e10vq

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark one)

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

For the quarterly period ended July 30, 2005

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

For the transition period from__________________ to ______________________

Commission file number 000-21543

WILSONS THE LEATHER EXPERTS INC.
(Exact name of registrant as specified in its charter)


MINNESOTA (State or other jurisdiction of incorporation or organization)		41-1839933 (I.R.S. Employer Identification No.)


7401 BOONE AVE. N. BROOKLYN PARK, MN (Address of principal executive offices)		55428 (Zip Code)

(763) 391-4000
(Registrant’s telephone number, including area code)

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

Yes R No £

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

Yes R No £

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes £ No R

As of September 2, 2005, there were 39,013,332 shares of the Registrant’s common stock, $0.01 par value per share, outstanding.

PART I — FINANCIAL INFORMATION

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

WILSONS THE LEATHER EXPERTS INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share amounts)


	July 30,			January 29,
	2005			2005⁽¹⁾
ASSETS
CURRENT ASSETS:
Cash and cash equivalents	$	28,263		$	48,821
Accounts receivable, net		2,829			3,643
Inventories		79,866			86,059
Prepaid expenses		6,106			3,246

TOTAL CURRENT ASSETS		117,064			141,769
Property and equipment, net		42,338			44,606
Other assets, net		1,891			2,205

TOTAL ASSETS	$	161,293		$	188,580

LIABILITIES AND SHAREHOLDERS’ EQUITY
CURRENT LIABILITIES:
Accounts payable	$	19,240		$	17,697
Current portion of long-term debt		—			5,000
Accrued expenses		18,005			22,959
Income taxes payable		2,839			4,307
Deferred income taxes		5,585			5,585

TOTAL CURRENT LIABILITIES		45,669			55,548
Long-term debt		20,000			20,000
Other long-term liabilities		17,861			17,925

TOTAL LIABILITIES		83,530			93,473

COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS’ EQUITY:
Common stock, $.01 par value; 150,000,000 shares authorized; 39,010,582 and 38,884,072 shares issued and outstanding on July 30, 2005 and January 29, 2005, respectively		390			389
Additional paid-in capital		133,584			133,103
Accumulated deficit		(56,227	)		(38,389	)
Accumulated other comprehensive income		16			4

TOTAL SHAREHOLDERS’ EQUITY		77,763			95,107

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	161,293		$	188,580

The accompanying notes are an integral part of these consolidated financial statements.

(1) Derived from audited consolidated financial statements.

WILSONS THE LEATHER EXPERTS INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)


	For the year-to-date period ended
	July 30,			July 31,
	2005			2004
OPERATING ACTIVITIES:
Net loss	$	(17,786	)	$	(57,236	)
Adjustments to reconcile loss from operations to net cash used in operating activities:
Depreciation		7,292			22,363
Amortization		—			48
Amortization of deferred financing costs		314			1,112
Loss (gain) on disposal of assets		(161	)		1,323
Restricted stock compensation expense		—			828
Changes in operating assets and liabilities:
Accounts receivable, net		814			3,126
Inventories		6,193			11,381
Prepaid expenses and other current assets		(2,860	)		(3,317	)
Accounts payable and accrued expenses		(3,411	)		(3,717	)
Income taxes payable and other liabilities		(1,686	)		(4,442	)

Net cash used in operating activities		(11,291	)		(28,531	)

INVESTING ACTIVITIES:
Additions to property and equipment		(4,926	)		(2,306	)
Proceeds from the disposition of property and equipment		165			27

Net cash used in investing activities		(4,761	)		(2,279	)

FINANCING ACTIVITIES:
Proceeds from issuance of common stock, net		482			32,426
Debt acquisition costs		—			(1,151	)
Repayments of long-term debt		(5,000	)		(64	)
Repurchase of debt		—			(22,010	)
Other financing		12			2

Net cash provided by (used in) financing activities		(4,506	)		9,203

NET CASH USED IN DISCONTINUED OPERATIONS		—			(187	)

NET DECREASE IN CASH AND CASH EQUIVALENTS		(20,558	)		(21,794	)
CASH AND CASH EQUIVALENTS, beginning of period		48,821			42,403

CASH AND CASH EQUIVALENTS, end of period	$	28,263		$	20,609

The accompanying notes are an integral part of these consolidated financial statements.

WILSONS THE LEATHER EXPERTS INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

1. Nature of organization

Wilsons The Leather Experts Inc. (“Wilsons Leather” or the “Company”), a Minnesota corporation, is the leading specialty retailer of quality leather outerwear, accessories and apparel in the United States. As of July 30, 2005, Wilsons Leather operated 429 permanent retail stores located in 45 states, including 305 mall stores, 109 outlet stores and 15 airport stores. The Company regularly supplements its permanent mall stores with seasonal stores during its peak selling season from October through January.

2. Summary of significant accounting policies

Basis of presentation

The accompanying consolidated financial statements include those of the Company and all of its subsidiaries. All material intercompany balances and transactions between the entities have been eliminated in consolidation. At July 30, 2005, Wilsons Leather operated in one segment: selling leather outerwear, accessories and apparel. The Company’s chief operating decision-maker evaluates revenue and profitability performance on an enterprise basis to make operating and strategic decisions.

The accompanying unaudited consolidated financial statements have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) applicable to interim financial information. Certain information and footnote disclosures, normally included in consolidated financial statements prepared in accordance with U. S. generally accepted accounting principles (“GAAP”), have been condensed or omitted in these interim statements pursuant to such rules and regulations. Although management believes that the accompanying disclosures are adequate so as not to make the information presented misleading, it is recommended that these interim consolidated financial statements be read in conjunction with the Company’s most recent audited consolidated financial statements and related notes included in its 2004 Annual Report on Form 10-K. In the opinion of management, all adjustments (which include normal recurring adjustments) necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods presented have been made. The Company’s business is highly seasonal, and accordingly, interim operating results are not indicative of the results that may be expected for the fiscal year ending January 28, 2006.

Fiscal year

The Company’s fiscal year ends on the Saturday closest to January 31. The periods that will end or have ended February 3, 2007, January 28, 2006, January 29, 2005, January 31, 2004, and February 1, 2003 are referred to herein as 2006, 2005, 2004, 2003, and 2002, respectively.

Use of estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Matters of significance in which management relies on these estimates relate primarily to the realizability of assets such as accounts receivable, property and equipment, and inventories, and the adequacy of certain accrued liabilities and reserves. Ultimate results could differ from those estimates.

Cash and cash equivalents

Cash equivalents consist principally of short-term investments with original maturities of three months or less and are recorded at cost, which approximates fair value. The short-term investments consist primarily of commercial paper and money market funds.

Inventories

The Company values its inventories, which consist primarily of finished goods held for sale that have been purchased from domestic and foreign vendors, at the lower of cost or market value, determined by the retail inventory method on the last-in, first-out

(“LIFO”) basis. As of July 30, 2005, and January 29, 2005, the LIFO cost of inventories approximated the first-in, first-out cost of inventories. The inventory cost includes the cost of merchandise, freight, duty, sourcing overhead, and other merchandise-specific charges. A periodic review of inventory quantities on hand is performed in order to determine if the inventory value is properly stated at the lower of cost or market. Factors related to current inventories such as future consumer demand, fashion trends, current aging, current and anticipated retail markdowns, and class or type of inventory are analyzed to determine estimated net realizable values. A provision is recorded to reduce the cost of inventories to the estimated net realizable values, if required. Any significant unanticipated changes in the factors noted above could have a significant impact on the value of the Company’s inventories and its reported operating results.

Property and equipment

The Company’s property and equipment consists principally of store leasehold improvements and store fixtures and are included in the “Property and equipment” line item in its consolidated balance sheets included in this report. Leasehold improvements include the cost of improvements funded by landlord incentives and lease costs during the build-out period. These long-lived assets are recorded at cost and are amortized using the straight-line method over the lesser of the applicable store lease term or the estimated useful life of the leasehold improvements. The typical initial lease term for the Company’s stores is ten years and the estimated useful lives of the assets range from five to 10 years. Capital additions required for lease extensions subsequent to initial lease term are amortized over the term of the lease extension. Computer hardware and software and distribution center equipment are amortized over three to five years and 10 years, respectively. Property and equipment retired or disposed of are removed from cost and related accumulated depreciation accounts. Maintenance and repairs are charged directly to expense as incurred. Major renewals or replacements are capitalized after making the necessary adjustment to the asset and accumulated depreciation accounts for the items renewed or replaced.

