) or under all defined contribution plans included in an Aggregation Group (for aggregated plans) determined as of the most recent plan Valuation Date within a 12-month period ending on the Determination Date, increased by any allocations due after such Valuation Date and before the Determination Date.

(c) Cumulative Accrued Benefit means the sum of the present value of an Employee’s accrued benefits under a defined benefit plan (for an unaggregated plan) or under all defined benefit plans included in an Aggregation Group (for aggregated plans), determined under the actuarial assumptions set forth in such plan or plans, as of the most recent plan Valuation Date within a 12-month period ending on the Determination Date as if the Employee voluntarily terminated service as of such Valuation Date.

(d) Accounts and benefits shall be calculated to include all amounts attributable to both Matching Allocations and Employee contributions but excluding amounts attributable to voluntary deductible Employee contributions.

(e) Accounts and benefits shall be increased by the aggregate distributions during the one-year period ending on the Determination Date made with respect to an Employee under the plan or plans as the case may be or under a terminated plan which, if it had not been terminated, would have been required to be included in the Aggregation Group. In

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the case of a distribution made for a reason other than separation from service, death, or disability, this provision shall be applied by substituting “five-year period” for “one-year period.”

(f) Rollovers and direct plan-to-plan transfers shall be handled as follows:

(i) If the transfer is initiated by the Employee and made from a plan maintained by one Employer to a plan maintained by another Employer, the transferring plan continues to count the amount transferred under the rules for counting distributions. The receiving plan does not count the amount if accepted after December 31, 1983, but does count it if accepted prior to December 31, 1983.

(ii) If the transfer is not initiated by the Employee or is made between plans maintained by the Employers, the transferring plan shall no longer count the amount transferred and the receiving plan shall count the amount transferred.

(iii) For purposes of this subsection (f), all Employers aggregated under the rules of Code Sections 414(b), (c) and (m) shall be considered a single employer.

(g) The accrued benefits and accounts of any individual who has not performed services for the Employer during the one-year period ending on the Determination Date shall not be taken into account.

21.07 Other Definitions.

(a) Solely for purposes of this Section 21, the definitions in paragraphs (b) through (i) of this Section 21.07 shall apply, to be interpreted in accordance with the provisions of Code Section 416 and the regulations thereunder.

(b) Aggregation Group means a plan or group of plans which included all plans maintained by the Employer in which a Key Employee is a participant or which enables any plan in which a Key Employee is a participant to meet the requirements of Code Section 401(a)(4) or Code Section 410, as well as all other plans selected by the Company for permissive aggregation, the inclusion of which would not prevent the group of plans from continuing to meet the requirements of such Code sections.

(c) Determination Date means, with respect to any Plan Year, the last day of the preceding Plan Year.

(d) Employee means any person employed by an Employer and shall also include any Beneficiary of such persons, provided that the requirements of Sections 21.02 and 21.03 shall not apply to any person included in a unit of Employees covered by an agreement which the Secretary of Labor finds to be a collective bargaining agreement between Employee representatives and one or more Employers if there is evidence that retirement

55

benefits were the subject of good faith bargaining between such Employee representatives and such Employer or Employers.

(e) Employer means any corporation which is a member of a controlled group of corporations (as defined in Code Section 414(b)) which includes the Company or any trades or businesses (whether or not incorporated) which are under common control (as defined in Code Section 414(c)) with the Company, or a member of an affiliated service group (as defined in Code Section 414(m)) which includes the Company,

(f) Key Employee means any Employee or former Employee (including any deceased Employee) who is, at any time during the Plan Year which includes the Determination Date, any one or more of the following: (1) an officer of an Employer who has annual Pay of more $130,000 (as adjusted under Code Section 416(i)(1))(2) any person owning (or considered as owning within the meaning of the Code Section 318) more than five percent of the outstanding stock of an Employer or stock possessing more than five percent of the total combined voting power of such stock; (3) a person who would be described in subsection (2) above if “one percent” were substituted for “five percent” each place it appears in subsection (2) above, and who has annual Pay of more than $150,000 (for purposes of determining ownership under this subsection, Code Section 318(a)(2)(C) shall be applied by substituting “five percent” for “50 percent” and the rules of subsections (b), (c) and (m) of Code Section 414 shall not apply).

     IN WITNESS WHEREOF, the Company has caused this amended Plan to be executed by a duly authorized officer effective November 10, 2005.

PAYLESS SHOESOURCE, INC.

By:

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EX-10.13

EXHIBIT - - 10.13

PAYLESS SHOESOURCE, INC.
STOCK OWNERSHIP PLAN
(as amended January 1, 2007)

1. PURPOSE AND EFFECT OF PLAN

     The purpose of the Plan is to provide associates, including executive officers, an opportunity to purchase Common Stock of Payless ShoeSource, Inc. (the “Company”) through payroll deductions at a discount on a tax deferred basis. It is believed that this will help attract, motivate and retain highly qualified and talented associates who are important to the Company’s success. The Plan is also intended to offer equity ownership in the Company to associates to encourage them to enhance the value of the Company and therefore the price of the Company’s Common Stock and the shareowners’ return.

     The Plan is intended to comply with Code section 423 and to be a “tax conditioned plan” within the meaning of SEC Rule 16b-3(c).

2. SHARES RESERVED FOR THE PLAN

     There shall be reserved for issuance and purchase by Eligible Associates under the Plan an aggregate of 2,000,000 shares of Common Stock, subject to adjustment as provided in Section 16. Shares purchased for the Plan shall be purchased in the open market or in private transactions, or a combination thereof.

3. DEFINITIONS

     Where indicated by initial capital letters, the following terms shall have the following meanings:

     ACT: The Securities Exchange Act of 1934.

     BASE COMPENSATION: The regular earnings of an Eligible Associate (before withholding or other deductions), including overtime, after any salary reduction contributions pursuant to elections under a plan subject to Code sections 125 or 401(k) and excluding bonuses and any other special payments; provided, that the Committee may expand or narrow the definition of Base Compensation from time to time so long as such definition is consistent with the requirements of Section 423 of the Code.

     BOARD: The Board of Directors of the Company.

     BUSINESS DAY: Each day on which shares of Common Stock are or could be traded on the New York Stock Exchange, or such other definition as the Committee may from time to time specify.

     CODE: The Internal Revenue Code of 1986, as amended, or any subsequently enacted federal revenue law. A reference to a particular section of the Code shall include a reference to any regulations issued under the section and to the corresponding section of any subsequently enacted federal revenue law.

     COMMITTEE: The committee established pursuant to Section 13 to be responsible for the general administration of the Plan.

     COMMON STOCK: The Company’s common stock, $.01 par value.

     COMPANY: Payless ShoeSource, Inc., a Missouri corporation, provided, that immediately after the effective time of the Merger such term shall mean Payless ShoeSource, Inc. (formerly Payless ShoeSource Holdings, Inc.), a Delaware corporation, and any successor by merger, consolidation or otherwise.

     ELIGIBLE ASSOCIATE: Each employee, including each executive officer, of the Company and its domestic Subsidiaries who meet the eligibility requirements of Section 4.

     EMPLOYER: A Participating Company that is the employer of a Participant.

     ENROLLMENT PROCEDURE: The procedure specified from time to time by the Committee to enable an Eligible Associate to participate in the Plan and to authorize payroll deductions pursuant to Section 5.

     FAIR MARKET VALUE: The weighted average price per share paid for all shares purchased on the date in question with respect to a determination of the Purchase Price of Common Stock purchased other than from the Company by an independent trustee or purchasing agent in arms-length transactions. For all other purposes, Fair Market Value shall mean the average of the reported lowest and highest sales prices per share for the Common Stock on the New York Stock Exchange on the date in question, or, if there are no such sales on that date, the reported lowest and highest sales prices per share for the Common Stock on the New York Stock Exchange for the last Business Day prior to the date in question for which sales of the Common Stock were reported.

     INVESTMENT ACCOUNT: The account established for each Participating Associate to hold Common Stock purchased under the Plan pursuant to Section 5.

     INVESTMENT DATE: The date on which the shares of Common Stock are purchased for the Plan.

     “MERGER” means the merger of Payless Merger Corp., a Missouri corporation and wholly-owned subsidiary of Payless ShoeSource, Inc. (formerly Payless ShoeSource Holdings, Inc.), a Delaware corporation, with the Company, pursuant to an Agreement and Plan of Merger among the Company, Payless Merger Corp. and Payless ShoeSource, Inc. (formerly Payless ShoeSource Holdings, Inc.).

     MONTH: A calendar month.

     PARENT: Any corporation (other than the Company) in an unbroken chain of corporations ending with the Company if, as of an Investment Date, each of the corporations other than the Company owns stock possessing 50% or more of the total combined voting power of all classes of stock in one of the other corporations in such chain.

     PARTICIPATING COMPANIES: The Company and its domestic Subsidiaries.

     PARTICIPANT OR PARTICIPATING ASSOCIATE: Eligible Associates who elect to participate in the Plan pursuant to Section 5.

     PAYROLL DEDUCTION ACCOUNT: The account established for a Participating Associate to hold payroll deductions pursuant to Section 5.

     PLAN: The “Payless ShoeSource, Inc. Stock Ownership Plan,” as set forth herein and as amended from time to time.

     PURCHASE PRICE: The price for each whole and fractional share of Common Stock, including those purchased by dividend reinvestment, which shall be 95% of the Fair Market Value of such whole or fractional share on the Investment Date; provided, however, the Committee may change such purchase price so long as the purchase price is not lower than the lesser of (i) 85% of the Fair Market Value of the Common Stock on the first day of the applicable purchase period, and (ii) 85% of the Fair Market Value of the Common Stock on the Investment Date.

     PURCHASE PERIOD: That period specified by the Committee during which payroll deductions shall be accumulated for the purchase of Common

3

Stock under the Plan; provided, that such period shall not have a duration that exceeds the limitations provided in Section 423(b)(7) of the Code.

     RULE 16B-3: Rule 16b-3 of the Securities and Exchange Commission promulgated under the Act, as now and hereafter amended.

     SUBSIDIARY OR SUBSIDIARIES: Any corporation (other than the Company) in an unbroken chain of corporations beginning with the Company if, as of an Investment Date, each of the corporations other than the last corporation in the unbroken chain owns stock possessing 50% or more of the total combined voting power of all classes of stock in one of the other corporations in such chain.

     TRUSTEE: The trustee of the Plan designated by the Committee as provided in Section 13.

4. ELIGIBLE ASSOCIATES

     Participation in the Plan shall be open to each associate of a Participating Company (including each executive officer of the Company) who has been continuously employed by one or more Participating Companies for at least six months; provided, that the Committee may establish such other or different employment requirements as it may deem appropriate so long as such other or different requirements are consistent with the provisions of Section 423 of the Code. For purposes of this section any break in service of less than thirty-one days shall not be deemed to constitute a discontinuance of employment, unless the Committee shall otherwise provide.

     No director of the Company or of any its Subsidiaries who is not an associate shall be eligible to participate in the Plan.

5. ELECTION TO PARTICIPATE; METHOD OF PURCHASE; INVESTMENT ACCOUNTS; DIVIDENDS

     5.1 ELECTION TO PARTICIPATE. Each Eligible Associate may become a Participant effective on the first day of any Month coincident with or following the date the Participant becomes an Eligible Associate by complying with the Enrollment Procedure authorizing specified regular payroll deductions from the Participant’s Base Compensation. Such regular payroll deductions shall be subject to a minimum deduction of $5.00 per weekly pay period and $10.00 per bi-weekly pay period and a maximum deduction of $480.00 per weekly pay period and $960.00 per bi-weekly pay period; provided, that the Committee may increase or decrease such minimum and maximum deductions from time to time. All regular payroll deductions shall be credited to the Payroll Deduction Account that the Company has established in the name of the Participant.

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     5.2 PURCHASE OF COMMON STOCK. Each Participating Associate having eligible funds in the Participant’s Payroll Deduction Account on an Investment Date shall be deemed, without any further action, to have purchased the number of shares which the eligible funds in the Participant’s Payroll Deduction Account could purchase at the Purchase Price on that Investment Date. All shares purchased shall be maintained by the Trustee in separate Investment Accounts for Participating Associates. Fractional shares will be allocated to accounts under the Plan unless the Committee otherwise provides; provided that share certificates shall only be issued for whole shares. If fractional shares are not allocated to accounts under the Plan, amounts that otherwise would have been applied to the purchase of fractional shares will continue to be held for the Participant and be applied towards the purchase of shares on the last day of the next Purchase Period.

     5.3 TIMING AND MANNER OF PURCHASE. The Committee shall designate Purchase Periods during which funds shall be accumulated in Payroll Deduction Accounts for the purchase of Common Stock. Until otherwise specified the Purchase Periods shall consist of each Month in a year. The Investment Date shall occur during an interval immediately following the end of each Purchase Period having such duration as the Committee shall from time to time specify, provided that until the Committee otherwise specifies, such interval shall be the ten Business Days immediately following the end of the Purchase Period. However, nothing contained in this Plan shall authorize the Committee, the Company or any affiliate of the Company to exercise any direct or indirect control or influence over the times when, or the prices at which, the Trustee or its independent agent may purchase the Common Stock for the Plan, the amounts of the Common Stock to be purchased, the manner in which the Common Stock is to be purchased, or the selection of a broker or dealer (other than the Trustee) through which purchases may be executed; provided, that the Company, the Committee and affiliates of the Company, shall not be deemed to have such control or influence solely because the Committee revises not more than once in any three month period the basis for determining the amount of the Company’s contributions to the Plan, the basis for determining the frequency of the Company’s allocations to the Plan, or any formula in the Plan that determines the amount or timing of shares to be purchased by the Trustee.