Store closing and impairment of long-lived assets

The Company continually reviews its stores’ operating performance and assesses plans for store closures. In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (“SFAS No. 144”), losses related to the impairment of long-lived assets are recognized when expected future cash flows are less than the asset’s carrying value. When a store is closed or when a change in circumstances indicates the carrying value of an asset may not be recoverable, the Company evaluates the carrying value of the asset in relation to its expected future cash flows. If the carrying value is greater than the expected future cash flows, a provision is made for the impairment of the asset to write the asset down to estimated fair value. Fair value is determined by estimating net future cash flows, discounted using a risk-adjusted rate of return. These impairment charges are recorded as a component of selling, general and administrative expenses.

When a store under a long-term lease is to be closed, the Company records a liability for any lease termination or broker fees at the time an agreement related to such closing is executed. At July 30, 2005, and January 29, 2005, there were no amounts accrued for store lease terminations.

Debt issuance costs

Debt issuance costs are amortized on a straight-line basis over the life of the related debt. Amortization expense is included in interest expense in the accompanying consolidated statements of operations.

Operating leases

The Company has 431 noncancelable operating leases, primarily for retail stores, which expire at various times through 2017. These leases generally require the Company to pay costs, such as real estate taxes, common area maintenance costs and contingent rentals based on sales. In addition, these leases generally include scheduled rent increases and may include rent holidays. The Company accounts for these scheduled rent increases and rent holidays on a straight-line basis over the initial terms of the leases, including any rent holiday periods, commencing on the date the Company can take possession of the leased facility. Resulting liabilities are recorded as short-term or long-term deferred rent liabilities as appropriate. Rent expense for lease extensions subsequent to the initial lease terms are also calculated using a straight-line basis to the extent that they include scheduled rent increases or rent holidays. In addition, leasehold improvements funded by landlord incentives are recorded as short-term or long-term deferred rent liabilities as appropriate. These liabilities are then amortized as a reduction of rent expense on a straight-line basis over the life of the related lease. As is more fully discussed below in Note 3, “Reclassification of financial statements,” the Company changed its accounting method for leasehold improvements funded by landlord incentives and adopted an accounting policy for rent costs during construction build-out periods. Accordingly, certain amounts presented in the prior period were reclassified.

Revenue recognition

The Company recognizes sales upon customer receipt of the merchandise generally at the point of sale. Shipping and handling revenues are excluded from net sales as a contra-expense and the related costs are included in cost of goods sold, buying and occupancy costs. Per Staff Accounting Bulletin No. 104, Revenue Recognition in Financial Statements, the Company recognizes layaway sales in full upon final payment and delivery of the merchandise to the customer. All customer payments prior to the final payment are recorded as customer deposits and are included in accrued expenses in the accompanying balance sheet. Revenue for gift certificate or gift card sales and store credits is recognized at redemption. A reserve is provided at the time of sale for projected merchandise returns based upon historical experience. The Company recognizes revenue for on-line sales at the time goods are received by the customer. An allowance for on-line sales is recorded to cover in-transit shipments, as product is shipped to these customers Free on Board destination.

Income taxes

Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rate is recognized in income in the period that includes the enactment date. In light of cumulative losses over the past three fiscal years, the Company believes it is more likely than not that the Company’s deferred tax assets will not be realized. Accordingly, a valuation allowance has been established against the net deferred tax assets exclusive of the LIFO reserve.

Foreign currency translation

The functional currency for the Company’s foreign operations is the applicable foreign currency. The translation from the applicable foreign currency to U. S. dollars is performed for balance sheet accounts using the current exchange rate in effect at the balance sheet date and for revenue and expense accounts using a weighted average exchange rate during the period. The gains or losses resulting from such translation are included in shareholders’ equity as other comprehensive loss. Transaction gains and losses are reflected in income.

Loss per share

Basic loss per share is computed by dividing the net loss by the weighted average number of common shares outstanding during the year. Diluted loss per share is computed by dividing the net loss by the sum of the weighted average number of common shares outstanding plus all additional common shares that would have been outstanding if potentially dilutive common shares related to stock options and warrants had been issued, calculated using the treasury stock method. The following table reconciles the number of shares utilized in the loss per share calculations (in thousands):


	For the three months ended				For the year-to-date period ended
	July 30,		July 31,		July 30,		July 31,
	2005		2004		2005		2004
Weighted average common shares outstanding — basic		38,996		26,698		38,949		23,693
Effect of dilutive securities: stock options		—		—		—		—
Effect of dilutive securities: warrants		—		—		—		—

Weighted average common shares outstanding — diluted		38,996		26,698		38,949		23,693

The total dilutive potential common shares excluded from the above calculations were 2,237,925 and 86,315 for the three months ended July 30, 2005 and July 31, 2004, respectively, and 1,824,726 and 89,149 for the year-to-date periods ended July 30, 2005 and July 31, 2004, respectively.

Stock-based compensation

As permitted by SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS No. 123”), the Company uses the intrinsic-value method for employee stock-based compensation pursuant to Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, (“APB Opinion No. 25”) under which no compensation cost has been recognized. The Company adopted the disclosure provisions for employee stock-based compensation and the fair-value method for non-employee stock-based compensation of SFAS No. 123. Had compensation cost for the stock option plans been determined consistent with SFAS No. 123, the Company’s net loss and basic and diluted loss per share would have been the following pro forma amounts (in thousands, except per share amounts):


	For the three months ended						For the year-to-date period ended
	July 30,			July 31,			July 30,			July 31,
	2005			2004			2005			2004
Net Loss:
As reported	$	(13,993	)	$	(30,444	)	$	(17,786	)	$	(57,236	)
Stock based employee compensation expense included in net loss		—			727			—			828
Stock based employee compensation determined under fair value based method for all awards*		(542	)		(2,246	)		(690	)		(2,787	)

Pro forma loss	$	(14,535	)	$	(31,963	)	$	(18,476	)	$	(59,195	)

Basic and diluted loss per share:
As reported	$	(0.36	)	$	(1.14	)	$	(0.46	)	$	(2.42	)
Stock based employee compensation expense included in net loss		—			0.03			—			0.04
Stock based employee compensation determined under fair value based method for all awards*		(0.01	)		(0.09	)		(0.01	)		(0.12	)

Pro forma loss	$	(0.37	)	$	(1.20	)	$	(0.47	)	$	(2.50	)

Weighted average fair value of options granted	$	3.43		$	2.81		$	3.43		$	2.28


*		For the three months ended July 31, 2004 and the year-to-date period ended July 31, 2004, $1,105 of pro-forma expense is due to stock option acceleration from the private placement equity transaction that occurred in July 2004 which resulted in a change in control under the Company’s stock incentive plans (see Note 9 — Additional financing).

In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 123 (Revised 2004) (“SFAS No. 123R”), Share-Based Payment. SFAS No. 123R is a revision of FASB Statement No. 123, Accounting for Stock-Based Compensation and supersedes APB Opinion No. 25 and its related implementation guidance. SFAS No. 123R focuses primarily on accounting for transactions in which an entity obtains employee services through share-based payment transactions. SFAS No. 123R requires that a public entity measure the cost of employee services received in exchange for the award of equity instruments based on the fair value of the award at the date of grant. The cost will be recognized over the period during which an employee is required to provide services in exchange for the award. SFAS No. 123R is effective as of the beginning of the first annual reporting period that begins after June 15, 2005, and, accordingly, the Company will adopt the standard in the first quarter of 2006. While the Company cannot precisely determine the impact on net earnings as a result of the adoption of SFAS No. 123R, estimated compensation expense related to prior periods can be found above in “Stock-based compensation.” The ultimate amount of increased compensation expense will depend on the number of option shares granted during the year, their timing and vesting period and the method used to calculate the fair value of the awards, among other factors. As allowed by SFAS No. 123R, the Company will calculate the fair value of each option granted on the date of grant using the Black-Scholes option pricing model.

which is the first intended use of the property. The Company re-evaluated FASB Technical Bulletin No. 85-3, Accounting for Operating Leases with Scheduled Rent Increases, and determined that, consistent with the letter issued by the Office of the Chief Accountant, the lease term should include the pre-opening period of construction, renovation, fixturing and merchandise placement (the “build-out period,” typically one to two months prior to store opening). However, the Company has elected to capitalize these construction period rent costs and amortize them over the term of the lease. The Company did not previously have a policy or practice to expense or capitalize rent costs during the construction period. In order to properly state the rent costs related to the build-out period for the three- and six-month periods ended July 31, 2004, the Company was required to record additional deferred rent in other accrued expenses, and reclassify a portion of the previously reported rent expense to depreciation.

Following is a summary of the effects of these changes on the Company’s consolidated statements of operations for the three- and six-month periods ended July 31, 2004, and the consolidated statement of cash flows for the six-month period ended July 31, 2004, (in thousands):


	Consolidated Statement of Operations
	As Previously
	Reported		Adjustments			Reclassified
THREE MONTHS ENDED JULY 31, 2004:
Cost of goods sold, buying and occupancy costs	$	46,488	$	(852	)	$	45,636
Gross margin		8,842		852			9,694
Depreciation and amortization		3,687		852			4,539
FOR THE YEAR-TO-DATE PERIOD ENDED JULY 31, 2004:
Cost of goods sold, buying and occupancy costs	$	124,821	$	(3,367	)	$	121,454
Gross margin		28,260		3,367			31,627
Depreciation and amortization		19,044		3,367			22,411


	Consolidated Statement of Cash Flows
	As Previously
	Reported			Adjustments			Reclassified
FOR THE YEAR-TO-DATE PERIOD ENDED JULY 31, 2004:
Depreciation	$	18,996		$	3,367		$	22,363
Income taxes payable and other liabilities		(1,086	)		(3,356	)		(4,442	)
Net cash provided by operating activities of continuing operations		(28,542	)		11			(28,531	)
Additions to property, equipment and other assets		(2,295	)		(11	)		(2,306	)
Net cash used in investing activities of continuing operations		(2,268	)		(11	)		(2,279	)

4. Reorganization and partial store liquidation

On January 22, 2004, the Company announced that it would liquidate up to 100 underperforming mall and outlet stores (subsequently revised to 111 stores — the “liquidation stores”) and eliminate approximately 950 store-related positions. The Company entered into an Agency Agreement with a joint venture comprised of Hilco Merchant Resources, LLC, Gordon Brothers Retail Partners, LLC and Hilco Real Estate, LLC (the “Hilco/Gordon Brothers Joint Venture”) to liquidate the inventory in the 111 stores and assist in the discussions with landlords regarding lease terminations in approximately 94 of these stores. Pursuant to the Agency Agreement, the Hilco/Gordon Brothers Joint Venture guaranteed to pay the Company an amount of 84.0% of the cost value of the inventory at the liquidation stores, subject to certain adjustments. The Hilco/Gordon Brothers Joint Venture was responsible for all expenses related to the sale. The liquidation stores were selected based on strategic criteria, including negative sales and earnings trends, projected real estate costs, location and financial conditions within the market. In addition, the Company announced that it would eliminate approximately 70 positions at its corporate headquarters in Brooklyn Park, Minnesota and its distribution center in Las Vegas, Nevada, close its distribution center in Las Vegas, Nevada, and write-off essentially all remaining assets located at its distribution centers in Maple Grove, Minnesota and Las Vegas, Nevada.

The Company recorded charges related to the restructuring and partial store liquidation of $8.2 million and $22.4 million during the second fiscal quarter and first six months of 2004, respectively, primarily related to the transfer of inventory to an independent liquidator in conjunction with the closing of the liquidation stores, and lease termination costs and accelerated depreciation related to store closings. For the three months ended July 31, 2004, a total of $9.1 million and $0.4 million of these charges were recorded in selling, general and administrative expenses and depreciation and amortization, respectively, as partially offset by $1.3 million of gross margin earned on the liquidation sales. For the six months ended July 31, 2004, a total of $12.3 million and $13.6 million of these charges were recorded in selling, general and administrative expenses and depreciation and amortization, respectively, as partially offset by $3.5 million of gross margin earned on liquidation sales. The liquidation sales were completed in April 2004, and as of May 1, 2004, all the liquidation stores had been closed.

5. Other comprehensive income

The Company reports accumulated other comprehensive income as a separate item in the shareholders’ equity section of the consolidated balance sheets. Other comprehensive income consists of foreign currency translation adjustments. For the three-month and year-to-date periods ending July 30, 2005, and July 31, 2004, the amounts were not significant.

6. Long-term debt

Long-term debt at July 30, 2005, and January 29, 2005, consisted of the following (in thousands):


	July 30,		January 29,
	2005		2005
Term B promissory note	$	20,000	$	25,000

Total debt	$	20,000	$	25,000
Less: current portion		—		(5,000	)

Total long-term debt	$	20,000	$	20,000

Senior notes

The Company retired the remaining $30.6 million of 11^1/4% Senior Notes due August 15, 2004 (the “11^1/4% Senior Notes”) in 2004.

Term B promissory note and senior credit facility

General Electric Capital Corporation and a syndicate of banks have provided the Company with a senior credit facility, as amended, that provides for borrowings of up to $150.0 million in aggregate principal amount, including a $25.0 million Term B promissory note and a $75.0 million letter of credit subfacility. With the completion of the Equity Financing described below in Note 9, “Additional financing,” and the subsequent repurchase and repayment of the 11^1/4% Senior Notes in full at maturity, the senior credit facility expiration date was extended to June 28, 2008, at which time all borrowings, including the Term B promissory note, will become due and payable.

The Term B promissory note is collateralized by the Company’s inventory. The remainder of the senior credit facility is collateralized by the Company’s inventory, equipment and credit card receivables. Through the third quarter of 2005 interest on cash borrowings under the senior credit facility is at LIBOR plus 1.50%, the commercial paper rate plus 1.50% or the prime rate plus 0.25%. Commencing with the fourth quarter of 2005, interest will be payable on revolving credit borrowings at variable rates determined by LIBOR plus 1.25% to 1.75%, or the prime rate plus 0.0% to 0.5% (commercial paper rate plus 1.25% to 1.75% if the loan is made under the “swing line” portion of the revolver). The applicable rate will be adjusted quarterly on a prospective basis based on achievement of defined quarterly targets of earnings before interest, taxes, depreciation and amortization (“EBITDA”). With respect to the Term B promissory note, the interest rate is the prime rate plus 4.0%, plus an additional 2.75% pursuant to a separate letter agreement with General Electric Capital Corporation. The Company pays monthly fees of 0.375% per annum on the unused portion of the senior credit facility, as defined, and 3.25% per annum on the average daily amount of letters of credit outstanding during each month.

The Company is allowed to prepay up to $10.0 million on the Term B promissory note portion of the senior credit facility on or before February 28, 2006, without penalty, subject to certain conditions. A total of $5.0 million was prepaid on March 3, 2005. Prepayment of the Term B promissory note (other than the potential prepayment of an additional $5.0 million on or prior to February 28, 2006) is subject to a 0.5% prepayment fee if prepayment is made on or prior to January 31, 2006. The revolving credit portion of the senior credit facility is subject to a 1.0% prepayment fee under most circumstances. The remaining $15.0 million of the Term B promissory note is prepayable only with the consent of the senior lenders under the senior credit facility. The Company has not determined if it will repay the additional $5.0 million by February 28, 2006.

The senior credit facility contains certain restrictions and covenants, which, among other things, restrict the Company’s ability to make capital expenditures; acquire or merge with another entity; make investments, loans or guarantees; incur additional indebtedness; create liens or other encumbrances; or pay cash dividends or make other distributions. At July 30, 2005, the Company was in compliance with all covenants related to the senior credit facility.

At July 30, 2005, and January 29, 2005, there were no borrowings under the revolving portion of the credit facility. At July 30, 2005, and January 29, 2005, there were $21.6 million and $8.0 million, respectively, in letters of credit outstanding. The Term B promissory note had a balance of $20.0 million and $25.0 million on July 30, 2005, and January 29, 2005, respectively. As of January 29, 2005, $5.0 million of the Term B promissory note was classified as current.

7. Legal proceedings

The Company is involved in various legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on the Company’s consolidated financial position and results of operations.