     5.4 DIVIDENDS AND OTHER DISTRIBUTIONS. All cash dividends paid with respect to the whole and fractional shares of the Common Stock and shares so purchased shall be reinvested in Common Stock on the immediately following Investment Date and added to the shares held for a Participating Associate in the Participant’s Investment Account. Stock dividends and stock splits received by the Plan will be credited to Participants having Common Stock allocated to their Investment Account to the extent that they are attributable to such allocated Common Stock. Property, other than shares of Common Stock or

5

cash, received by the Trustee as a distribution with respect to Common Stock allocated to Participant Common Stock accounts will be distributed in kind to Participants in proportion to the number of shares of Common Stock contained in their Investment Account.

     5.5 STOCK PURCHASES. The Trustee shall effect purchases of Common Stock on the open market or in private transactions. Purchases shall be made using total amounts contained in all Payroll Deduction Accounts immediately preceding the purchase. The Company will pay the difference between the Purchase Price and the price at which such shares are purchased for the Plan on or prior to the required closing date for the purchase. Expenses incurred in the purchase of shares shall also be paid by the Company.

     5.6 PAYMENT OF DEDUCTIONS TO THE TRUSTEE. Participating Companies shall pay to the Trustee or to the order of the Trustee payroll deductions made during a Month prior to the time required for the closing of purchases of Common Stock for the Plan, as directed by the Committee. Interest shall not accrue on any amount paid to the Trustee or otherwise allocated to an Investment Account pending investment in Common Stock or other distribution.

6. CHANGE IN PARTICIPATION, WITHDRAWALS AND DISTRIBUTIONS

     6.1 PERIOD OF PARTICIPATION. After an Eligible Associate has become a Participant in the Plan, such participation will continue thereafter, so long as the Plan continues in effect, until the employment of the Participant with all Participating Companies terminates, the Participant ceases to make contributions to the Plan and makes a complete withdrawal from the Plan, or the Participant ceases to be an Eligible Associate.

     6.2 CHANGE IN PARTICIPATION. A Participant may change the amount of the Participant’s payroll deductions in accordance with rules established by the Committee.

     6.3 PARTIAL WITHDRAWALS. The Trustee shall deliver whole shares allocated to a Participant’s Investment Account upon written request for a partial withdrawal received in accordance with rules established by the Committee so long as the Participant’s Investment Account following such delivery contains at least one share or such other amount as the Committee may from time to time require. Deliveries shall be made as soon as practicable after the request is received.

     6.4 COMPLETE WITHDRAWAL, TERMINATION OF EMPLOYMENT, DEATH. A Participant may effect a complete withdrawal from the Plan by giving notice in accordance with rules established by the Committee. A withdrawal from the Plan shall also be deemed to occur at such time as the Participant ceases to

6

be an Eligible Associate for any reason, including death, or upon the occurrence of such other event as may herein be specified as one which triggers a withdrawal. The Employer shall give prompt notice to the Trustee of such withdrawal. Upon any such withdrawal the Participant, or the Participant’s beneficiary or estate in the case of death, shall be entitled to receive from the Trustee, as soon as practicable after the Trustee shall have completed its purchases of Common Stock hereunder with all funds attributable to amounts received by the Trustee with respect to the part of the Purchase Period that precedes the effective date of such withdrawal: (a) the number of whole shares of Common Stock credited to the account of such Participant, (b) cash in the amount of any fractional share credited to the Participant’s Investment Account and (c) any cash balance credited to such Participant’s Accounts which has not been invested by the Trustee. In the case of the death of the Participant the deliveries shall be made to the beneficiary designated by the Participating Associate in a writing filed with the Company. If no beneficiary has been designated, or if the designated beneficiary does not survive the Participating Associate, such amount and all shares shall be delivered to the Participant’s estate.

     6.5 PLAN RE-ENTRY; SUSPENSION DURING APPROVED LEAVE. A Participant who withdraws from the Plan and continues to otherwise be an Eligible Associate may re-enter the Plan in accordance with such rules as the Committee may establish; provided that until the Committee otherwise specifies, re-entry may be effected at any time in accordance with the Enrollment Procedure. A Participant whose contributions under the Plan shall have been temporarily discontinued shall not be considered to have withdrawn from the Plan.

7. REGISTRATION OF SHARES

     The shares to be delivered to a Participant will be issued in such registration as shall have been specified by the Participant in accordance with procedures established by the Committee. The Committee may, in its discretion, restrict the use of any form of registration other than registration solely in the name of the Participant and may permit such other registrations as may be permitted under Section 423 of the Code and related Code sections and rules. The shares of a Participant who is a minor may, with the consent of the Committee, and upon written instructions by such associate, be registered in the name of an adult as custodian for such minor associate.

8. REQUIRED NOTICE OF SUBSEQUENT SALE

     As a condition of participation in the Plan, each Participating Associate agrees to notify the Company if the Participant sells or otherwise disposes of any

7

of the Participant’s shares of Common Stock within two years of the Investment Date on which such shares were purchased.

9. STATEMENT OF ACCOUNT

     As soon as practicable after the end of each calendar quarter each Participant will receive from the Trustee or the Company a statement of the Participant’s account with respect to such period, subject to the right of the Committee to prescribe the form and content of such statement and to otherwise change the frequency, coverage and delivery of such statement.

10. EXERCISE OF VOTING AND OTHER RIGHTS

     Prior to the time when the Trustee makes delivery to the Participating Associate of the shares of Common Stock held in the Participant’s Investment Account, the Trustee will exercise all voting rights pertaining to the shares of Common Stock allocated to the Investment Account of each Participant only in accordance with written directions, if any, given to the Trustee by such Participant prior to the date fixed for the exercise of such voting rights. In the absence of such direction, the Trustee shall not vote allocated shares but may vote any unallocated Common Stock in its discretion. All stock rights or offers received by the Trustee with respect to any Common Stock held by it hereunder shall be exercised by the Trustee to the extent appropriately specified in writing by Participants with respect to Common Stock allocated to the Investment Accounts of such Participants. Rights or offers relating to any unallocated Common Stock shall be exercised or otherwise disposed of by the Trustee in its discretion.

11. DESIGNATION OF BENEFICIARY

     A Participant may file with the Company a written designation of a beneficiary with respect to the assets in the accounts of the Participant in the event of the Participant’s death, provided that no such designation shall be effective unless so filed prior to the death of the Participant. The written designation of a beneficiary filed with the Company may be changed or revoked by the sole action of the Participant unless such action is precluded by statute. If upon the death of a Participant there is doubt as to the right of any beneficiary to receive any amount, the Committee may direct the Trustee to retain such amount, without liability for any interest thereon, until the rights thereto are determined, or the Committee may direct the Trustee to distribute such amount into any court of appropriate jurisdiction, in either of which events neither the Trustee nor the Committee nor any Employer shall be under any further liability to anyone with respect to such amount.

12. SALE OF SHARES

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     A Participating Associate shall have the right to direct the Trustee to sell shares in the Participant’s Investment Account in lieu of a withdrawal or distribution of the shares in kind; provided that the Committee may adopt rules regulating such elections, the timing of such sales, and requirements that sales be aggregated with other sales. The Committee may also choose to completely or temporarily suspend or terminate such rights. Upon any permitted direction to sell, the Trustee will sell all shares allocated to the Investment Account that are covered by the direction together with any fractional interest that may be aggregated with other fractional interests into a whole share, and remit the proceeds of such sale, less brokerage commissions and other selling expenses to the Participant or other permitted distributee. The Trustee may, consistent with applicable securities laws, sell the shares in private transactions, in the open market, or to the Company. If so directed the Trustee shall sell the shares to the Company. Any sale of shares to the Company shall be effected at Fair Market Value on the date of purchase.

13. ADMINISTRATION OF THE PLAN

     13.1 THE COMMITTEE. The Plan shall be administered by the Committee, which shall consist of not less than two members appointed by the Board. Committee members shall be directors, officers or salaried employees of the Company. The Board from time to time may appoint members previously appointed and may fill vacancies, however caused, in the Committee.

     13.2 THE TRUSTEE. The Committee will designate one or more individuals, a bank, trust company or investment firm having trust powers to act as trustee under the Plan (the “Trustee”), with the right in the Committee to change such designation in its discretion. The Trustee will hold all funds received by it under the Plan and, until delivery thereof to the Participants hereunder, all shares of Common Stock acquired by the Trustee under the Plan. The Trustee may rely on all orders, requests, and instructions with respect to the Plan given in writing and signed by any person authorized by the Committee or the Company’s Board of Directors, and the Trustee shall not be liable to any person for any action taken in accordance therewith. The Trustee or such other agent as the Trustee may appoint to effect purchases under the Plan shall be an “agent independent of the issuer” within the meaning of Regulation M of the Securities and Exchange Commission, as amended.

     13.3 AUTHORITY OF THE COMMITTEE. Subject to the express provisions of the Plan, the Committee shall have the authority to take any and all actions (including directing the Trustee as to the acquisition of shares) necessary to implement the Plan, to interpret the Plan, to prescribe, amend and rescind rules and regulations relating to it, and to make all other determinations necessary or advisable in administering the Plan. All of such determinations shall

9

be final and binding upon all persons. A quorum of the Committee shall consist of a majority of its members and the Committee may act by vote of a majority of its members at a meeting at which a quorum is present, or without a meeting by a written consent to the action taken signed by all members of the Committee. The Committee may request advice or assistance or employ such other persons as are necessary for proper administration of the Plan. To the extent that the Committee exercises discretionary authority with respect to the establishment and modification of rules, regulations and guidelines for the administration of the Plan, such rules and rule changes shall be made to apply uniformly to all Participants, consistent with the requirements of Section 423 of the Code.

14. LIMITATION ON PURCHASES

     No Participating Associate may purchase during any one calendar year under the Plan (or under any other plan of the Company, a Parent or Subsidiary qualified under Code section 423) shares of Common Stock having an aggregate Fair Market Value (determined by reference to the Fair Market Value on each Investment Date) in excess of the limitations of Code section 423(b)(8).

     A Participating Associate’s Payroll Deduction Account may not be used to purchase Common Stock on any Investment Date to the extent that after such purchase the Participating Associate would own (or be considered as owning within the meaning of Code section 424(d)) stock possessing 5 percent or more of the total combined voting power of the Company or its Parent or Subsidiary. For this purpose, Common Stock which the Participating Associate may purchase under any outstanding rights to purchase shall be treated as owned by such Participating Associate. As of the first Investment Date on which this paragraph limits a Participating Associate’s ability to purchase Common Stock, the associate shall cease to be an Eligible Associate.

15 RIGHTS NOT TRANSFERABLE

     Rights under the Plan are not transferable by a Participating Associate otherwise than by will or the laws of descent and distribution, and are exercisable, during the Associate’s lifetime, only by the Associate.

16. CHANGE IN CAPITAL STRUCTURE

     In the event of a stock dividend, stock split or combination of shares, recapitalization or merger in which the Company is the surviving corporation or other change in the Company’s capital stock (including, but not limited to, the creation or issuance to shareholders generally of rights, options or warrants for the purchase of Common Stock or preferred stock of the Company), the number and kind of shares of stock or securities of the Company to be subject to the Plan, the maximum number of shares or securities which may be delivered under

10

the Plan, the selling price and other relevant provisions shall be appropriately adjusted by the Committee, whose determination shall be binding on all persons.

     If the Company is a party to a consolidation or a merger in which the Company is not the surviving corporation, a transaction that results in the acquisition of substantially all of the Company’s outstanding stock by a single person or entity, or a sale or transfer of substantially all of the Company’s assets, the Committee may take such actions with respect to the Plan as the Committee deems appropriate.

     Notwithstanding anything in the Plan to the contrary, the Committee may take the foregoing actions without the consent of any Participant, and the Committee’s determination shall be conclusive and binding on all persons for all purposes.

17. AMENDMENT OF THE PLAN

     The Board of Directors may at any time, or from time to time, amend the Plan in any respect; provided, however, that the shareholders of the Company must approve any amendment that would (i) increase the number of securities that may be issued under the Plan, or (ii) modify the requirements as to eligibility for participation in the Plan.

18. TERMINATION OF THE PLAN

     The Plan and all rights of associates hereunder shall terminate:

          a. on the Investment Date that Participating Associates become entitled to purchase a number of shares greater than the number of reserved shares remaining available for purchase; or

          b. at any date at the discretion of the Board of Directors.

     In the event that the Plan terminates under circumstances described in (a) above, reserved shares remaining as of the termination date shall be issued to Participating Associates on a pro rata basis. Upon termination of the Plan, all amounts in an associate’s Payroll Deduction Account that are not used to purchase Common Stock will be refunded.

19. EFFECTIVE DATE OF PLAN

     The Plan was approved by the Board of Directors on March 20, 1997, and shall become effective on August 1, 1997, subject to receiving shareholder approval.

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20. GOVERNMENT AND OTHER REGULATIONS

     The Plan, and the grant and exercise of the rights to purchase shares hereunder, and the Company’s obligation to sell and deliver shares upon the exercise of rights to purchase shares, shall be subject to all applicable federal, state and foreign laws, rules and regulations, and to such approvals by any regulatory or government agency as may, in the opinion of counsel for the Company, be required.

21. INDEMNIFICATION AND LIABILITY OF COMMITTEE AND TRUSTEE

     The Committee and all persons employed by each Participating Company who are engaged in administering the Plan shall be entitled to rely upon all valuations, certificates and reports furnished by the Trustee or by any accountant or actuary selected by the Committee and upon all opinions given by any legal counsel selected by the Committee. The members of the Committee, the Trustee, each Participating Company, and all persons employed by each Participating Company and the Trustee who are engaged in administering the Plan (a) shall be fully protected with respect to any action taken by them in good faith and all actions so taken shall be conclusive and binding upon all persons having or claiming to have any interest under the Plan; and (b) shall not be personally liable by reason of any instrument made or executed by them or on their behalf or in the course of administering the Plan or for any mistake of judgment made by them or any other person, or for any neglect, omission or wrongdoing of any other person or for any loss to the Plan unless resulting from their own willful misconduct. No member of the Committee shall have any liability to any person for any action or omission except each for his own individual willful misconduct.