8. Supplemental balance sheet information


	July 30,			January 29,
(In thousands)	2005			2005

Accounts receivable, net:
Trade receivables	$	2,261		$	3,454
Other receivables		630			305

Total		2,891			3,759
Less — Allowance for doubtful accounts		(27	)		(76	)
Less — Deferred sales		(35	)		(40	)

Total accounts receivable, net	$	2,829		$	3,643

Inventories:
Raw materials	$	4,655		$	2,155
Finished goods		75,211			83,904

Total inventories	$	79,866		$	86,059

Property and equipment, net:
Equipment and furniture	$	75,638		$	75,130
Leasehold improvements		38,424			37,621

Total		114,062			112,751
Less — Accumulated depreciation		(71,724	)		(68,145	)

Total property and equipment, net	$	42,338		$	44,606

Other assets, net:
Debt issuance costs	$	5,384		$	5,384
Other intangible assets		82			82

Total		5,466			5,466
Less — Accumulated amortization		(3,575	)		(3,261	)

Total other assets, net	$	1,891		$	2,205

9. Additional financing

On April 25, 2004, the Company entered into an agreement to issue 17,948,718 shares of the Company’s common stock to three institutional investors at a price of $1.95 per share (the “Equity Financing”). The transaction closed on July 2, 2004, with gross proceeds before offering expenses of $35.0 million. As additional consideration for the investors’ commitment, on April 25, 2004, the Company issued two million warrants exercisable for five years to the investors upon signing the Equity Financing agreement, and at closing, issued an additional two million warrants exercisable for five years, all at an exercise price of $3.00 per share of common stock. All four million of the warrants issued contain certain weighted average anti-dilution rights. On July 9, 2004, the Company repurchased $22.0 million of the 11^1/4% Senior Notes with proceeds from the Equity Financing. The Company used $8.6 million of

this letter, we conducted a review of our lease-related accounting methods and determined that our methods of accounting for: (1) leasehold improvements funded by landlord incentives, and (2) rent expense prior to commencement of operations and rent payments, while in line with common industry practice, were not in accordance with GAAP. However, these misstatements had no impact on our net income or loss for any period and, as a result, we reclassified certain amounts within our consolidated financial statements filed with our 2004 Annual Report on Form 10-K for 2003 and 2002, the first three fiscal quarters of 2004 and all four fiscal quarters of 2003.

We had historically accounted for leasehold improvements funded by landlord incentives as reductions in the cost of related leasehold improvements reflected in the consolidated balance sheets and the capital expenditures reflected in investing activities in the consolidated statements of cash flows. We determined that the appropriate interpretation of FASB Technical Bulletin No. 88-1, Issues Relating to Accounting for Leases, requires these incentives to be recorded as deferred rent liabilities in the consolidated balance sheets and as a component of operating activities in the consolidated statements of cash flows. This resulted in a reclassification of the deferred rent amortization from depreciation and amortization expense to rent expense, which is included in cost of goods sold, buying and occupancy costs in the consolidated statements of operations. We also reclassified lease incentives to operating activities, which were previously included as a reduction of the cost component of capital expenditures in investing activities in the consolidated statements of cash flows.

Additionally, we had historically recognized rent holiday periods on a straight-line basis over the lease term commencing on the related retail store opening date. The store opening date coincides with the commencement of business operations, which is the first intended use of the property. We re-evaluated FASB Technical Bulletin No. 85-3, Accounting for Operating Leases with Scheduled Rent Increases and determined that, consistent with the letter issued by the Office of the Chief Accountant, the lease term should include the pre-opening period of construction, renovation, fixturing and merchandise placement (the “build-out period,” typically one to two months prior to store opening). However, we have elected to capitalize these construction period rent costs and amortize them over the term of the lease. We did not previously have a policy or practice to expense or capitalize rent costs during the construction period.

See Note 3, “Reclassification of financial statements,” above for a more detailed description of applicable reclassifications. The accompanying discussion gives effect to these corrections.

Critical accounting policies

We consider our critical accounting policies to be those related to inventories and property and equipment impairment as discussed in the section with this title in Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” that begins on page 25 of our 2004 Annual Report on Form 10-K. No material changes occurred to these policies in the periods covered by this quarterly report.

RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED JULY 30, 2005,
COMPARED TO THE THREE MONTHS ENDED JULY 31, 2004

Net Sales. Net sales increased 5.6% to $58.4 million in the three months ended July 30, 2005, from $55.3 million in the comparable period last year. The increased net sales are reflective of a comparable store sales increase of 8.7% for the three months ended July 30, 2005, compared to an increase of 11.0% in comparable store sales in the same period last year. This improvement was driven primarily by continued strong sales of our expanding NASCAR merchandise line, increased levels of inventory and strong promotional programs.

We opened four stores and closed four stores in the three months ended July 30, 2005, compared to opening one store and closing six stores in the comparable period last year. At July 30, 2005, we operated 429 stores compared to 453 stores at July 31, 2004. We regularly supplement our permanent mall stores with seasonal stores during our peak selling season from October to January.

Cost of Goods Sold, Buying and Occupancy Costs. Cost of goods sold, buying and occupancy costs decreased $0.6 million, or 1.4%, in the three months ended July 30, 2005, compared to the same period last year on a 5.6% increase in net sales, reflecting improved merchandise margins discussed below. This decrease was primarily driven by a $1.5 million decrease in product costs, markdowns and delivery costs, partially offset by a $0.9 million increase in buying and occupancy costs. The increased buying and occupancy costs were primarily related to the release of deferred rent liabilities for the 111 liquidation stores recorded in the second fiscal quarter of 2004 as we exited leases. When adjusted to remove the effects of the liquidation, costs of goods sold, buying and

occupancy costs decreased $1.9 million, or 4.1%, from $46.9 million as a result of improved merchandise margins and fewer markdowns, along with decreased delivery and buying and occupancy costs, which offset the increased sales volume.

Gross margin as a percentage of net sales increased 550 basis points to 23.0% in the second quarter of 2005 compared to 17.5% in the second quarter of 2004 primarily as a result of improved merchandise margins. Our improved merchandise margins are the result of higher initial markups and fewer markdowns. When adjusted to remove the effects of the liquidation, gross margin as a percentage of net sales increased 770 basis points in the second quarter of 2005 from 15.3% in the second quarter of 2004. This increase is reflective of a 540 basis point improvement in merchandise margins and decreased buying and occupancy costs discussed above.

Selling, General and Administrative Expenses. Selling, general and administrative expenses (“SG&A”) decreased to $24.6 million in the second quarter of 2005 from $33.6 million in the second quarter of 2004, and decreased as a percentage of net sales to 42.1% from 60.8%. The $9.1 million decrease was primarily due to the $9.1 million of reorganization and liquidation charges incurred in the second quarter of 2004 primarily related to lease termination and executive severance costs. Excluding liquidation effects, SG&A was flat to last year on an absolute dollar basis. SG&A for the second quarter of 2005 includes a higher level of accrued incentive compensation as offset by decreased administrative and other costs due to a lower store count and reduced staffing levels. In the first fiscal quarter of 2005, we began accruing for incentive bonuses quarterly based on our performance in that quarter relative to our annual incentive targets. Previously, we had not recorded incentive bonuses, if any, until the fourth quarter of any given year as a result of the significant annual operating losses incurred in 2002 through 2004. As a result of our restructuring activities over the past three years, we have concluded that we have a more predictable business, which allows us to better estimate probable bonus payments.

SG&A as a percentage of net sales, excluding liquidation effects (which totaled $9.1 million in the second quarter of 2004) decreased to 42.1% compared to 44.4% for the second quarter of 2004. The improvement in rate as a percentage of net sales reflects our continued focus on effectively managing expenses and the leverage obtained from the comparable store sales increase. This gain was partially offset by the higher level of accrued incentive compensation related to business performance discussed above.

Depreciation and Amortization. Depreciation and amortization decreased to $3.6 million in the three months ended July 30, 2005, from $4.5 million in the comparable period last year, and decreased as a percentage of net sales to 6.1% from 8.2%. The decrease of $0.9 million was primarily the result of: (1) $0.4 million in accelerated depreciation recorded in the second quarter of 2004 related to the liquidation stores, and (2) a $0.5 million decrease in store depreciation due to a 5.7% decrease in average store count for the three months ended July 30, 2005 compared to 2004. Depreciation and amortization, excluding liquidation effects (which totaled $0.4 million) decreased to $3.6 million, or 6.1% of net sales, in the second quarter of 2005 as compared to $4.1 million, or 7.4% of net sales, in the second quarter of 2004.

Operating Loss. As a result of the above, the operating loss was $14.7 million in the three months ended July 30, 2005, compared to a $28.5 million loss for the comparable period last year, or 25.2% of net sales in 2005 as compared to 51.5% of net sales in 2004. This improvement was largely due to restructuring costs of $8.2 million in 2004, as well as $5.0 million in improved gross margin dollars in 2005 as compared to the prior year, and $0.5 million in decreased depreciation expense in 2005 due to a lower asset base. Excluding the liquidation sales and restructuring charges, an operating loss of $14.7 million was reported in the second quarter of 2005 as compared to an operating loss of $20.3 million in the second quarter of 2004. This improvement reflects the restructuring and store closing initiatives, as well as the impact of our improved net sales and gross margin performance.

Interest Expense. Net interest expense decreased to $0.7 million in 2005 from $2.0 million in 2004, due to the repurchase and repayment of our 11^1/4% Senior Notes due August 15, 2004 (the “11^1/4% Senior Notes”) in the second and third quarters of 2004 and the prepayment of $5.0 million of the Term B promissory note in March 2005. The liquidation and restructuring did not impact interest expense.

Income Tax Benefit. We recorded an income tax benefit of $1.4 million in the second quarter of fiscal 2005 relating primarily to the resolution of certain income tax contingencies previously accrued as a result of a recently completed Internal Revenue Service review of amended returns. Due to sustained losses, which currently require the recording of a valuation allowance against potentially unrealizable net operating losses in future periods, there were no income tax benefits recorded in 2005 and 2004 related to the net operating losses. The ability to utilize net operating loss carryforwards is limited under various provisions of the Internal Revenue Code, as disclosed in our 2004 Annual Report on Form 10-K.

Net Loss. As a result of the above, the net loss for the three months ended July 30, 2005, was $14.0 million compared to a net loss of $30.4 million in the comparable period last year. The $16.4 million decrease in net loss over the prior year is primarily due to the $8.2 million decrease in net loss related to the liquidation and restructuring activities, as well as: (1) $5.0 million in improved gross

margin, (2) $0.5 million in decreased depreciation expense, (3) a $1.3 million decrease in interest expense, and (4) the $1.4 million income tax benefit recorded in 2005, all discussed above. Excluding the liquidation sales and restructuring charges, the net loss was $14.0 million for the second quarter of 2005 as compared to a net loss of $22.2 million for the second quarter of 2004.

RESULTS OF OPERATIONS FOR THE YEAR-TO-DATE PERIOD ENDED JULY 30, 2005,
COMPARED TO THE YEAR-TO-DATE PERIOD ENDED JULY 31, 2004

Net Sales. Net sales decreased 6.8% to $142.7 million in the year-to-date period ended July 30, 2005, from $153.1 million in the comparable period last year. This decrease in net sales is primarily due to the fact that net sales for 2004 included approximately $20.8 million in liquidation sales recorded in the first quarter of 2004 resulting from the liquidation of 111 stores. See Note 4, “Reorganization and partial store liquidation.” When adjusted to remove the liquidation sales, net sales increased 7.9% from $132.3 million in the 2004 year-to-date period. This increase reflects a comparable store sales increase of 12.8% for the six months ended July 30, 2005, as compared to a 3.1% increase in the similar period last year. This improvement was the result of continued strong demand for our expanding NASCAR merchandise line, increased levels of inventory and strong promotional programs.

We opened four stores and closed 11 stores in the year-to-date period ended July 30, 2005. In the comparable period last year we also opened four stores and closed 11 stores (excluding the 111 liquidation stores).

Cost of Goods Sold, Buying and Occupancy Costs. Cost of goods sold, buying and occupancy costs decreased $17.5 million or 14.4% to $103.9 million for the year-to-date period ended July 30, 2005, as compared to $121.5 million in the similar period last year. This decrease was primarily driven by the lower sales volume due to the $20.8 million of liquidation sales in the first quarter of fiscal 2004. When adjusted to remove the liquidation effects, cost of goods sold, buying and occupancy costs decreased $0.3 million, or less than 1.0%, from $104.2 million as a result of a $0.7 million decrease in buying and occupancy costs offsetting the increased product costs due to the increased sales volume. These essentially flat year-on-year cost of goods sold, buying and occupancy costs on an absolute dollar basis reflect the improved merchandise margins discussed below. The lower buying and occupancy costs are reflective of a 5.7% decrease in average store count for the comparable year-to-date period.

Gross margin as a percent of net sales increased by 650 basis points to 27.2% in the first six months of 2005 as compared to 20.7% in the similar period of 2004, primarily as a result of improved merchandise margins, due to higher initial markups. Excluding the effects of the liquidation sales and restructuring charges, gross margin as a percent of net sales was 600 basis points higher than the 21.2% for year-to-date 2004. This improvement was the result of a 310 basis point improvement in merchandise margins and decreased buying and occupancy costs.

Selling, General and Administrative Expenses. SG&A decreased to $49.4 million, down $12.4 million or 20.1%, from $61.8 million in the similar period last year. As a percent of net sales, 2005 year-to-date SG&A decreased to 34.6% as compared to 40.3% last year. The $12.4 million decrease was primarily due to: (1) $12.3 million of restructuring and liquidation charges incurred in the first six months of 2004, primarily related to lease termination costs, (2) a $0.4 million decrease in promotional spending, and (3) a $1.2 million decrease in other administrative costs due to lower store count and reduced staffing levels. These decreases were somewhat offset by: (1) a $0.2 million increase in store-related expenses due to higher adjusted sales volume, (2) a $0.2 million increase in spending related to our e-commerce site, and (3) $1.0 million of additional benefit spending related to increased bonuses accrued through the first six months of 2005 that were not accrued in 2004, partially offset by reduced spending on medical insurance claims and workers compensation expenditures due to lower store count and reduced staffing levels. As previously discussed, in the first quarter of 2005 we began accruing incentive bonuses quarterly based on current performance relative to our annual incentive targets.

SG&A as a percentage of net sales, excluding liquidation effects (which totaled $12.3 million, or 59.2% of the year-to-date liquidation sales of $20.8 million) decreased to 34.6% compared to 37.4% for the similar period last year. The year-to-date improvement in rate as a percentage of sales again reflects our continued focus on effectively managing expenses and the leverage obtained from the comparable store sales increases, partially offset by the higher level of accrued incentive compensation discussed above.

Depreciation and Amortization. Depreciation and amortization decreased $15.1 million in the year-to-date period ended July 30, 2005 to $7.3 million, from $22.4 million in the comparable period last year, and as a percentage of net sales to 5.1% from 14.6%. The decrease was primarily the result of: (1) $13.6 million in accelerated depreciation recorded in the first six months of 2004 related to the liquidation stores, (2) a $1.2 million decrease in store depreciation due to a 5.7% decrease in average store count year-to-date, and (3) a $0.2 million decrease in administrative depreciation and amortization. Excluding the effects of the liquidation, depreciation and

amortization decreased $1.5 million to $7.3 million from $8.8 million a year ago, or as a percentage of net sales, 5.1% and 6.6%, respectively.

Operating Loss. For the year-to-date period ended July 30, 2005, the operating loss was $17.9 million as compared to $52.5 million a year ago, or 12.5% of net sales in 2005 as compared to 34.3% of 2004 net sales. This improvement was primarily due to: (1) liquidation and restructuring costs of $22.4 million in 2004, (2) $10.7 million in improved gross margin dollars as compared to the prior year, (3) essentially flat SG&A year-over-year, and (4) $1.5 million in decreased depreciation and amortization expenditures in 2005. Excluding the liquidation sales and restructuring charges, the 2005 year-to-date operating loss of $17.9 million was $12.2 million less than the $30.1 million operating loss in the comparable period of 2004. The year-to-date improvement also reflects the restructuring and store closing initiatives, as well as the impact of our improved net sales and gross margin performance.

Interest Expense. Net interest expense of $1.3 million year-to-date in 2005 decreased $3.4 million as compared to $4.7 million in 2004, due to the repurchase and repayment of our 11^1/4% Senior Notes in the second and third quarters of 2004 and the prepayment of $5.0 million of the Term B promissory note in March 2005. In addition, during the first quarter of 2004 we wrote off $0.5 million of debt issuance costs related to the amended senior credit facility. The liquidation and restructuring did not impact year-to-date interest expense.

Income Tax Benefit. We recorded an income tax benefit of $1.4 million in the second fiscal quarter of 2005 primarily relating to the resolution of certain income tax contingencies previously accrued as a result of a recently completed Internal Revenue Service review of amended returns. Due to sustained losses, which currently require the recording of a valuation allowance against potentially unrealizable net operating losses in future periods, there were no income tax benefits recorded in 2005 and 2004 related to the net operating losses incurred. The ability to utilize net operating loss carryforwards is limited under various provisions of the Internal Revenue Code, as disclosed in our 2004 Annual Report on Form 10-K.