     Service on the Committee shall constitute service as a director of the Company so that members of the Committee shall be entitled to indemnification and reimbursement as directors of the Company pursuant to its Articles of Incorporation and Bylaws.

     In addition to the foregoing, each member of the Committee, the Trustee, and each director and officer of each Participating Company shall be indemnified by the Company against all expenses (including costs and attorneys fees) actually and necessarily incurred or paid by such person in connection with the defense of any action, suit or proceeding in any way relating to or arising from the Plan to which the Participant may be made a party by reason of the party being or having been such member of the Committee, Trustee, director or officer or by reason of any action or omission or alleged action or omission by him in such capacity, and against any amount or amounts which may be paid by him (other than to the Employer) in reasonable settlement of any such action, suit or proceeding, where the Company has consented to such settlement. In cases

12

where such action, suit or proceeding shall proceed to final adjudication, such indemnification shall not extend to matters as to which it shall be adjudged that such member of the Committee, Trustee, director or officer is liable for willful misconduct in the performance of the duties of such person as such. The right of indemnification herein provided shall not be exclusive of other rights to which any member of the Committee, Trustee, director or officer may now or hereafter be entitled, shall continue as to a person who has ceased to be such member of the Committee, Trustee, director or officer and shall inure to the benefit of the heirs, executors, administrators, successor or assigns of such members of the Committee, director or officer.

22. APPLICABLE LAW

     The place of administration of the Plan shall conclusively be deemed to be within the State of Kansas and the validity, construction, interpretation and administration of the Plan and of any rules or regulations or determinations or decisions made thereunder, and the rights of any and all persons having or claiming to have any interest therein or thereunder, shall be governed by and be determined exclusively and solely in accordance with, the laws of the State of Kansas. Without limiting the generality of the foregoing, the period within which any action arising under or in connection with the Plan, or any payment or award made or purportedly made under or in connection therewith, must be commenced shall be governed by the laws of the State of Kansas, irrespective of the place where the act or omission complained of took place and of the residence of any party to such action and irrespective of the place where the action may be brought.

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EX-10.19

EXHIBIT 10.19

PAYLESS SHOE SOURCE, INC.
2007 RESTRICTED STOCK AGREEMENT

          Pursuant to the terms and conditions of the Payless ShoeSource, Inc. 2006 Stock Incentive Plan (the “2006 Plan”), you have been granted the shares of stock outlined below:

Granted to:	name
	SSN
Grant Date:	date
Shares Granted:	shares
Expiration Date:	expiration

          Vesting Schedule:

          If the following consolidated store-for-store sales (“SFS”) goals are met for Fiscal 2007, the number of shares indicated below will vest in 1/3 increments over three years, beginning May 31, 2008:

Less than .00% SFS	No shares will vest
.00% SFS	50% of shares will vest
1.5% SFS	75% of shares will vest
3.0% SFS	100% of shares will vest

     The number of shares to be vested will be interpolated between 50% and 100%, if actual 2007 store-for-store sales are greater than .00%.

     In addition to the Company performance requirements, the Board of Directors reserves the right to cancel all or part of this Award, at its absolute discretion, based on individual performance.

     Payless ShoeSource, Inc. has caused this Agreement, which includes the Terms and Conditions contained on the following pages, to be executed in its corporate name and Executive has executed the same in evidence of the Executive’s acceptance hereof upon the terms and conditions herein set forth as of the grant date shown above. By accepting this award, Executive agrees to conform to all terms and conditions of this Agreement and the 2006 Plan.

Page 1 of 3 ( RSTUS-CEO)

TERMS AND CONDITIONS

          The Committee under the 2006 Stock Incentive Plan (“2006 Plan”) of Payless ShoeSource, Inc., a Delaware corporation, has approved granting Executive restricted stock on the terms and subject to the conditions set forth in this Agreement.

          Therefore, the Company and Executive hereby agree as follows:

1. The Company hereby grants to Executive, in the aggregate, the number of shares of the presently authorized common stock of the Company shown on the first page of this agreement (“Restricted Stock”), which shall be subject to the restrictions and conditions set forth in the 2006 Plan and in this Agreement.

2. The Company shall hold the certificates for the Restricted Stock in custody until the restrictions thereon shall lapse, at which time the Company shall deliver the certificates for such shares to Executive, less any required withholding.

3. The restrictions on the Restricted Stock are that the shares (i) may not be sold, assigned, conveyed, transferred, pledged, hypothecated or otherwise disposed of, and (ii) shall be returned to the Company forthwith, and all of the Executive’s rights to such shares shall immediately terminate without any payment or consideration by the Company regardless of any notice period or period of pay in lieu of such notice required under local statute or at common law, on the earlier of (a) the date established by the Company on which your employment with the Company terminates, or (b) the date your employment with the Company terminates, if Executive’s continuous employment with the Company or any Subsidiary shall terminate for any reason except for Executive’s death, termination for “good reason” (if applicable), or involuntary termination without “cause”, as provided in Sections 7 and 8.

4. Executive agrees that, subject to Section 5 of this Agreement, (a) no later than the date(s) as of which the restrictions on the Restricted Stock shall lapse with respect to all or any of the shares of Restricted Stock covered by this Agreement, Executive shall pay to the Company (in cash or shares of Company common stock whose Fair Market Value on the date the Restricted Stock vests is equal to the amount of Executive’s tax withholding liability) or make other arrangements satisfactory to the Committee regarding payment of any Federal, state or local taxes of any kind required by law to be withheld with respect to the shares of Restricted Stock for which the restrictions shall lapse; and (b) the Company shall, to the extent permitted by law, have the right to deduct from any payment of any kind otherwise due to Executive any Federal, state or local taxes of any kind required by law to be withheld with respect to the shares of Restricted Stock.

5. If Executive properly elects, within thirty (30) days of the Grant Date shown above, to include in gross income for Federal income tax purposes an amount equal to the fair market value of the shares of Restricted Stock granted on the Grant Date, Executive shall pay to the Company, or make other arrangements satisfactory to the Committee to pay to the Company in the year of such grant, any Federal, state or local taxes required to be withheld with respect to such shares. If Executive fails to make such payments, the Company shall, to the extent permitted by law, have the right to deduct from any payment of any kind otherwise due to Executive any Federal, state or local taxes of any kind required by law to be withheld with respect to such shares.

6. The restrictions on the Restricted Stock shall lapse on the date(s) and with respect to the corresponding number of shares shown on the previous page, subject to all the other terms and conditions of this agreement.

7. Notwithstanding the foregoing, if (i) Executive ceases to be an employee of the Company by reason of death and (ii) Executive has been in the continuous employment of the Company from the Grant Date shown above through the date of death, then the restrictions shall lapse as to all shares of Restricted Stock on the date of the Executive’s death.

8. Notwithstanding the foregoing, (a) if Executive is the Chief Executive Officer of the Company on the Grant Date and Executive’s employment with the Company is involuntarily terminated without “cause” (as that term is defined in Executive’s employment agreement with the Company) or Executive terminates his employment for “good reason” (as that term is defined in Executive’s employment agreement with the Company), then all shares of Restricted Stock granted under this Agreement that would have vested during the twenty four (24) month period immediately following Executive’s termination, if Executive’s employment was not terminated, shall immediately vest and (b) if Executive is a designated member of the Company’s Executive Committee (other than the Chief Executive Officer) on the Grant Date and Executive’s employment with the Company is involuntarily terminated without “cause” (as that term is defined in Executive’s employment agreement with the Company), then all shares of Restricted Stock granted under this Agreement that would have vested during the twelve (12) month period

Page 2 of 3 ( RSTUS-PLG)

immediately following Executive’s termination, if Executive’s employment was not terminated, shall immediately vest.

9. If there is (i) any change in the capital structure of the Company through merger, consolidations, reorganization, recapitalization, spin-off or otherwise, (ii) any dividend on the Restricted Stock, payable in common stock of the Company, or (iii) a stock split or a combination of shares, the Board shall make appropriate adjustments in the number of shares relating to Restricted Stock as it deems equitable, in its absolute discretion.

10. If a Change of Control as defined under the 2006 Plan occurs and Executive is actively employed on the date of such event, then from and after such date, the restrictions on all Restricted Stock covered by this Agreement shall immediately lapse.

11. Nothing in this Agreement shall be deemed by implication or otherwise to impose any limitation on any right of the Company to terminate the Executive’s employment at any time, in the absence of a specific agreement to the contrary.

12. If the Company determines that the listing, registration or qualification of any shares of stock is necessary or desirable as a condition of or in connection with the grant of Restricted Stock made under this Agreement, then delivery of certificates for such shares of Restricted Stock shall not be made until such listing, registration or qualification shall have been completed.

13. So long as this Agreement shall remain in effect, the Company will furnish to Executive, as and when available, a copy of any prospectus issued with respect to the shares of stock covered hereby, and also copies of all material hereafter distributed by the Company to its shareowners.

14. This Agreement shall be governed by the laws of the State of Delaware. It may not be modified except in writing signed by both parties.

15. Executive acknowledges that Executive has received a copy of the 2006 Incentive Stock Plan and/or Plan Summary, as such Plan is in effect on the date of this Agreement, has read and understands the terms of the 2006 Plan and of this Agreement, and agrees to all the terms and conditions provided for in the 2006 Plan and in this Agreement.

16. Except as otherwise provided herein, or unless the context clearly indicates otherwise, capitalized terms herein which are defined in the 2006 Plan have the same definitions as provided in the 2006 Plan.

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EX-10.20

EXHIBIT - - 10.20

PAYLESS SHOESOURCE, INC. STOCK APPRECIATION RIGHT AGREEMENT
(FREESTANDING STOCK SETTLED SAR ONLY)

     Pursuant to the terms and conditions of the Payless ShoeSource, Inc. 2006 Stock Incentive Plan (the “2006 Plan”), you have been granted a Stock Appreciation Right (a “SAR”) for the right and privilege to receive compensation, in stock, equal to the appreciation on such numbers of shares of Stock identified and further outlined below:

Granted to:	name
	SSN
Grant Date:	date
SARs Granted:	units
Exercise Price per SAR ($)	price
Expiration Date:	expiration
Vesting Schedule:	33% per year for 3 years on:
	May 31, 2008
	May 31, 2009
	May 31, 2010
Maximum Value Appreciation:	If the Payless stock price reaches three times the grant price (200% appreciation) prior to the expiration of this grant, all vested stock-settled SARs will automatically be exercised with no further notice.

     Payless ShoeSource, Inc. has caused this Agreement, which includes the Terms and Conditions contained on the following pages, to be executed in its corporate name and Executive has executed the same in evidence of the Executive’s acceptance hereof upon the terms and conditions herein set forth as of the grant date shown above. By accepting this award, Executive agrees to conform to all terms and conditions of this Agreement and the Plan.

Page 1 of 8 (SSAR-PLG)

TERMS AND CONDITIONS

     The Committee under the 2006 Stock Incentive Plan, as may be amended from time to time, (the “2006 Plan” or “Plan”) of Payless ShoeSource, Inc., a Delaware corporation (the “Company”) has approved granting Executive stock appreciation rights settled in stock (referred to in this Agreement as “SARs”) on the terms and subject to the conditions set forth in this Stock Appreciation Right Agreement (the “Agreement”) and the 2006 Plan. Capitalized terms in this Agreement shall have the meaning given to such terms in the 2006 Plan, unless otherwise specified herein.

     Therefore, in consideration of the mutual covenants set forth below and the grant of SARs, the Company and Executive hereby agree as follows:

1. The Company hereby grants to Executive, as of the Grant Date identified on page one of this Agreement, the right and privilege to receive compensation, in stock, equal to the appreciation on each of the shares of Stock identified on page one of this Agreement, from the Grant Date to the date the SAR with respect to such shares of Stock is exercised. Subject to all other terms and conditions in this Agreement, the SARs shall be irrevocable.

2. Subject to all the other terms and conditions in this Agreement and the Company’s policy on Trading in Securities as in existence from time to time, the SARs may be exercised by Executive on and after the dates and for the corresponding number of shares shown in the vesting schedule on the first page of this Agreement; provided, however, the SARs may only be exercised on or before the expiration date set forth on page one of this Agreement.

3. Subject to all the other terms and conditions in this Agreement, Executive may exercise SARs on and after the appropriate vesting dates (and before a date or event of termination or cancellation) in whole at any time, or in part from time to time, in each case to the extent vested. Executive shall provide the Company or its designee with written or electronic notice (“Notice”) to exercise such SARs in whole or in a specified part that certifies Executive is in compliance with the terms and conditions of this Agreement and Section 5(m) of the 2006 Plan. This Notice will be considered properly delivered, if received electronically, on the date received by the Compensation Department of the Company or its designee. Upon exercise of the SAR, subject to the satisfaction of applicable tax withholding, the Executive shall be entitled to receive payment from the Company in an amount determined by multiplying (x) the positive difference between the Fair Market Value of a share of Stock on the SAR exercise date at the time the exercise is executed (which ends at 3 p.m. CST on the date of exercise) and the Exercise Price per share of Stock (as set forth on page one of this Agreement) by (y) the number of shares of Stock with respect to which the SAR is exercised. The payment upon a SAR exercise shall be solely in whole shares of Stock equal in value to the amount of payment calculated immediately above. Fractional shares shall be rounded down to the nearest whole share, and any remaining cash will be credited to Executive’s brokerage account.