Net Loss. As a result of the above, the year-to-date net loss for the first six months of fiscal 2005 was $17.8 million compared to a net loss of $57.2 million in the similar period last year. The $39.4 million improvement in net loss year-over-year is primarily due to: (1) a $22.4 million net loss relating to the 2004 liquidation and restructuring activities, (2) a $10.7 million improvement in gross margin, (3) essentially flat SG&A, (4) a $1.5 million decrease in depreciation and amortization, (5) a $3.4 million decrease in interest expense, and (6) a $1.4 million tax benefit recorded in 2005. Excluding the effects of the liquidation and restructuring activities, net loss was $17.8 million for the first six months of 2005 as compared to $34.8 million in the comparable period in 2004.

Liquidity and capital resources

Our capital requirements are primarily driven by our seasonal working capital needs, investments in new stores, remodeling existing stores, enhancing information systems and increasing capacity and efficiency for our distribution center. Our peak working capital needs typically occur during the period from August through early December as inventory levels are increased in advance of our peak selling season from October through January.

Our future capital requirements depend on the sustained demand for our leather products. Many factors affect the level of consumer spending on our products, including, among others, general economic conditions, including rising energy prices, customer shopping patterns, interest rates, the availability of consumer credit, weather, the outbreak of war, acts of terrorism or the threat of either, other significant national and international events, taxation and consumer confidence in future economic conditions. Consumer purchases of discretionary items, such as our leather products, tend to decline during recessionary periods when disposable income is lower. The uncertain outlook in the United States’ economy has shifted consumer spending habits toward large discount retailers, which has decreased mall traffic, resulting in lower net sales on a quarterly and annual basis.

Our ability to meet our debt service obligations will be dependent upon our future performance, which will be subject to general economic conditions and financial, business and other factors affecting our operations. If we are unable to generate sufficient cash flow from operations in the future to service our debt, we may be required to refinance all or a portion of our existing debt to obtain additional financing. There can be no assurance that any such refinancing would be possible or could be obtained on terms that are favorable to us.

General Electric Capital Corporation and a syndicate of banks have provided us with a senior credit facility, as amended, that provides for borrowings of up to $150.0 million in aggregate principal amount, including a $25.0 million Term B promissory note and a $75.0 million letter of credit subfacility. The maximum amount available under the revolving credit portion of the senior credit facility is limited to:

	•		85% of net inventories, provided that such percentage at no time may exceed 85% of the then applicable discount rate applied in appraising such inventories to reflect their value as if sold in an orderly liquidation, except that the discount rate is gradually increased from August 17 to October 1 of each year and gradually decreased from December 17 to February 1 of each year, and except that such amount is reduced by the amount of certain in-transit inventory to the extent such in-transit inventory reflects a disproportionate amount of our total inventory;

	•		plus 85% of outstanding and undrawn trade letters of credit, provided that such percentage at no time may exceed 85% of the discount rate applied in appraising the future inventories related to such letters of credit to reflect their value as if sold in an orderly liquidation;

	•		plus 85% of credit card receivables; and

	•		minus a $10.0 million reserve.

In addition, borrowings under the senior credit facility are subject to the further limitations that:

	•		the revolving credit portion of such borrowings cannot exceed the sum of 85% of credit card receivables, plus 85% of the appraised value of inventory (including inventory subject to trade letters of credit) as if sold on a going-out-of-business basis;

	•		the total borrowings (i.e. the revolving credit portion of the facility and the Term B promissory note) cannot exceed the sum of 85.0% of the book value of credit card receivables, plus 92.5% of the appraised value of inventory (including inventory subject to trade letters of credit) as if sold on a going-out-of-business basis; and

	•		from December 31 of each year, through March 31 of the following year, we must have no borrowings under the revolving credit portion of the facility and outstanding letters of credit must be no greater than $20.0 million.

As of July 30, 2005, we had no borrowings under the senior credit facility, except for the Term B promissory note, and we had $21.6 million in outstanding letters of credit.

Through the third quarter of 2005, interest is payable on revolving credit borrowings at variable rates determined by LIBOR plus 1.50%, or the prime rate plus 0.25% (commercial paper rate plus 1.50% if the loan is made under the swing line portion of the revolver). Commencing with the fourth quarter of 2005, interest will be payable on revolving credit borrowings at variable rates determined by LIBOR plus 1.25% to 1.75%, or the prime rate plus 0.0% to 0.5% (commercial paper rate plus 1.25% to 1.75% if the loan is made under the swing line portion of the revolver). The applicable rate will be adjusted quarterly on a prospective basis based on achievement of defined quarterly EBITDA targets. Interest is payable on the $25.0 million Term B promissory note at a variable rate equal to the prime rate plus 4%, plus an additional 2.75% payable pursuant to a separate letter agreement with General Electric Capital Corporation. We pay monthly fees on the unused portion of the senior credit facility and on the average daily amount of letters of credit outstanding during each month. With the completion of the Equity Financing in 2004 (See Note 9, “Additional financing”) and subsequent repurchase and repayment of the 11^1/4% Senior Notes, the senior credit facility expiration date was extended to June 28, 2008, at which time all borrowings, including the Term B promissory note, become due and payable. We are allowed to prepay up to $10.0 million on the Term B promissory note portion of the senior credit facility on or before February 28, 2006, without penalty, subject to certain conditions. A total of $5.0 million was prepaid on March 3, 2005. Prepayment of the Term B promissory note (other than the potential prepayment of an additional $5.0 million on or prior to February 28, 2006) is subject to a 0.5% prepayment fee if prepayment is made on or prior to January 31, 2006. The revolving credit portion of the senior credit facility is subject to a 1.0% prepayment fee under most circumstances. The remaining $15.0 million of the Term B promissory note is prepayable only with the consent of the senior lenders under the senior credit facility. The Company has not determined if it will repay the additional $5.0 million by February 28, 2006.

The senior credit facility contains certain restrictions and covenants, which, among other things, restrict our ability to make capital expenditures; acquire or merge with another entity; make investments, loans or guarantees; incur additional indebtedness; create liens or other encumbrances; or pay cash dividends or make other distributions. At July 30, 2005, we were in compliance with all covenants related to the senior credit facility.

We plan to use the senior credit facility for our immediate and future working capital needs. We are dependent on the senior credit facility to fund working capital and letter of credit needs. We believe that the borrowing capacity under the senior credit facility,

together with cash on hand, current and anticipated cash flow from operations, cost reductions associated with the lower store count from the liquidation of stores and natural lease terminations and the proceeds from the equity financing discussed below, will be adequate to meet our working capital and capital expenditure requirements through 2005.

On April 25, 2004, we entered into an agreement to issue 17,948,718 shares of our common stock to three institutional investors at a price of $1.95 per share (the “Equity Financing”). See Note 9, “Additional financing.” The Equity Financing closed on July 2, 2004, with gross proceeds of $35.0 million before offering costs. As additional consideration for the investors’ commitment, on April 25, 2004, we issued two million warrants exercisable for five years to the investors upon signing the Equity Financing agreement, and at closing issued an additional two million warrants exercisable for five years, all at an exercise price of $3.00 per share of common stock. $30.6 million of the offering proceeds were used to repay our 11^1/4% Senior Notes. See Note 6, “Long-term debt.” The remaining balance of these funds was used for general working capital purposes.

Cash flow analysis

Operating Activities. Operating activities for the six months ended July 30, 2005, used cash of $11.3 million compared to utilizing $28.5 million in the corresponding period of 2004.

The $11.3 million of cash used by operating activities in 2005 was comprised primarily of: (1) a net loss from operations of $17.8 million, (2) a $3.4 million decrease in accounts payable and accrued expenses primarily as a result of lower inventory levels and payout of accrued 2004 incentives, (3) a $2.9 million increase in prepaid expenses and other current assets due to the timing of rent payments, and (4) a $1.7 million decrease in income taxes payable and other liabilities as a result of the release of certain tax reserves.

These uses of cash were somewhat offset by: (1) a $6.2 million decrease in inventories, (2) a $0.8 million reduction in accounts receivable due to lower seasonal sales volumes, and (3) $7.4 million in non-cash adjustments for depreciation, amortization and property and equipment impairment.

The $28.5 million of cash used by operating activities in 2004 was comprised of: (1) a net loss from operations of $57.2 million, (2) a $3.7 million decrease in accounts payable and accrued expenses, (3) a $3.3 million increase in prepaid expenses, and (4) a $4.4 million decrease in income taxes payable and other liabilities.

These uses of cash were primarily offset by: (1) an $11.4 million decrease in inventories due to more tightly managed inventory levels and lower store count than in the prior year due primarily to the 111 store liquidation completed in April 2004, (2) $25.7 million in non-cash adjustments for depreciation, amortization, property and equipment impairment, and restricted stock compensation expense, and (3) a $3.1 million decrease in accounts receivable.

Investing Activities. Investing activities of $4.8 million for the six months ended July 30, 2005, were comprised of $4.9 million in capital expenditures primarily for the renovation of and improvements to existing stores, including new store fixtures and certain distribution center equipment, offset by $0.2 million in proceeds on the sale of property and equipment. For 2005, capital expenditures are capped by the senior credit facility at $10.0 million.

Investing activities for the six months ended July 31, 2004, were comprised primarily of $2.3 million in capital expenditures used primarily for the construction of new stores and the renovation of and improvements to existing stores.

Financing Activities. Cash used for financing activities for the six months ended July 30, 2005, was $4.5 million and was comprised of $5.0 million used for pre-payment of a portion of the Term B promissory note offset by $0.5 million provided from the issuance of common stock primarily from the exercise of stock options.

The $9.2 million in cash provided by financing activities for the six months ended July 31, 2004, was comprised primarily of $32.4 million in net proceeds from the Equity Financing, offset by $22.0 million used for payment of the 11^1/4% Senior Notes and $1.2 million used for debt acquisition costs related to amendments to our senior credit facility in April 2004.

Off-balance sheet arrangements

We have no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in our financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors.

Contractual obligations and commercial commitments

We had $21.6 million of standby and documentary letters of credit outstanding at July 30, 2005. We also have a Term B promissory note with $20.0 million outstanding at July 30, 2005. These commitments are further discussed in the “Liquidity and capital resources” section of this Form 10-Q. We retired $30.6 million of the 11^1/4% Senior Notes in 2004. Otherwise, there are no known material commitments, other than store operating leases that we have committed to in the ordinary course of business.

Seasonality and inflation

A majority of our net sales and operating profit is generated in the peak selling period from October through January, which includes the holiday selling season. As a result, our annual operating results have been, and will continue to be, heavily dependent on the results of our peak selling period. Net sales are generally lowest during the period from April through July, and we typically do not become profitable, if at all, until the fourth quarter of a given year. Most of our stores are unprofitable during the first three quarters. Conversely, in a typical year nearly all of our stores are profitable during the fourth quarter, even those that may be unprofitable for the full year. Historically, we have opened most of our stores during the last half of the year. As a result, new mall stores opened just prior to the fourth quarter produce profits in excess of their annualized profits since the stores typically generate losses in the first nine months of the year.

We do not believe that inflation has had a material effect on the results of operations during the past three years; however, there can be no assurance that our business will not be affected by inflation in the future. Increased energy prices have put additional pressure on consumer purchases of discretionary items and may potentially increase our shipping and delivery costs, which could negatively affect our net sales and merchandise margins.

Recently issued accounting pronouncements

See Note 2, “Summary of significant accounting polices — New accounting pronouncements,” of the consolidated financial statements beginning on page 7 of this report for a full description of recently issued accounting pronouncements, including the respective expected dates of adoption and effects on results of operations and financial condition.

Forward-looking statements

Except for historical information, matters discussed in Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contain certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These statements involve risks and uncertainties, and actual results may be materially different. Because actual results may differ, readers are cautioned not to place undue reliance on forward-looking statements. Such statements are based on information available to management as of the time of such statements, and relate to, among other things, expected results of operations and operating performance, capital needs, and demand for the Company’s products. Factors that could cause actual results to differ include: changes in customer shopping patterns; competition in our markets; uncertainty in general economic conditions, including rising energy prices; our inability to effectively respond to changes in fashion trends and consumer demands; failure of results of operations to meet expectations of research analysts; our inability to grow the business as planned; decreased availability and increased cost of leather; risks associated with foreign sourcing and international business; seasonality of our business; risks associated with our debt service; risks associated with estimates made by management based on our critical accounting policies; changes to financial accounting standards that may affect our results of operations; loss of key members of our senior management team; the sale into the market of the shares issued in our 2004 Equity Financing or issuable upon exercise of warrants delivered in connection with our Equity Financing; concentration of our common stock; volatility of the market price of our common stock; reliance on third parties for upgrading and maintaining our management information systems; war, acts of terrorism or the threat of either; interruption in the operation of our corporate offices and distribution center; and the sale into the market of our common stock by existing shareholders, including shares issuable upon exercise of outstanding vested options. For a further description of our risk factors, please see Exhibit 99.1 filed with this quarterly report on Form 10-Q.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our senior credit facility carries interest rate risk that is generally related to LIBOR, the commercial paper rate or the prime rate. If any of those rates were to change while we were borrowing under the senior credit facility, interest expense would increase or decrease accordingly. As of July 30, 2005, there were no borrowings under the revolving portion of the credit facility, $20.0 million under the Term B promissory note, and $21.6 million in outstanding letters of credit.

ITEM 4. CONTROLS AND PROCEDURES

As of the end of the period covered by this report, we conducted an evaluation, under the supervision and with the participation of the principal executive officer and principal financial officer, of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)). Based on this evaluation, the principal executive officer and principal financial officer concluded that our disclosure controls and procedures are effective to ensure that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. There was no change in our internal control over financial reporting during our most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II — OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

We are involved in various legal actions arising in the ordinary course of business. In the opinion of our management, the ultimate disposition of these matters will not have a material adverse effect on our consolidated financial position and results of operations.

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

See Part I, Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and capital resources” contained herein for a description of working capital restrictions and limitations upon the payment of dividends. We did not repurchase any shares of our common stock during the first six months of 2005.

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

At our annual meeting held on June 2, 2005, the shareholders approved the following:

(a)

The election of two directors for a three-year term. Each nominated director was elected as follows:


Director-Nominee	Votes For		Votes Withheld
Bradley K. Johnson		36,668,398		1,707,665
Michael M. Searles		36,893,653		1,482,410

(b)

Approval of the amendment and restatement of the 2000 Long Term Incentive Plan.

The proposal received 27,940,438 votes for and 3,528,756 votes against. There were 962,038 abstentions and 5,944,831 broker non-votes.

(c)

Ratification of the appointment of KPMG LLP as our independent registered public accounting firm for the fiscal year ending January 28, 2006.

The proposal received 38,329,840 votes for and 21,121 votes against. There were 25,102 abstentions and no broker non-votes.

ITEM 6. EXHIBITS


Exhibit
No		Description	Method of Filing
	3.1	Amended and Restated Articles of Incorporation of Wilsons The Leather Experts Inc. adopted June 16, 1998, as amended by the Articles of Amendment dated February 17, 2000, and the Articles of Amendment dated May 23, 2002. (1)	Incorporated by Reference

	3.2	Restated Bylaws of Wilsons The Leather Experts Inc. as amended June 16, 1998, January 25, 2000, May 23, 2002, and February 5, 2004. (2)	Incorporated by Reference

	4.1	Specimen of common stock certificate. (3)	Incorporated by Reference

	4.2	Registration Rights Agreement dated as of May 25, 1996, by and among CVS New York, Inc. (formerly known as Melville Corporation), Wilsons The Leather Experts Inc., the Managers listed on the signature pages thereto, Leather Investors Limited Partnership I and the Partners listed on the signature pages thereto. (4)	Incorporated by Reference

	4.3	Amendment to Registration Rights Agreement dated as of August 12, 1999, by and among Wilsons The Leather Experts Inc. and the Shareholders listed on the attachments thereto. (5)	Incorporated by Reference

	4.4	Common Stock and Warrant Purchase Agreement, dated as of April 25, 2004, by and among Wilsons The Leather Experts Inc. and the Purchasers identified on the signatory pages thereto (the “Purchase Agreement”). (6)	Incorporated by Reference

	4.5	Registration Rights Agreement, dated as of April 25, 2004, by and among Wilsons The Leather Experts Inc. and the Investors identified therein. (7)	Incorporated by Reference

	4.6	Form of Warrant issued to the Purchasers named in the Purchase Agreement on April 25, 2004. (8)	Incorporated by Reference

	10.1	Unqualified Release Agreement dated as of August 15, 2005, by and between Arthur J. Padovese and River Hills Wilsons, Inc. (9)	Incorporated by Reference

	31.1	Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer.	Electronic Transmission

	31.2	Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer.	Electronic Transmission

	32.1	Certification of Chief Executive Officer pursuant to Section 1350, Chapter 63 of Title 18, United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.	Electronic Transmission

	32.2	Certification of Chief Financial Officer pursuant to Section 1350, Chapter 63 of Title 18, United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.	Electronic Transmission

	99.1	Risk Factors Relating to Forward-Looking Statements	Electronic Transmission


1.		Incorporated by reference to the same numbered exhibit to the Company’s Report on Form 10-Q for the quarter ended May 4, 2002 (File No. 000-21543).