4.	A.	(i)	In no event may any SAR be exercised after the seventh (7th) anniversary of the Grant Date shown on page one of this Agreement, and any SAR may be sooner terminated in accordance with the provisions of the 2006 Plan and/or this Section 4.A.
		(ii)	If Executive ceases to be an employee of the Company, for any reason other than death, Disability, Retirement, or termination (whether voluntary or involuntary) other than for “Cause” (collectively referred to as a “Qualifying Separation From Service”), then all outstanding SARs shall immediately terminate regardless of any notice period or period of pay in lieu of such notice required under local statute or at common law, on the earlier of (a) the date established by the Company on which your employment with the Company

Page 2 of 8 (SSAR-PLG)

	terminates, or (b) the date your employment with the Company terminates. Executive’s employment will not be deemed to have ceased solely by reason of a leave of absence (a) during the first 90 consecutive days of a paid military, sick, family or other bona fide paid leave of absence or (b) thereafter, if Executive has a right of reemployment expressly guaranteed by either statute or contract. In the event of such a leave of absence, the number of shares of Stock for which SARs may be exercised during the periods described in clauses (a) and (b) of the foregoing sentence shall be the number of shares of Stock for which SARs were exercisable as of the date that the leave of absence began, subject to the other terms and conditions of this Section 4.A. Termination for “Cause” shall have the same meaning given to such term in the employment agreement, severance agreement or similar agreement between the Company and Executive that is in effect as of the Grant Date identified on page one of this Agreement or, if no such agreement exists, the Company’s termination of Executive’s employment for:
	(a)	an act of fraud, embezzlement, theft, or any other violation of the law (excluding minor traffic violations); or
	(b)	unauthorized disclosure of the Company’s Confidential Information; or
	(c)	breach of any of the terms of the Plan or this Agreement; or
	(d)	abuse of Executive’s position for personal gain, or breach of Executive’s duties to the Company; or
	(e)	engagement in any competitive activity which would constitute a breach of Executive’s duty loyalty or of Executive’s obligations under the Plan or this Agreement; or
	(f)	intentional breach of any Company policy, including those contained in the Company’s Code of Ethics; or
	(g)	the conviction of Executive, or any entry of a plea of guilty or nolo contender by Executive, to any crime involving moral turptitude; or
	(h)	the willful and continued failure by Executive to substantially perform Executive’s duties with the Company (other than any such failure resulting from Executive’s incapacity due to physical or mental illness); or
	(i)	the willful violation of applicable discrimination laws, the Foreign Corrupt Practices Act, securities law or anti-trust statutes.
(iii)	If Executive experiences a Qualifying Separation From Service, the term of any then outstanding SARs shall be for the period ending on the earliest of (a) the date upon which the SARs would otherwise expire, (b) three years after Executive’s Qualifying Separation From Service due to Retirement (for a reason other than Disability), (c) ninety (90) days after Executive’s Qualifying Separation From Service due to termination other than for Cause, or (d) twelve months after Executive’s Qualifying Separation From Service due to Disability. In such event, the number of shares for which SARs may be exercised after Executive’s Qualifying Separation From Service (other than involuntary termination without “cause”) shall be the number of shares for which SARs were exercisable as of the date of the Qualifying Separation From Service, subject to the other terms and conditions of this Section 4.A. Notwithstanding the foregoing, (a) if Executive

Page 3 of 8 (SSAR-PLG)

	is the Chief Executive Officer of the Company on the Grant Date and Executive’s employment with the Company is involuntarily terminated without “cause” (as that term is defined in Executive’s employment agreement with the Company) or for “good reason” (as that term is defined in Executive’s employment agreement with the Company), then all SARs granted under this Agreement that would have vested during the twenty four (24) month period immediately following Executive’s termination, if Executive’s employment was not terminated, shall immediately vest, or (b) if Executive is a designated member of the Company’s Executive Committee (other than the Chief Executive Officer of the Company) on the Grant Date and Executive’s employment with the Company is involuntarily terminated without “cause” (as that term is defined in Executive’s employment agreement with the Company), then all SARs granted under this Agreement that would have vested during the twelve (12) month period immediately following Executive’s termination, if Executive’s employment was not terminated, shall immediately vest. SARs which were not exercisable as of the date of Executive’s Qualifying Separation From Service shall be cancelled as of that date and will no longer be deemed to be outstanding thereafter. If Executive is terminated for Cause, all unexercised SARs shall lapse immediately upon such termination.
(iv)	(a)	If Executive dies while in the employment of the Company without having fully exercised any then outstanding SARs, the beneficiary designated by Executive (or, in the absence of such designation, the executors or administrators or legatees or distributees of Executive’s estate) shall have the right to exercise such SARs, in whole or in part during the period ending on the earlier of (1) the date upon which the SARs would otherwise expire or (2) three years after the date of death. In that event, the number of shares for which SARs may be exercised after such death shall be the number of shares for which SARs were outstanding on the date of death (whether or not the SARs were already exercisable on the date of death).
	(b)	If Executive dies during any period following Executive’s Retirement or Disability, without having fully exercised any then outstanding SARs, the beneficiary designated by Executive (or, in the absence of such designation, the executors or administrators or legatees or distributees of Executive’s estate) shall have the right to exercise such SARs, in whole or in part during the period ending on the earlier of (1) the date upon which the SARs would otherwise expire or (2) three years after the date of death. In that event, the number of shares for which SARs may be exercised after such death shall be the number of shares for which SARs were exercisable as of the date of the Retirement or Disability and remain outstanding on the date of Executive’s death.
(v)	Notwithstanding any other provision of this Agreement to the contrary:
	(a)	The Committee has the absolute right to cancel all unexercised SARs hereunder at any time if the Executive’s Retirement was without the Company’s consent or if, during Executive’s period of Retirement or Disability, the Executive engages in employment or activities that, in the sole opinion of the Committee, are contrary to the best interests of the Company.
	(b)	The Committee has the absolute right to cancel all unexercised SARs, and rescind any exercise of SARs, if, prior to any such exercise or within six months after such exercise (1) one of the events described in Section 5(m) of the 2006 Plan occurs (which events include engaging in a “Competing Business” or divulging

Page 4 of 8 (SSAR-PLG)

“Confidential Information” to persons outside the Company or using such information in other than the Company’s business), (2) upon the Company’s request and/or upon Executive’s termination of employment (for any reason), Executive fails to return to the Company all documents, records, notebooks, computer diskettes and tapes and anything else containing the Company’s Confidential Information, including all copies thereof, as well as any other Company property, in Executive’s possession, custody or control, including deleting from Executive’s personal computer(s) and other electronic storage medium any of the Company’s proprietary or Confidential Information, (3) Executive fails to (i) notify and provide the Company with the details of any unauthorized possession, use or knowledge of any of the Company’s Confidential Information as soon as Executive becomes aware of such circumstance, (ii) assist the Company in preventing any reoccurrence of such possession, use or knowledge, or (iii) cooperate with the Company in any litigation or other action to protect or retrieve the Company’s Confidential Information, or (4) (i) Executive fails to assign and transfer to the Company, the right, title and interest in and to any and all inventions, discoveries, improvements, innovations, and/or designs (the “Work Product”) conceived, discovered, developed, acquired or secured by Executive, solely or jointly with others or otherwise, together with all associated U.S. and foreign intellectual property rights (i.e., patents, copyrights, trademarks or trade secrets) if such Work Product is related directly or indirectly to the Company’s business or to the research or development work of the Company, or (ii) upon discovery, development or acquisition of any Work Product, Executive fails to notify the Company and/or fails to execute and deliver to the Company, without further compensation, such documents prepared by the Company as may be reasonable or necessary to prepare or prosecute applications of the Work Product and to assign and transfer to the Company all of Executive’s right, title and interest in and to such Work Product and intellectual property rights thereof.

Within 10 days after receiving notice that the Committee has rescinded the exercise of a SAR, Executive must either (i) pay to the Company an amount equal to the Fair Market Value of the Stock, as of the date of exercise, for the Stock received as compensation for the exercise and/or (ii) return to the Company the number of shares of Stock received upon the exercise. The Company may deduct from any amounts the Company owes to the Executive from time to time any amounts Executive owes the Company pursuant to such rescission. Notwithstanding any other terms in this Agreement, nothing in this Agreement shall be deemed or construed as extending the seven-year period described in Section 4.A(i). This paragraph, 4.A.(v), shall not apply to the Executive if the Executive is employed by, or acting as an advisor to, a Competing Business solely in Executive’s capacity as an attorney.

For purposes of this Agreement, “Competing Business” includes, but is not limited to:

(1) any retail business with gross sales or revenue in the prior fiscal year of more than $25 million (or which is a subsidiary, affiliate or joint venture partner of a business with gross sales or revenue in the prior fiscal year of more than $25 million) that sells footwear and/or accessories at retail to consumers at price points competitive, or likely to be competitive, with the Company (e.g. including, without limitation, Wal-Mart Stores, Inc., Sears Holdings Corporation, Target Corporation, Shoe Zone Limited, Bata Limited, Aldo Shoes, Inc., Genesco, Inc., Footlocker, Inc., Brown Shoe Company, Inc., Shoe Carnival, Inc., Kohl’s Corporation, Liz Claiborne Inc., Big 5 Sporting Goods

Page 5 of 8 (SSAR-PLG)

	Corporation, and J.C. Penney Company, Inc.) within 10 miles of any Company store or the store of any wholesale customer of the Company in the United States or anywhere in any foreign country in which the Company has retail stores, franchisees or wholesale customers;
(2)	any franchising or wholesaling business with gross sales or revenue in the prior fiscal year of more than $25 million (or which is a subsidiary, affiliate or joint venture partner of a business with gross sales or revenue in the prior fiscal year of more than $25 million) which sells footwear at wholesale to franchisees, retailer or other footwear distributors located within 10 miles of any Company store or the store of any wholesale customer of the Company in the United States, or anywhere in any foreign country in which the Company has retail stores, franchisees or wholesale customers;
(3)	any footwear and/or accessory manufacturing business with gross sales or revenue in the prior fiscal year of more than $25 million (or which is a subsidiary, affiliate or joint venture partner of a business with gross sales or revenue in the prior fiscal year of more than $25 million) that sells footwear and/or accessories to retailers or other footwear distributors located within 10 miles of any Company store or the store of any wholesale customer of the Company in the United States, or anywhere in any foreign country in which the Company has retail stores, franchisees or wholesale customers; (e.g. including without limitation, Nine West Shoes, Dexter Shoe Company, Liz Claiborne Inc., Wolverine World Wide, Inc., The Timberland Company, Nike, Inc., Reebok International Ltd., K-Swiss Inc., The Stride Rite Corporation and Adidas Salomon AG); or
(4)	any business that provides buying office services to any store or group of stores or businesses referred to in (i), (ii) and (iii) above.

Executive acknowledges and agrees that Executive understands the non-compete and non-solicitation restrictions contained in this Agreement and the 2006 Plan, that such restrictions are reasonable and enforceable in view of, among other things: (1) the market in which the Company operates its business, (2) the confidential information to which Executive has access, (3) Executive’s training and background, which are such that neither the Company nor Executive believe that the restraint will pose an undue hardship on the Executive, (4) the fact that a Competing Business could greatly benefit if it were to obtain the Company’s Confidential Information, (5) the fact that the Company would not have adequate protection if Executive was permitted to work for any Competing Business, since the Company would be unable to verify whether its Confidential Information was being disclosed or used in a manner that is damaging to the Company, (6) the limited duration of, and the limited activities prohibited by, the restrictions contained in the Agreement and/or the Plan, and (7) the Company’s legitimate interests in protecting its Confidential Information, goodwill and relationships.

(vi) If (a) a Change of Control (as described and defined in Section 11 of the 2006 Plan) occurs and (b) Executive is actively employed by the Company on the date of such event, then from and after such date all SARs outstanding under this Agreement shall be exercisable in full without regard to the provisions of Section 2 of this Agreement.

B. Promptly following each exercise of a SAR, shares of Stock shall be delivered to the Executive by the Company, subject to the provisions of Section 4.D.

Page 6 of 8 (SSAR-PLG)

C. Each SAR is personal to Executive, is not transferable by Executive (other than, upon the death of Executive, by beneficiary designation, by last will and testament or by laws of descent and distribution) and, during Executive’s lifetime, is exercisable only by Executive.

D. The exercise of each SAR shall be subject to the condition that if at any time the Company determines in its discretion that the satisfaction of withholding tax or other withholding liabilities under any applicable U.S. Federal, state or foreign law (“Withholding Obligation”), or that the listing, registration or qualification of any shares otherwise deliverable upon such exercise upon any securities exchange or under any applicable U.S. Federal, state or foreign law, or the consent or approval of any regulatory body, is necessary or desirable as a condition of, or in connection with, the exercise or the delivery or purchase of shares hereunder, then in any of those events, the exercise shall not be effective unless that withholding, listing, registration, qualification, consent or approval shall have been effected or obtained free of any conditions not acceptable to the Company. Executive shall pay any Withholding Obligation to the Company at the time of the exercise. Further, Executive agrees that in the event Executive is required to pay an amount to Company pursuant to the terms of Section 5(m) of the 2006 Plan or this Agreement, Executive agrees and consents to a deduction from any amounts the Company owes Executive (including wages or other compensation, fringe benefits, or vacation pay or other amounts owed by the Company to Executive) to satisfy its obligation to the Company. Executive further acknowledges that whether or not the Company elects to make any such set-off in whole or in part, if the Company does not recover by means of set-off, the full amount owed by the Executive, will immediately be due and payable to the Company.

E. If a circumstance listed under Section 10 of the 2006 Plan occurs, the Committee shall make appropriate adjustments consistent with the terms of the 2006 Plan.

F. The employment relationship between Executive and the Company is at will and nothing in this Agreement shall be deemed by implication or otherwise to impose any limitation on any right of the Company or subsidiary to terminate the Executive’s employment at any time for any reason or no reason, in the absence of a specific agreement to the contrary.

G. This paragraph 4. G. shall only apply if Executive is a licensed attorney (in any jurisdiction). If Executive is a licensed attorney, and taking into consideration the Executive’s ethical duties and responsibilities as a licensed attorney (if so licensed), the parties agree that nothing in this Agreement will prevent Executive from providing legal advice or otherwise being engaged in the practice of law. Executive, however, agrees not to breach any ethical obligations Executive has by virtue of being, or having been, the Company’s corporate counsel (e.g., without limitation marinating the attorney/client confidentiality).

H. Any notice to be given under this Agreement by Executive shall be sent by mail addressed to the Company for the attention of the Compensation Department, 3231 S.E. Sixth Avenue, Topeka, KS 66607, and any notice by the Company to Executive shall be sent by mail addressed to the Executive at the address shown on the face of this Agreement, or, if an address is not available, to Executive at Executive’s work location. Either party may, by notice given to the other in accordance with the provisions of this Section, change the address to which subsequent notices shall be sent.

I. Executive recognizes that irreparable injury will result to the Company in the event of a breach or threat of breach of any provision of this Agreement. Therefore, Executive agrees that in the event of a breach or threat of a breach of any provision of this Agreement, the

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Company will be entitled to, in addition to other remedies and damages that maybe available to Company, an injunction to restrain any such breach or threat of breach by Executive and all persons acting for and/or in concert with Executive. If any dispute arises between the Company and Executive with respect to any matter that is the subject of this Agreement, the Company or the Executive, upon prevailing in such dispute, shall be entitled to recover from the non-prevailing party all of the prevailing party’s costs and expenses including but not limited to reasonable attorneys’ fees. Executive’s obligations and agreements set forth in this Agreement shall survive any termination, whether initiated by the Company or Executive, regardless of the reason, if any, for the termination.

J. This Agreement shall be governed by the laws of the State of Delaware. It may not be modified except in writing signed by both parties.

K. If any part of this Agreement is declared by any court or governmental authority with competent jurisdiction to be unlawful or invalid, such unlawfulness or invalidity shall not serve to invalidate any part of this Agreement not declared to be unlawful or invalid. Any part so declared unlawful or invalid shall , if possible, be construed in a manner which gives effect to the terms of such part to the fullest extent possible while remaining lawful and valid.

L. Executive acknowledges that Executive has received a copy of the 2006 Plan and/or Plan summary, as the Plan is in effect on the date of this Agreement, has read and understands the terms of the 2006 Plan and of this Agreement, and agrees to all of the terms and conditions provided for in the 2006 Plan and in this Agreement.

M. So long as this Agreement remains in effect, the Company will furnish to Executive, as and when available, a copy of each prospectus issued with respect to the shares of stock covered hereby, and also copies of all material hereafter distributed by the Company to its shareowners.

N. Except as otherwise provided in this Agreement, or unless the context clearly indicates otherwise, capitalized terms herein which are defined in the 2006 Plan have the same definitions as provided in the 2006 Plan.

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EX-10.21

EXHIBIT-10.21

2006 Payless ShoeSource, Inc. Stock

Incentive Plan

as approved May 25, 2006

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2006 PAYLESS SHOESOURCE, INC. STOCK INCENTIVE PLAN

Section 1: Purpose

The purpose of the 2006 Payless Shoesource, Inc. Stock Incentive Plan (the “Plan”) is to promote the interests of Payless Shoesource, Inc. (the “Company”), its Subsidiaries and stockholders by (i) attracting and retaining individuals eligible to participate in the Plan; (ii) motivating such individuals by providing incentive compensation; and (iii) aligning the interests of such individuals with the interests of the Company’s stockholders.

Section 2: Definitions

The following terms, as used in the Plan, shall have the meanings specified below. Other capitalized terms shall have the meanings specified in the Plan.

a.	“Appreciation Value Award Vehicle” means an Award type structured to correlate the realization of gains based on absolute Stock price appreciation. May include but not be limited to Options, cash-settled stock appreciation rights and stock-settled stock appreciation rights.
b.	“Award” means an award granted pursuant to Section 4.
c.	“Award Agreement” means a document described in Section 7 setting forth the terms and conditions applicable to the Award granted to the Participant.
d.	“Board of Directors” means the Board of Directors of the Company, as it may be comprised from time to time.
e.	“Change of Control” means Change of Control as defined in Section 11.
f.	“Code” means the Internal Revenue Code of 1986, and any successor statute, as it or they may be amended from time to time.

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g.	“Committee” means the Compensation, Nominating & Governance Committee of the Board of Directors or such other committee as may be designated by the Board of Directors from time to time. To the extent that compensation realized in respect of Awards is intended to be “performance based” under Section 162(m) of the Code and the Committee is not comprised solely of individuals who are “outside directors” within the meaning of section 162(m) of the Code, or that any member of one Committee is not a “non-employee director” within the meaning of Rule 16b-3 under the Exchange Act, the Committee may from time to time delegate some or all of its functions under the Plan to a committee or subcommittee composed of members that meet the relevant requirements. The term “Committee” includes only such committee or subcommittee, to the extent of the Committee’s delegation.
h.	“Company” means Payless ShoeSource, Inc., a Delaware corporation, and any successor thereto.
i.	“Covered Employee” means a covered employee within the meaning of Code section 162(m)(3).
j.	“Disability” means a permanent and total disability which enables the Participant to be eligible for and receive a disability benefit under the Federal Social Security Act.
k.	“Dividend Equivalent” means an amount equal to the amount of cash dividends, if any, payable with respect to a share of Stock after the date an Award is granted.
l.	“Employee” means any person employed by Payless ShoeSource, Inc. or any of its Subsidiaries and classified as a common law employee. Employee does not include independent contractors or leased employees from third parties.
m.	“Exchange Act” means the Securities Exchange Act of 1934, and any successor statute, as it may be amended from time to time.
n.	“Fair Market Value” of a Stock, as later defined, means the average of the high and low prices of the Stock on the New York Stock Exchange Composite Transaction Tape on the date in question, (or if the Stock is not then so traded, the average of the highest and lowest sale prices of the Stock on the stock exchange or over-the-counter market on which the Stock is principally trading on such date) or, if no sale or sales of the Stock occurred on such exchange on that day, the average of the high and low

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	prices of the Stock on the last preceding day when the Stock was sold on the exchange. In the event that no sale of the Stock occurred on such exchange or the over the counter market on that day because the exchange was closed, then Fair Market Value shall be the average of the high and low prices of the Stock on the next day the exchange is open for trading. If Stock is no longer traded on the New York Stock Exchange and if there is no public market for the Stock, “Fair Market Value” shall be determined in good faith by the Committee using other reasonable means.
o.	“Full Value Award Vehicle” means an Award type structured to provide equivalent value of a share of Stock based on a ratio of 1:1. Full Value Award Vehicles may include but not be limited to restricted Stock, Stock Equivalent Units and other Stock Awards such as unrestricted Stock, restricted Stock unit grants and performance based shares.
p.	“Incentive Stock Option” means an Option that is intended to qualify as an “incentive stock option” under Section 422 of the Code and which is so designated in the applicable Award Agreement. Under no circumstances shall an Option that is not specifically designated as an Incentive Stock Option be considered an Incentive Stock Option.
q.	“Insider” means any person who is subject to Section 16 of the Exchange Act, and any successor statutory provision, as it may be amended from time to time.
r.	“Non-Qualified Stock Option” means an Option that is not intended to qualify as an “incentive stock option” under Section 422 of the Code.
s.	“Option” means an option granted pursuant to Section 4(a).
t.	“Participant” means any Employee who has been granted an Award.
u.	“Performance Goal” means with respect to the Performance Measure(s) selected by the Committee, the goal or goals established by the Committee, for an Award, for a Performance Period. Performance Goals may vary from Performance Period to Performance Period and from Participant to Participant and may be established on a stand-alone basis, in tandem or in the alternative.

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v. “Performance Measure” means one or more of the following, either alone or in combination, selected by the Committee to measure individual Participant, Company or one or more operating units, groups or any Subsidiary performance for a Performance Period, whether in absolute or relative terms: cash flow; cash flow from operations; total earnings; earnings per share, diluted or basic; earnings per share from continuing operations, diluted or basic; earnings before interest and taxes; earnings before interest, taxes, depreciation, and amortization; earnings from continuing operations; net asset turnover; inventory turnover; net earnings; operating earnings; operating margin; return on equity; return on assets or net assets; return on total assets; return on capital; return on investment; return on investment capital; return on sales; revenues; sales; store for store sales; net or gross sales; income or net income; operating income or net operating income; operating profit or net operating profit; gross margin; operating margin or profit margin; market share; economic value added; expense reduction levels; cost of capital; change in assets; stock price; total shareholder return; capital expenditures; debt; debt reduction; working capital, completion of acquisitions; business expansion; product diversification; productivity; new or expanded market penetration and other financial and non-financial operating and management performance objectives. For any Performance Period, Performance Measures may be determined on an absolute basis or relative to internal goals or relative to levels attained in a year or years prior to such Performance Period or relative to other companies or indices or as ratios expressing relationships between two or more Performance Measures. For any Performance Period, the Committee shall provide how any Performance Measure shall be adjusted to the extent necessary to prevent dilution or enlargement of any Award as a result of extraordinary events or circumstances, as determined by the Committee, or to exclude the effects of extraordinary, unusual, or non-recurring items; changes in applicable laws, regulations, or accounting principles; currency fluctuations; discontinued operations; non-cash items, such as amortization, depreciation, or reserves; or any recapitalization, restructuring, reorganization, merger, acquisition, divestiture, consolidation, spin-off, split-up, combination, liquidation, dissolution, sale of assets, or other similar corporate transaction, or stock dividends, or stock splits or combinations. Unless otherwise specified by the Committee, each such measure shall be determined in accordance with generally accepted accounting principles as consistently applied by the Company. Performance Measures may vary from

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	Performance Period to Performance Period and from Participant to Participant and may be established on a stand-alone basis, in tandem or in the alternative. Other Performance Measures may be used by the Committee in its sole discretion, except that the Performance Measures set forth above in this paragraph v shall be used if the compensation under the Award (other than an Option) is intended to qualify as performance based under Section 162(m) of the Code.
w.	“Performance Period” means one or more periods of time (of not less than 364 calendar days), as the Committee may designate, over which the attainment of one or more Performance Goals will be measured for the purpose of determining a Participant’s rights in respect of an Award.
x.	“Plan” means the 2006 Payless ShoeSource, Inc. Stock Incentive Plan, as amended from time to time.
y.	“Retirement” means a Participant’s termination of employment on or after age 55 and after completing at least five (5) years of service with the Company or a Subsidiary of the Company.
z.	“Stock” means common stock of the Company, $ .01 par value, or any other equity securities of the Company designated by the Committee, including any attached rights.
aa.	“Stock Award” means a grant of Stock or the right to receive Stock or its cash equivalent (or both).
bb.	“Subsidiary” means (i) any corporation or other entity in which the Company, directly or indirectly, controls fifty percent (50%) or more of the total combined voting power of such corporation or other entity or (ii) any other corporation or other entity in which the Company has a significant equity interest, in either case as determined by the Committee.
cc.	“Ten-percent Stockholder” means any person who owns, directly or indirectly, on the relevant date, securities having ten percent (10%) or more of the combined voting power of all classes of the Company’s securities or of its parent or subsidiaries. For purposes of applying the foregoing ten percent (10%) limitation, the rules of Code section 424(d) shall apply.

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Section 3: Eligibility

The Committee may grant one or more Awards to any Employee designated by it to receive an Award as the Committee shall select in its sole discretion.

Section 4: Awards

The Committee may grant any one or more of the following types of Awards, either singly, in tandem or in combination with other types of Awards:

Appreciation Value Award Vehicles

a. Options. An Option is a right or rights (either an Incentive Stock Option or a Non-Qualified Stock Option) to purchase a specific number of shares of Stock exercisable at such time or times and subject to such terms and conditions as the Committee may determine in its sole discretion subject to the Plan, including but not limited to the achievement of specific Performance Goals. Options may be settled in cash or stock.

(1) Incentive Stock Options shall be subject to the following provisions:

A.

The aggregate Fair Market Value (determined on the date that such Option is granted) of the shares of Stock subject to Incentive Stock Options which are exercisable by one person for the first time during a particular calendar year shall not exceed $100,000. To the extent that the aggregate Fair Market Value (determined at the time of grant) of Stock with respect to which Incentive Stock Options are exercisable for the first time by any Option holder during any calendar year (under all plans of the Company and its Subsidiaries) exceeds $100,000, or such other limit as may be set by applicable law, the Options or portions thereof which exceed such limit (according to the order in which they were granted) shall be treated as Non-Qualified Stock Options.

B.

Each Award Agreement with respect to an Incentive Stock Option shall set forth the periods during which the Option shall be exercisable, whether in whole or in part. Such periods shall be

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determined by the Committee in its discretion. No Incentive Stock Option may be exercisable more than:

(i)	in the case of an Employee who is not a Ten-Percent Stockholder on the date that such Option is granted, seven (7) years from the date the Option is granted or such earlier period as otherwise specified in the Plan or an Award Agreement, and
(ii)	in the case of an Employee who is a Ten-Percent Stockholder on the date such Option is granted, five (5) years from the date the Option is granted.