2.		Incorporated by reference to the same numbered exhibit to the Company’s Report on Form 10-K for the year ended January 31, 2004 (File No. 000-21543).

3.		Incorporated by reference to the same numbered exhibit to Amendment No. 1 to the Company’s Registration Statement on Form S-l (333-13967) filed with the Commission on December 24, 1996.

4.		Incorporated by reference to Exhibit 4.8 to the Company’s Registration Statement on Form S-l (333-13967) filed with the Commission on October 11, 1996.

5.		Incorporated by reference to Exhibit 4.5 to the Company’s Report on Form 10-K for the fiscal year ended January 29, 2000, filed with the Commission (File No. 000-21543).

6.		Incorporated by reference to Exhibit 4.1 to the Company’s Report on Form 8-K filed with the Commission on April 27, 2004.

7.		Incorporated by reference to Exhibit 4.2 to the Company’s Report on Form 8-K filed with the Commission on April 27, 2004.

8.		Incorporated by reference to Exhibit 4.3 to the Company’s Report on Form 8-K filed with the Commission on April 27, 2004.

9.		Incorporated by reference to the same numbered exhibit to the Company’s Report on Form 8-K filed with the Commission on August 16, 2005.

INDEX TO EXHIBITS


Exhibit
No		Description	Method of Filing
	3.1	Amended and Restated Articles of Incorporation of Wilsons The Leather Experts Inc. adopted June 16, 1998, as amended by the Articles of Amendment dated February 17, 2000, and the Articles of Amendment dated May 23, 2002. (1)	Incorporated by Reference

	3.2	Restated Bylaws of Wilsons The Leather Experts Inc. as amended June 16, 1998, January 25, 2000, May 23, 2002, and February 5, 2004. (2)	Incorporated by Reference

	4.1	Specimen of common stock certificate. (3)	Incorporated by Reference

	4.2	Registration Rights Agreement dated as of May 25, 1996, by and among CVS New York, Inc. (formerly known as Melville Corporation), Wilsons The Leather Experts Inc., the Managers listed on the signature pages thereto, Leather Investors Limited Partnership I and the Partners listed on the signature pages thereto. (4)	Incorporated by Reference

	4.3	Amendment to Registration Rights Agreement dated as of August 12, 1999, by and among Wilsons The Leather Experts Inc. and the Shareholders listed on the attachments thereto. (5)	Incorporated by Reference

	4.4	Common Stock and Warrant Purchase Agreement, dated as of April 25, 2004, by and among Wilsons The Leather Experts Inc. and the Purchasers identified on the signatory pages thereto (the “Purchase Agreement”). (6)	Incorporated by Reference

	4.5	Registration Rights Agreement, dated as of April 25, 2004, by and among Wilsons The Leather Experts Inc. and the Investors identified therein. (7)	Incorporated by Reference

	4.6	Form of Warrant issued to the Purchasers named in the Purchase Agreement on April 25, 2004. (8)	Incorporated by Reference

	10.1	Unqualified Release Agreement dated as of August 15, 2005, by and between Arthur J. Padovese and River Hills Wilsons, Inc. (9)	Incorporated by Reference

	31.1	Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer.	Electronic Transmission

	31.2	Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer.	Electronic Transmission

	32.1	Certification of Chief Executive Officer pursuant to Section 1350, Chapter 63 of Title 18, United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.	Electronic Transmission

	32.2	Certification of Chief Financial Officer pursuant to Section 1350, Chapter 63 of Title 18, United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.	Electronic Transmission

	99.1	Risk Factors Relating to Forward-Looking Statements	Electronic Transmission



1.		Incorporated by reference to the same numbered exhibit to the Company’s Report on Form 10-Q for the quarter ended May 4, 2002 (File No. 000-21543).

2.		Incorporated by reference to the same numbered exhibit to the Company’s Report on Form 10-K for the year ended January 31, 2004 (File No. 000-21543).


	Page
PART I — FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (Unaudited)
Consolidated Balance Sheets as of July 30, 2005 and January 29, 2005		3
Consolidated Statements of Operations for the three months ended July 30, 2005 and July 31, 2004		4
Consolidated Statements of Operations for the year-to-date periods ended July 30, 2005 and July 31, 2004		5
Consolidated Statements of Cash Flows for the year-to-date periods ended July 30, 2005 and July 31, 2004		6
Notes to Consolidated Financial Statements		7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		13
Item 3. Quantitative and Qualitative Disclosures About Market Risk		21
Item 4. Controls and Procedures		22
PART II — OTHER INFORMATION
Item 1. Legal Proceedings		22
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		22
Item 4. Submission of Matters to a Vote of Security Holders		22
Item 6. Exhibits		23
Signature		25
Rule 13a-14(a)/15d-14(a) Certification of CEO
Rule 13a-14(a)/15d-14(a) Certification of CFO
Certification of CEO Pursuant to Section 906
Certification of CFO Pursuant to Section 906
Risk Factors


	For the three months ended
	July 30,			July 31,
	2005			2004
NET SALES	$	58,417		$	55,330
COST OF GOODS SOLD, BUYING AND OCCUPANCY COSTS		44,989			45,636

Gross margin		13,428			9,694
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES		24,568			33,646
DEPRECIATION AND AMORTIZATION		3,581			4,539

Operating loss		(14,721	)		(28,491	)
INTEREST EXPENSE, net		683			1,953

Loss before income taxes		(15,404	)		(30,444	)
INCOME TAX BENEFIT		(1,411	)		—

Net loss	$	(13,993	)	$	(30,444	)

BASIC AND DILUTED LOSS PER SHARE:
Basic and diluted loss per share	$	(0.36	)	$	(1.14	)

Weighted average shares outstanding — basic and diluted		38,996			26,698


	For the year-to-date period ended
	July 30,			July 31,
	2005			2004
NET SALES	$	142,746		$	153,081
COST OF GOODS SOLD, BUYING AND OCCUPANCY COSTS		103,933			121,454

Gross margin		38,813			31,627
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES		49,372			61,755
DEPRECIATION AND AMORTIZATION		7,292			22,411

Operating loss		(17,851	)		(52,539	)
INTEREST EXPENSE, net		1,346			4,697

Loss before income taxes		(19,197	)		(57,236	)
INCOME TAX BENEFIT		(1,411	)		—

Net loss	$	(17,786	)	$	(57,236	)

BASIC AND DILUTED LOSS PER SHARE:
Basic and diluted loss per share	$	(0.46	)	$	(2.42	)

Weighted average shares outstanding — basic and diluted		38,949			23,693


	Weighted average		Dividend		Expected		Expected
	risk free rate		yield		lives		volatility
2005		3.9%		0.0%		4.5		69.7%
2004		3.9%		0.0%		4.8		67.1%


	For the three months ended July 31, 2004
				Restructuring
				and other
	As reported ⁽¹⁾			charges ^{(1) (2)}			As adjusted
NET SALES	$	55,330		$	—		$	55,330
COST OF GOODS SOLD, BUYING AND OCCUPANCY COSTS		45,636			(1,256	)		46,892

Gross margin		9,694			1,256			8,438
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES		33,646			9,052			24,594
DEPRECIATION AND AMORTIZATION		4,539			423			4,116

Operating loss		(28,491	)		(8,219	)		(20,272	)
INTEREST EXPENSE, net		1,953			—			1,953

Loss before income taxes		(30,444	)		(8,219	)		(22,225	)
INCOME TAX PROVISION		—			—			—

Net loss	$	(30,444	)	$	(8,219	)	$	(22,225	)

BASIC AND DILUTED LOSS PER SHARE:
Basic and diluted loss per share	$	(1.14	)	$	(0.31	)	$	(0.83	)

Weighted average shares outstanding — basic and diluted		26,698			—			26,698

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(1)		Reclassified for the presentation of certain lease accounting issues clarified by the Office of the Chief Accountant of the Securities and Exchange Commission in a letter to the American Institute of Certified Public Accountants on February 7, 2005. See Note 3, “Reclassification of financial statements.”

(2)		Includes $8.2 million related primarily to lease termination costs and asset write-offs related to store closings and other restructuring costs. See Note 4, “Reorganization and partial store liquidation.”


WILSONS THE LEATHER EXPERTS INC.

By:		/s/ Peter G. Michielutti

		Peter G. Michielutti Executive Vice President, Chief Financial Officer and Chief Operating Officer