C.	Each Award Agreement with respect to an Incentive Stock Option shall set forth the price at which a share of Stock may be acquired under the Option (the “Exercise Price”), which shall be at least 100% of the Fair Market Value of a share of Stock on the date the option is granted (except as permitted under Section 424(a) of the Code with respect to Acquisition Awards (as defined in Section 4(i)). In the case of an Employee who is a Ten-Percent Stockholder on the date that such Option is granted, the Exercise Price of any Incentive Stock Option shall not be less than 110% of the Fair Market Value of the Stock subject to such Option on such date.
D.	No Incentive Stock Option may be granted to an Employee who is not a Employee of the Company or a Subsidiary (as defined in Section 2(bb) on the date that such Option is granted.
E.	Notwithstanding any other provision of the Plan to the contrary, the maximum aggregate number of shares of Stock that may be issued under the Plan pursuant to Incentive Stock Options is 2 million shares of Stock (the “ISO Limit”), subject to adjustments provided for in Section 10 of the Plan.

b. Appreciation Rights. An Appreciation Right is a right to receive an amount payable entirely in cash, entirely in Stock or partly in cash and partly in Stock and exercisable at such time or times and subject to such conditions as the Committee

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may determine in its sole discretion subject to the Plan, including but not limited to the achievement of specific Performance Goals.

c.

Other Awards. Subject to limitations under applicable law, the Committee may from time to time grant other Awards under this Plan, using Appreciation Value Award Vehicles, that provide the Participant with Stock or the right to purchase Stock, or provide other incentive Awards that have a value derived from the value of Stock, or an exercise or conversion privilege at a price related to Stock, or that are otherwise payable in or convertible into shares of Stock. These Awards shall be in a form and based upon the terms and conditions determined by the Committee (including but not limited to the achievement of specific Performance Goals if determined by the Committee), provided that the Award shall not be inconsistent with the other terms of this Plan.

Full Value Award Vehicles

d.

Stock Award. Stock Awards may include shares with or without restrictions. Restricted Stock is Stock that is issued to a Participant subject to restrictions on transfer and such other restrictions on incidents of ownership, and/or other terms and conditions as the Committee may determine, including but not limited to the achievement of specific Performance Goals. A certificate for the shares of Restricted Stock, which certificate shall be registered in the name of the Participant, shall bear an appropriate restrictive legend and shall be subject to appropriate stop-transfer orders; provided, however, that the certificates representing shares of Restricted Stock shall be held in custody by the Company until the restrictions relating thereto otherwise lapse, and the Participant shall deliver to the Company a stock power endorsed in blank relating to the Restricted Stock or other form as appropriate.

e.

Stock Equivalent Units. A Stock Equivalent Unit is an Award based on the Fair Market Value of one share of Stock. All or part of any Stock Equivalent Units Award may be subject to conditions and restrictions established by the Committee, including but not limited to the achievement of specific Performance Goals. Stock Equivalent Units may be settled in Stock or cash or both as determined by the Committee.

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f. Other Awards. Subject to limitations under applicable law, the Committee may from time to time grant other Full Value Awards under this Plan that provide the Participants with Stock or the right to purchase Stock, or provide other incentive Awards that have a value derived from the value of Stock, or an exercise or conversion privilege at a price related to Stock, or that are otherwise payable in or convertible into shares of Stock. These Awards shall be in a form and based upon the terms and conditions determined by the Committee (including but not limited to the achievement of specific Performance Goals if determined by the Committee), provided that the Award shall not be inconsistent with the other terms of this Plan.

Other Award Vehicles

g.	Performance Units. A Performance Unit is an Award denominated in cash or shares of Stock, the amount of which may be based on the achievement of specific Performance Goals subject to terms and conditions established by the Committee. The maximum amount of such compensation that may be paid to any one Participant with respect to any one Performance Period shall be 100,000 shares of Stock or the equivalent Fair Market Value thereof. Performance Units may be settled in Stock or cash or both.
h.	Performance Compensation Awards.
	(1) The Committee may, at the time of grant of an Award (other than an Option), designate such Award as a Performance Compensation Award in order that such Award constitute qualified performance-based compensation under Code section 162(m). With respect to each such Performance Compensation Award, the Committee shall (on or before the ninetieth (90th) day of the applicable Performance Period), establish, in writing, the Performance Goal or Goals.
	(2) A Participant shall be eligible to receive payment in respect of a Performance Compensation Award only to the extent that the Performance Goal(s) for such Award are achieved as certified by the Committee.
i.	Acquisition Awards. An Acquisition Award is an Award granted under this Plan in substitution for options, rights, and such other awards with respect to the

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capital stock of another corporation which is merged into, consolidated with, or all or a substantial portion of the property or stock of which is acquired by, the Company or one of its Subsidiaries.

j.

Other Awards. Subject to limitations under applicable law and the Plan, the Committee may from time to time grant other Awards under this Plan that provide the Participants with Stock or the right to purchase Stock, or provide other incentive Awards that have a value derived from the value of Stock, or an exercise or conversion privilege at a price related to Stock, or that are otherwise payable in or convertible into shares of Stock. The Awards shall be in a form and based upon the terms and conditions determined by the Committee (including but not limited to the achievement of specific Performance Goals), provided that the Awards shall not be inconsistent with the other terms of this Plan.

Section 5: Other General Terms and Conditions for Awards

(a)	The term of an Award shall not exceed seven (7) years.
(b)	Unless otherwise provided under the Plan or by the Committee, no Award (or any rights or obligations thereunder) may be sold, exchanged, transferred, assigned, pledged, hypothecated hedged, or otherwise disposed of (other than upon the death of the Participant, by beneficiary designation, by last will and testament or by the laws of descent and distribution) and shall be exercisable and subject to receipt during the Participant’s lifetime only by the Participant.
(c)	The Award price for each Award that allows for the purchase of a share of Stock under an Award shall be specified in an Award Agreement containing the terms and conditions as determined by the Committee and subject to the provisions of Section 10, shall not be less than Fair Market Value on the date the Award is granted; provided, however, that in no event shall the Award price per share be less than the par value thereof. The Exercise Price, as applicable, of an Award shall not be less than 100% of the Fair Market Value of the Stock on the date such Award is granted and the exercise opportunity may be capped if the Committee determines appropriate and so specifies in the Award Agreement pertaining thereto.

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(d)	There shall be no grant of an Appreciation Value Award to a Participant in exchange for a Participant’s agreement to the cancellation of a higher-priced Appreciation Value Award that was previously granted to such Participant. Re-pricing of Appreciation Value Awards is prohibited.
(e)	The Exercise Price, as applicable, of an Award may be paid in cash, personal check (subject to collection), bank draft or such other method as the Committee may determine from time to time. The Exercise Price may also be paid by the tender, by either actual delivery or attestation, of Stock acceptable to the Committee and valued at its Fair Market Value on the date of exercise; through a combination of Stock and cash. Without limiting the foregoing, to the extent permitted by applicable law: the Committee may, on such terms and conditions as it may determine, permit a Participant to elect to pay the Exercise Price by authorizing a third party, pursuant to a brokerage or similar arrangement approved in advance by the Committee, to simultaneously sell all (or a sufficient portion) of the Stock acquired upon exercise of such Award and to remit to the Company a sufficient portion of the proceeds from such sale to pay the entire Exercise Price of such Award and any required tax withholding resulting therefrom.
(f)	No Award may be granted under this Plan on or after the tenth anniversary of the date this Plan is approved by stockholders.
(g)	The exercise or delivery of Stock or payment of cash pursuant to an Award shall be subject to the condition that if at any time the Company shall determine in its discretion that the satisfaction of withholding tax or other withholding liabilities under any state or Federal law, or that the listing, registration or qualification of any shares of Stock otherwise deliverable upon any securities exchange or under any state or Federal Law, or that the consent or approval of any regulatory body, is necessary or desirable as a condition of, or in connection with, such exercise or the delivery or purchase of shares thereunder, then in any such event such exercise or delivery shall not be effective unless such withholding, listing, registration, qualification, consent or approval shall have been effected or obtained free of any conditions not acceptable to the Company.

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(h) Each Participant shall agree that, subject to the provisions of Section 5(i) below,

(i)	no later than the date as of which the restrictions mentioned in the instrument evidencing the Award shall lapse, such Participant will pay to the Company in cash, or, if the Committee approves, in Stock or make other arrangements satisfactory to the Committee regarding payment of, any Federal, state or local taxes of any kind required by law to be withheld with respect to such Award, and
(ii)	the Company and its Subsidiaries shall, to the extent permitted by law, have the right to deduct from any payment of any kind otherwise due to the Participant any Federal, state or local taxes of any kind required by law to be withheld with respect to the Award.

(i)	If any Participant properly elects, as permitted by Code Section 83b (or any successor Code provisions) within thirty (30) days of the date of the grant, to include in gross income for Federal income tax purposes, an amount equal to the Fair Market Value of the shares of Stock granted pursuant to an Award, such Participant shall pay to the Company, or make arrangements satisfactory to the Committee to pay to the Company, any Federal, state or local taxes required to be withheld with respect to such shares. If such Participant shall fail to make such payments, the Company and its Subsidiaries shall, to the extent permitted by law, have the right to deduct from any payment of any kind otherwise due to the employee any Federal, state or local taxes of any kind required by law to be withheld with respect to such shares.
(j)	Dividends or Dividend Equivalents may be granted with respect to all or part of an Award. If dividends are granted they may be paid, as determined by the Committee (i) in cash, (ii) in Dividend Equivalents or (iii) accumulated or reinvested in Stock and held subject to the same restrictions as the Stock under the Award.
(k)	Unless expressly provided otherwise in the Award Agreement (and as provided in Section 4d) no Participant shall have any rights as a

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	stockholder with respect to any Stock covered by an Award until the date the Participant becomes the holder of record thereof.
(l)	With respect to each type of Award, the Committee may establish such Performance Goals it deems appropriate, in its sole discretion. For each Award established with Performance Goals, as soon as practicable after the close of each Performance Period, the Committee shall review and certify in writing whether, and to what extent, the Performance Goals(s) for the Performance Period have been achieved and, if so, determine and certify in writing the amount of the Performance Compensation Award earned by the Participant for such Performance Period based upon such Participant’s achievement of the Performance Goals. The Committee shall then determine the actual amount of the Performance Compensation Award to be paid to the Participant. In so doing, the Committee may use negative discretion to decrease any Participant Award based upon such performance, but may not increase, the amount of the Award otherwise payable to a Covered Employee based upon such performance. The maximum Performance Compensation Award for any one Participant for any one Performance Period shall be determined in accordance with Sections 4 and 6. If Performance Goals are established for an Award to a Covered Employee, once established for a Performance Period, such Performance Goals shall not be amended or otherwise modified to the extent such amendment or modification would cause the compensation payable pursuant to the Award to fail to constitute qualified performance-based compensation under Code section 162(m).
(m)	Unless an Award Agreement specifies otherwise, the Committee may cancel at any time any Award or rescind any prior delivery of shares or value of shares, cash or property, if the Participant is not in compliance with all other applicable provisions of the Award Agreement or the Plan or if, within sixth months or such longer period as specified with respect to the Participant, in any noncompete entered into between the Participant and the Company, after exercise, as applicable, the Participant:

(i) engages in a Competing Business, as such term is defined in the Award Agreement; or

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(ii)	solicits for employment, hires or offers employment to, or discloses information to or otherwise aids or assists any other person or entity other than the Company in soliciting for employment, hiring or offering employment to, any employee of the Company; or
(iii)	takes any action which is intended to harm the Company or its reputation, which the Company reasonably concludes could harm the Company or its reputation or which the Company reasonably concludes could lead to unwanted or unfavorable publicity to the Company; or
(iv)	discloses to anyone outside of the Company, or uses in other than the Company’s business, any “confidential information”, as such term is defined in the Agreement.
	The Company shall immediately notify the Participant in writing of any cancellation of any unexercised or unvested Award. Following such notice, the Participant shall have no further rights with respect to such Award. In the event of the rescission of the exercise of an Award within six months (or such longer period specified in any agreement between Participant and Company) after the activity referred to above in this Section 5(m), the Company shall notify the Participant in writing. Within ten (10) days after receiving such notice from the Company, the Participant shall either (i) pay to the Company the excess of the Fair Market Value of the Stock on the date of exercise of an Award over the exercise price for the Award or the Fair Market Value of the Stock and/or cash distributed to the Participant as a result of the exercise of an Award or (ii) return the Stock received upon the exercise of an Award (in which case the Company will return the exercise price to the Participant) or return the Stock and/or cash delivered upon the exercise of this Award.

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(n)	The Participant shall agree and consent to a deduction from any amounts the Company owes to the Participant from time to time (including amounts owed as wages or other compensation, fringe benefits, or vacation pay, as well as any other amounts owed to the Participant by the Company), to the extent of the amounts the Participant owes the Company under Section 5(m) above. Whether or not the Company elects to make any set-off in whole or in part, if the Company does not recover by means of set-off the full amount owed by the Participant, calculated as set forth in Section 5(m) above, then the Participant agrees to pay immediately the unpaid balance to the Company.
(o)	The Committee may establish such other terms and conditions for an Award as it deems appropriate.
(p)	The Committee may, at any time and in its sole discretion, determine that any outstanding Awards granted under the Plan will be canceled and terminated and that in connection with such cancellation and termination the holder of such Awards may receive for each share of Stock subject to such Award a cash payment (or the delivery of shares of stock, other securities or a combination of cash, stock and securities equivalent to such cash payment) as follows:

1.	Appreciation Value Award Vehicles-whether or not exercisable, a cash payment (or the delivery of shares of stock, other securities or a combination of cash, stock, and securities equivalent to such cash payment) equal to the difference, if any, between the amount determined by the Committee to be the Fair Market Value of the Stock and the exercise price per share multiplied by the number of shares of Stock subject to such Award; provided that if such product is zero or less or to the extent that the Award is not then exercisable, the Awards will be canceled and terminated without payment therefore.
2.	Full Value Award Vehicles-a cash payment equal to the Fair Market Value of the shares of Stock under the Award, as designated by the Committee.
3.	Other Awards-a payment amount as determined in the sole discretion of the Committee.

Section 6: Stock Available under Plan

a.	Subject to the adjustment provisions of Section 10, the number of shares of Stock with respect to which Awards may be granted (or, in the cases of Awards that may be settled in cash or Stock) under the Plan shall not exceed 2.5 million shares of Stock (the “Maximum Limit). The following amounts shall be reserved against the Maximum Limit for each type of Award:
	RESERVES
	Full Value Award Vehicles
	the greater of (i) one share of Stock for each Full Value Award or (ii) the maximum potential issuable pursuant to each Award.
	Appreciation Value Award Vehicle (other than Stock Settled Stock Appreciation Rights)
	The amount calculated based on the ratio set forth in the below Exchange Ratio table.
	Stock Settled Stock Appreciation Rights (“SSSAR”)
	The lesser of (i) 1 share of Stock for each SSSAR granted under an Award or the maximum potential of shares issuable upon exercise of a SSSAR.
	Other Awards
	The maximum number of shares of Stock authorized to be issued pursuant to such Other Award Vehicle.
	No single Participant shall receive, in any one calendar year, Awards in the form of (i) Appreciation Value Award Vehicles with respect to more than 250,000 shares of Stock and/or (ii) Full Value Award Vehicles for more than 100,000 shares of Stock.

16

\

EXCHANGE RATIO TABLE

Term of Grant	5 year		6 year		7 year
Appreciation Value Vehicle Awards (other than SSSAR)		.549		.598		.641

ACTUALS

	Upon exercise of each Award, all shares of Stock reserved for such Award shall be released and the Maximum Limit shall be reduced by the number following:
	Full Value Awards & Other Awards- by the shares of Stock actually issued pursuant to such Award.
	Appreciation Value Awards (other than a SSSAR)- by the number set forth in the Exchange Ratio table above.
	SSSAR- by the amount of shares actually issued under the Award.
b.	Awards payable entirely in cash shall not be counted against the Maximum Limit.
c.	If at the time of payment of dividends or Dividend Equivalents there are shares of Stock available that have not been previously reserved, then upon payment they will be deducted from the Plan Maximum Limit. If such shares to pay dividends are not available because all shares of Stock are currently reserved under the Plan Maximum Limit, then such dividends will be paid in cash.
d.	Shares of Stock covered by the unexercised or terminated or forfeited portion of any Award that did not result in the delivery of Stock shall be available for further Awards. Subject to Section 10, additional rules for determining the number of shares of Stock granted under an Award type under the Plan may be adopted by the Committee, as it deems necessary and appropriate and consistent with the overall limits set forth in the Plan.
e.	The Stock that may be issued pursuant to an Award under the Plan may be authorized and issued Stock held in the Company’s treasury or authorized but

17

	unissued Stock, or Stock may be acquired, subsequently or in anticipation of the transaction, in the open market to satisfy the requirements of the Plan.
f.	If any stock based award granted under the Company’s 1996 Stock Incentive Plan shall for any reason subsequent to April 30, 2006 (i) expire, be cancelled or otherwise terminate, in whole or in part, without having been exercised or redeemed in full, or (ii) be reacquired by the Company prior to issuance without restriction to the holder of such Award will be added to the Maximum Limit and will become available for issuance under this Plan based on the following formula: Full Value Award Vehicles made available under this provision shall increase the Maximum Limit on a ratio of 1:1. Appreciation Value Vehicle Awards, including SSSARs under this provision shall increase the Maximum Limit by 1/3 for each share of Stock covered by an Appreciation Value Vehicle Award.
g.	Any shares of Stock delivered by the Company, any shares of Stock with respect to which Awards are made by the Company and any shares of Stock with respect to which the Company becomes obligated to make Awards, through the assumption of, or in substitution for, outstanding awards previously granted by an acquired entity, shall not be counted against the shares of Stock available for Awards under this Plan.
h.	The Committee may direct that any stock certificate evidencing shares issued pursuant to the Plan shall bear a legend setting forth such restrictions on transferability as may apply to such shares pursuant to the Plan.

Section 7: Award Agreements

Each Award granted under the Plan shall be evidenced by an Award Agreement. Each Award Agreement shall set forth the terms and conditions applicable to the Award, as determined by the Committee in its discretion and subject to the Plan, including but not limited to provisions describing the treatment of an Award in the event of the termination of a Participant’s status as an Employee for reasons of Retirement, death or otherwise, or in the event of Participant’s Disability or in the event the Participant engages in a “competing business” as such term shall be defined in the Award Agreement. The Committee may deliver the Award Agreement by

18

interoffice mail, U.S. mail, email or other electronic means (including posting on a web site maintained by the Company or by a third party under contract with the Company) all documents relating to the Plan or any Award thereunder and other documents that the Company is required to deliver to its security holders unless otherwise prohibited by law. A Participant shall have no rights with respect to an Award unless such Participant accepts the Award within such period as the Committee shall specify by executing an Award Agreement in such form as the Committee shall determine and, if the Committee shall so require, makes payment to the Company in such amount as the Committee may determine.

Section 8: Amendment and Termination

The Board of Directors may at any time amend, suspend or terminate the Plan, in whole or in part, and the Committee may, subject to the Plan, at any time alter or amend any or all Award Agreements to the extent permitted by applicable law and the Plan; provided that no such action shall impair the rights of any holder of an Award without the holder’s consent. For purposes of the Plan, any action of the Board of Directors or the Committee that alters or affects the tax treatment of any Award shall not be considered to materially impair any rights of any holder. Notwithstanding the foregoing, neither the Board of Directors nor the Committee shall (except pursuant to Section 10) amend the Plan or any Award Agreement, without the approval of the stockholders of the Company to (i) increase the number of shares of Stock available for Awards as set forth in Section 6 or (ii) decrease the Exercise Price of any Award or (iii) make any other amendments to the Plan or Award Agreement which would require stockholder approval under the General Corporation Law of the State of Delaware, New York Stock Exchange Rules or such other rules as may govern the trading or quotation of the Company’s Stock, Rule 16b-3 of the Securities Exchange Act of 1934, as amended, or Section 162(m) of the Code.

Notwithstanding the above, the Board may, by resolution, amend the Plan in any way that it deems necessary or appropriate in order to make income with respect to the Plan deductible for Federal income tax purposes under Section 162(m) of the Code and any such amendment shall be effective as of such date as is necessary to make such income under the Plan so deductible.

Notwithstanding anything to the contrary in this Section, the Board of Directors or the Committee shall have full discretion to amend the Plan to the extent necessary to preserve fixed accounting treatment with respect to any Award and any outstanding Award Agreement shall be deemed to be so amended to the same extent, without obtaining the consent of any holder,

19

without regard to whether such amendment adversely affects a holder’s rights under the Plan or such Award Agreement.

Section 9: Administration

a.

The Plan and all Awards shall be administered by the Committee, provided that, in the absence of the Committee or to the extent determined by the Board of Directors, any action that could be taken by the Committee may be taken by the non-employee members of the Board of Directors. A majority of the members of the Committee shall constitute a quorum. The majority of non-employee Board of Director members shall constitute a quorum of the Board. The vote of a majority of a quorum shall constitute action by the Committee and/or the Board.

b.

The Committee shall have full and complete authority, in its sole and absolute discretion, (i) to exercise all of the powers granted to it under the Plan, (ii) to construe, interpret and implement the Plan, any Award Agreement and any related document, (iii) to prescribe, amend and rescind rules relating to the Plan including rules governing its own operation, (iv) to make all determinations necessary or advisable in administering the Plan, (v) to correct any defect, supply any omission and reconcile any inconsistency in the Plan, (vi) to authorize any person to execute on behalf of the Company any instrument required to effect the grant of an Award previously granted by the Committee, (vii) to impose such restrictions, conditions or limitations as it determines appropriate as to the timing and manner of any resales by a Participant or other subsequent transfers by the Participant of any shares of Stock issued as a result of or under an Award, including without limitation, restrictions under the Company’s Trading in Securities Policy as may be amended from time to time, (viii) to amend the Plan to reflect changes in applicable law, and (ix) to determine whether, to what extent and under what circumstances Awards may be settled or exercised in cash, shares of Stock, other securities, other Awards or other property, or canceled, forfeited or suspended and the method or methods by which Awards may be settled, canceled, forfeited or suspended. The actions and determinations of the Committee on all matters relating to the Plan and any Awards will be final and conclusive. The Committee’s determinations under the Plan need not be uniform and may be made by it selectively among Employees and Participants who receive, or who are

20

	eligible to receive, Awards under the Plan, whether or not such persons are similarly situated.
c.	The Committee and others to whom the Committee has allocated or delegated authority or duties shall keep a record of all their proceedings and actions and shall maintain all such books of account, records and other data as shall be necessary for the proper administration of the Plan.
d.	The Committee may appoint such accountants, counsel, and other experts as it deems necessary or desirable in connection with the administration of the Plan.
e.	The Company shall pay all reasonable expenses of administering the Plan, including, but not limited to, the payment of professional fees.
f.	It is the intent of the Company that this Plan and Awards hereunder satisfy, and be interpreted in a manner that satisfy, (i) in the case of Participants who are or may be Insiders, the applicable requirements of Rule 16b-3 of the Exchange Act, so that such persons will be entitled to the benefits of Rule 16b-3, or other exemptive rules under Section 16, and will not be subjected to avoidable liability thereunder and (ii) in the case of Performance Compensation Awards, the applicable requirements of Code section 162(m). If any provision of this Plan or of any Award Agreement would otherwise frustrate or conflict with the intent expressed in this Section 9(f), that provision to the extent possible shall be interpreted and deemed amended so as to avoid such conflict. To the extent of any remaining irreconcilable conflict with such intent, such provision shall be deemed void as applicable to Insiders and/or Covered Employees, as applicable.
g.	Except to the extent prohibited by applicable law or otherwise, the Committee may from time to time allocate to one or more of its members and delegate to one or more Employees all or any portion of its authority and duties, provided that the Committee may not allocate or delegate any discretionary authority with respect to substantive decisions or functions regarding the Plan or Awards to the extent inconsistent with the intent expressed in Section 9(f).
h.	No member of the Board of Directors or the Committee or any employee of the Company or any of its subsidiaries or affiliates (each such person a “Covered Person”) shall have any liability to any person (including, without limitation, any

21

Participant) for any action taken or omitted to be taken or any determination made in good faith with respect to the Plan or any Award. Each Covered Person shall be indemnified and held harmless by the Company against and from any loss, cost, liability or expense (including attorneys’ fees) that may be imposed upon or incurred by such Covered Person in connection with or resulting from any action, suit or proceeding to which such Covered Person may be a party or in which such Covered Person may be involved by reason of any action taken or omitted to be taken under the Plan and against and from any and all amounts paid by such Covered Person, with the Company’s approval, in settlement thereof, or paid by such Covered Person in satisfaction of any judgment in any such action, suit or proceeding against such Covered Person, provided that the Company shall have the right, at its own expense, to assume and defend any such action, suit or proceeding and, once the Company gives notice of its intent to assume the defense, the Company shall have sole control over such defense with counsel of the Company’s choice. The foregoing right of indemnification shall not be available to a Covered Person to the extent that a court of competent jurisdiction in a final judgment or other final adjudication, in either case, not subject to further appeal, determines that the acts or omissions of such Covered Person giving rise to the indemnification claim resulted from such Covered Person’s bad faith, fraud or willful criminal act or omission. The foregoing right of indemnification shall not be exclusive of any other rights of indemnification to which Covered Persons may be entitled under the Company’s Certificate of Incorporation or Bylaws, as a matter of law, or otherwise, or any other power that the Company may have to indemnify such persons or hold them harmless.

Section 10: Adjustment Provisions

a. In the event of any change in the outstanding shares of Stock by reason of a stock dividend greater than 5% of the Stock price, stock split or reverse stock split, recapitalization, merger or consolidation (whether or not the Company is a surviving Company), reorganization, combination, exchange or reclassification of shares, spin-off or other similar corporate changes or an extraordinary dividend payable in cash or property, (i) the number of shares of Stock (or other securities) then remaining subject to this Plan, including those that are then covered by

22

	outstanding Awards, and the maximum number of shares of Stock that may be issued, or with respect to which Awards may be granted, to any single Participant or in the aggregate pursuant to this Plan, (ii) the price or exercise price for each share or right then covered by an outstanding Award and (iii) the terms and conditions of each other outstanding Award may be proportionally adjusted as the Committee deems equitable in its absolute discretion to prevent dilution or enlargement of the rights of a Participant. Any adjustment made by the Committee under this Section shall be final, binding and conclusive on all persons.
b.	The existence of the Plan and the Awards granted hereunder shall not affect or restrict in any way the right or power of the Board of Directors or the shareholders of the Company to make or authorize any adjustment, recapitalization, reorganization or other capital structure of its business, any merger or consolidation of the Company, any issue of bonds, debentures, preferred or prior preference stock ahead of or affecting the Stock or the rights thereof, the dissolution or liquidation of the Company or any sale or transfer of all or any part of its assets or business, or any other corporate act or proceeding.
c.	No fractional shares of Stock will be issued or accepted. Any fractional shares will be paid in the equivalent amount of cash. The Committee may impose such other conditions, restrictions and contingencies with respect to shares of Stock delivered pursuant to the exercise of an Award as it deems desirable.

Section 11: Change of Control

a. In the event of a Change of Control, in addition to any action required or authorized by the terms of an Award Agreement, the Committee may, in its sole discretion, take any of the following actions as a result, or in anticipation, of any such event to assure fair and equitable treatment of Participants:

(i) accelerate time periods for purposes of vesting in, or realizing gain from, any outstanding Award made pursuant to this Plan and/or extend the time during which an Award may be exercised following a Participant’s termination of employment;

23

(ii)	offer to purchase any outstanding Award made pursuant to this Plan from the holder for its equivalent cash value, as determined by the Committee, as of the date of the Change of Control; or
(iii)	make adjustments or modifications to outstanding Awards as the Committee deems appropriate to maintain and protect the rights and interests of Participants following such Change of Control.

b. “Change of Control” means:

(i) Any individual, entity or group (within the meaning of Section 13(d)(3) or 14(d)(2) of the Exchange Act (a “Person”) acquires beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Exchange Act) of 20% or more of either (A) the then-outstanding shares of common stock of the Company (the “Outstanding Company Common Stock”) or (B) the combined voting power of the then-outstanding voting securities of the Company entitled to vote generally in the election of directors (the “Outstanding Company Voting Securities”); provided, however, that, for purposes of this Section 11, none of the following shall constitute a Change of Control: (a) any acquisition directly from the Company of 30% or less of Outstanding Company Common Stock or Outstanding Company Voting Securities provided that at least a majority of the members of the Board of Directors of the Company following such acquisition were members of the incumbent Board at the time of the Board’s approval of such acquisition, (b) any acquisition by the Company, (c) any acquisition by any employee benefit plan (or related trust) sponsored or maintained by the Company or any affiliated company, or (d) any acquisition by the Company which by reducing the number of shares of Outstanding Company Common Stock or Outstanding Company Voting Securities, increases the proportionate number of shares of Outstanding Company Common Stock or Outstanding Company Voting Securities beneficially owned by any Person to 20% or more of the Outstanding Company Common Stock or Outstanding Company Voting Securities; provided, however, that, if such Person shall thereafter become the beneficial owner of any additional shares of Outstanding Company Common Stock or Outstanding Company Voting Securities and beneficially owns 20% or

24

	more of either the Outstanding Company Common Stock or the Outstanding Company Voting Securities, then such additional acquisition shall constitute a Change of Control; or
(ii)	Individuals who, as of the date hereof, constitute the Board (the “Incumbent Board”) cease for any reason to constitute at least a majority of the Board; provided, however, that any individual becoming a director subsequent to the date hereof whose election, or nomination for election by the Company’s stockholders, was approved by a vote of at least a majority of the directors then comprising the Incumbent Board shall be considered as though such individual were a member of the Incumbent Board, but excluding, for this purpose, any such individual whose initial assumption of office occurs as a result of an actual or threatened election contest with respect to the election or removal of directors or other actual or threatened solicitation of proxies or consents by or on behalf of a Person other than the Board; or
(iii)	A reorganization, merger, consolidation or sale or other disposition of all or substantially all of the assets of the Company (a “Business Combination”) is consummated, in each case, unless, immediately following such Business Combination, (A), more than 50%, respectively, of the then-outstanding shares of common stock and the combined voting power of the then-outstanding voting securities entitled to vote generally in the election of directors, as the case may be, of (x) the corporation resulting from such Business Combination or (y) a corporation that, as a result of such transaction, owns the Company or all or substantially all of the Company’s assets whether directly or through one or more Subsidiaries, is represented by the Outstanding Company Common Stock and the Outstanding Company Voting Securities (or, if applicable, is represented by shares into which Outstanding Company Common Stock or Outstanding Company Voting Securities were converted pursuant to such Business Combination) in substantially the same proportions as their ownership immediately prior to such Business Combination of the Outstanding Company Common Stock and the Outstanding Company Voting Securities, as the case may be, (B) no Person (excluding any corporation resulting from such Business Combination or any employee benefit plan (or related trust) of the

25

Company or such corporation resulting from such Business Combination) beneficially owns, directly or indirectly, 20% or more of, respectively, the then-outstanding shares of common stock of the corporation resulting from such Business Combination or the combined voting power of the then-outstanding voting securities of such corporation, except to the extent that such ownership existed prior to the Business Combination, and (C) at least a majority of the members of the Board of Directors of the corporation resulting from such Business Combination were members of the Incumbent Board at the time of the execution of the initial agreement or of the action of the Board providing for such Business Combination; or

(iv)

The stockholders of the Company approve of a complete liquidation or dissolution of the Company.

Section 12: Miscellaneous

a.	Other Payments or Awards. Nothing contained in the Plan shall be deemed in any way to limit or restrict the Company or a Subsidiary from making any award or payment to any person under any other plan, arrangement or understanding, whether now existing or hereafter in effect.
b.	Unfunded Plan. The Plan shall be unfunded. No provision of the Plan or any Award Agreement shall require the Committee, the Company or a Subsidiary, for the purpose of satisfying any obligations under the Plan, to purchase assets or place any assets in a trust or other entity to which contributions are made or otherwise to segregate any assets, nor shall the Company or a Subsidiary maintain separate bank accounts, books, records or other evidence of the existence of a segregated or separately maintained or administered fund for such purposes. Participants shall have no rights under the Plan other than as unsecured general creditors of the Company or a Subsidiary.
c.	Limits of Liability. Any liability of the Company or a Subsidiary to any Participant with respect to an Award shall be based solely upon contractual obligations created by the Plan and the Award Agreement.

26

d.	Rights of Employees. Status as an eligible Employee shall not be construed as a commitment that any Award shall be made under this Plan to such eligible Employee or to eligible Employees generally. Nothing contained in this Plan or in any Award Agreement shall confer upon any Employee or Participant any right to continue in the employ or other service of the Company or a Subsidiary or constitute any contract or limit in any way the right of the Company or a Subsidiary to change such person’s compensation or other benefits or to terminate the employment or other service of such person with or without cause. Except as provided otherwise in an Award Agreement, an Employee’s (i) transfer from the Company to a Subsidiary or affiliate of the Company, whether or not incorporated, or visa versa, or from one Subsidiary to another or (ii) leave of absence, duly authorized in writing by the Company or a Subsidiary, shall not be deemed a termination of such Employee’s employment or other service.
e.	Section Headings. The section headings contained herein are for the purpose of convenience only, and in the event of any conflict, the text of the Plan, rather than the section headings, shall control.
f.	Construction. In interpreting the Plan, the masculine gender shall include the feminine, the neuter gender shall include the masculine or feminine, and the singular shall include the plural unless the context clearly indicates otherwise.
g.	Invalidity. If any term or provision contained herein or in any Award Agreement shall to any extent be invalid or unenforceable, such term or provision will be reformed so that it is valid, and such invalidity or unenforceability shall not affect any other provision or part thereof.
h.	Applicable Law. The Plan, the Award Agreements and all actions taken hereunder or thereunder shall be governed by, and construed in accordance with, the laws of the State of Delaware without regard to the conflict of law principles thereof.
i.	Supplementary Plans. The Committee may authorize Supplementary Plans applicable to Employees subject to the tax laws of one or more countries other than the United States and providing for the grant of Awards to such Employees on terms and conditions, consistent with the Plan, determined by the Committee which may differ from the term and conditions of such Awards pursuant to the Plan for the

27

	purpose of complying with the conditions for qualification of Awards for favorable treatment under foreign tax and/or securities laws. Notwithstanding any other provision hereof, Options granted under any Supplementary Plan shall include provisions that conform with Sections 4(a); and Restricted Stock granted under any Supplementary Plan shall include provisions that conform with Section 4(d).
j.	Effective Date and Term. The Plan was adopted by the Board of Directors effective as of May 25, 2006, subject to approval by the Company’s stockholders. The Committee may grant Awards prior to stockholder approval, provided, however, that Awards granted prior to such stockholder approval are automatically canceled if stockholder approval is not obtained at or prior to the period ending twelve months after the date the Plan is effective and provided further that no Award may be settled prior to the date stockholder approval is obtained. Unless sooner terminated, the Plan shall remain in effect until May 25, 2016. Termination of the Plan shall not affect any Award previously made.
k.	No Third Party Beneficiaries. Except as expressly provided therein, neither the Plan nor any Award Agreement shall confer on any person other than the Company and the grantee of any Award any rights or remedies thereunder.
l.	Successors and Assigns. The terms of this Plan shall be binding upon and inure to the benefit of the Company and its successors and assigns.

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EX-21.1

     EXHIBIT 21.1

SUBSIDIARIES OF REGISTRANT

The corporations listed below are subsidiaries of Registrant, and all are included in the consolidated financial statements of Registrant as subsidiaries (unnamed subsidiaries, considered in the aggregate as a single subsidiary, would not constitute a significant subsidiary):

	Jurisdiction
	in which
Name	organized
Payless ShoeSource Finance, Inc.	Nevada
Payless ShoeSource, Inc.	Missouri
Payless ShoeSource Distribution, Inc.	Kansas
Payless ShoeSource Merchandising, Inc.	Kansas
Payless ShoeSource Worldwide, Inc.	Kansas
PSS Canada, Inc.	Kansas
Payless ShoeSource Canada Inc.	Canada
Payless ShoeSource Canada GP Inc.	Canada
Payless ShoeSource Canada LP	Canada
Payless ShoeSource (BVI) Holdings, Ltd.	British Virgin Islands
Dyelights, Inc.	Delaware
Shoe Sourcing, Inc.	Kansas
Payless CA Management Ltd.	British Virgin Islands
PSS Holdings	Cayman Islands
PSS Latin America Holdings	Cayman Islands
Payless ShoeSource Gold Value, Inc.	Kansas
Payless ShoeSource International Limited	Hong Kong
Dynamic Assets Limited	Hong Kong
Payless NYC, Inc.	Kansas
Payless ShoeSource Andean Holdings	Cayman Islands
PSS Canada Finance, LP	Canada
Payless ShoeSource Uruguay SRL Finance Co.	Uruguay
Payless ShoeSource Spain, S.L.	Spain
Payless ShoeSource of Puerto Rico, Inc.	Puerto Rico
Eastborough, Inc.	Kansas
Payless International Finance BV	Netherlands
Shenzen Footwear Consulting Company	China
Payless ShoeSource Ecuador Cia. Ltda.	Ecuador
Payless ShoeSource Honduras S. De R.L.	Honduras
Payless ShoeSource of El Salvador, Ltda de C.V.	El Salvador
Payless ShoeSource Limitada	Costa Rica
Payless ShoeSource Limitada Compania Limitada	Nicaragua

	Jurisdiction
	in which
Name	organized
Payless ShoeSource de Guatemala LTDA	Guatemala
Payless ShoeSource de la Republica Dominicana, S.A.	Dominican Republic
Payless ShoeSource of St. Lucia, Ltd.	St. Lucia
Payless ShoeSource of Trinidad Unlimited	Trinidad & Tobago
Payless ShoeSource Overseas S.R.L.	Panama

EX-23.1

EXHIBIT - 23.1

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

We consent to the incorporation by reference in the Registration Statements on Form S-8 (Nos. 333-25877, 333-28483, 333-30371, 333-67684, 333-50671, 333-133098, and 333-134558) and on Form S-3 (No. 333-126670), of our reports dated March 30, 2007 relating to (1) the consolidated financial statements and financial statement schedule of Payless ShoeSource, Inc. and subsidiaries (which report expresses an unqualified opinion and includes an explanatory paragraph relating to the change in the method of accounting for stock-based compensation upon adoption of Statement of Financial Accounting Standards No. 123(R), “Share-Based Payment” and the change in the method of accounting for pension and other postretirement benefits upon adoption of Statement of Financial Accounting Standards No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans – An Amendment of Financial Accounting Standards Board Statements No. 87, 88, 106, and 132(R)”), and (2) management’s report on the effectiveness of internal control over financial reporting dated March 30, 2007, appearing in this Annual Report on Form 10-K of Payless ShoeSource, Inc. and subsidiaries for the fiscal year ended February 3, 2007.

/s/ Deloitte & Touche LLP

Kansas City, Missouri
March 30, 2007

EX-31.1

EXHIBIT 31.1

CERTIFICATIONS

I, Matthew E. Rubel, certify that:

1.	I have reviewed this Form 10-K of Payless ShoeSource, Inc., a Delaware corporation;
2.	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.	The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-14(f) and 15d-15(f)) for the registrant and have:

(a)	Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b)	Designed such internal controls over financial reporting, or caused such internal controls over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
(c)	Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d)	Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a)	All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information ; and
(b)	Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: April 3, 2007

/s/ Matthew E. Rubel  

Matthew E. Rubel 

Chief Executive Officer and President
(Principal Executive Officer) 

EX-31.2

EXHIBIT 31.2

CERTIFICATION

I, Ullrich E. Porzig, certify that:

1.	I have reviewed this Form 10-K of Payless ShoeSource, Inc., a Delaware corporation;
2.	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.	The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-14(f) and 15d-15(f)) for the registrant and have:

(a)	Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b)	Designed such internal controls over financial reporting, or caused such internal controls over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
(c)	Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d)	Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a)	All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b)	Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: April 3, 2007

/s/ Ullrich E. Porzig  

Ullrich E. Porzig 

Senior Vice President,
Chief Financial Officer and Treasurer
(Principal Financial and Accounting Officer) 

EX-32.1

EXHIBIT 32.1

CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350

In connection with the Annual Report of Payless ShoeSource, Inc. (the “Company”) on Form 10-K for the period ending February 3, 2007, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Matthew E. Rubel, Chief Executive Officer and President, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

(1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: April 3, 2007

/s/ Matthew E. Rubel  

Matthew E. Rubel 

Chief Executive Officer and President
(Principal Executive Officer) 

EX-32.2

EXHIBIT 32.2

CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350

In connection with the Annual Report of Payless ShoeSource, Inc. (the “Company”) on Form 10-K for the period ending February 3, 2007, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Ullrich E. Porzig, Senior Vice President — Chief Financial Officer and Treasurer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

(1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: April 3, 2007

/s/ Ullrich E. Porzig  

Ullrich E. Porzig 

Senior Vice President,
Chief Financial Officer and Treasurer
(Principal Financial and Accounting Officer)