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(Mark One)

[X]	Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended October 30, 2004
[  ]	Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from  _____________     to _____________

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

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

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

As of November 27, 2004, 18,196,916 common shares were outstanding.

BROWN SHOE COMPANY, INC. CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
	(Unaudited)						(Unaudited)
	Thirteen Weeks Ended						Thirty-nine Weeks Ended
($ thousands, except per share amounts)	October 30, 2004			November 1, 2003			October 30 , 2004			November 1, 2003
Net sales	$	514,825		$	493,433		$	1,465,314		$	1,398,261
Cost of goods sold		306,782			288,721			868,661			820,557
Gross profit		208,043			204,712			596,653			577,704
Selling and administrative expenses		179,762			172,278			540,177			511,317
Operating earnings		28,281			32,434			56,476			66,387
Interest expense		1,980			2,256			6,600			7,679
Interest income		(221	)		(118	)		(517	)		(318	)
Earnings before income taxes		26,522			30,296			50,393			59,026
Income tax provision		7,702			9,096			15,192			17,267
Net earnings	$	18,820		$	21,200		$	35,201		$	41,759
Basic net earnings per common share	$	1.05		$	1.19		$	1.97		$	2.37
Diluted net earnings per common share	$	1.01		$	1.13		$	1.87		$	2.25
Dividends per common share	$	0.10		$	0.10		$	0.30		$	0.30

See notes to condensed consolidated financial statements.

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

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

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

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

Note 2.

Earnings Per Share

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

Options to purchase 387,600 and 34,921 shares of common stock for the thirteen week periods and 284,978 and 37,216 shares of common stock for the thirty-nine week periods ended October 30, 2004 and November 1, 2003, respectively, were not included in the denominator for diluted net earnings per common share because their effect would be antidilutive.
 
 

Note 3.

Comprehensive Income

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

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

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

($ thousands)	Famous Footwear			Wholesale Operations			Naturalizer Retail			Other			Totals
Thirteen Weeks Ended October 30, 2004
External sales	$	311,685		$	148,696		$	49,911		$	4,533		$	514,825
Intersegment sales		414			46,786			-			-			47,200
Operating earnings (loss)		24,802			10,375			(1,491	)		(5,405	)		28,281
Operating segment assets		359,044			188,362			79,836			148,853			776,095
Thirteen Weeks Ended November 1, 2003
External sales	$	301,588		$	140,062		$	49,789		$	1,994		$	493,433
Intersegment sales		284			35,968			-			-			36,252
Operating earnings (loss)		23,427			15,460			(166	)		(6,287	)		32,434
Operating segment assets		345,000			171,986			70,669			120,246			707,901
Thirty-nine Weeks Ended October 30, 2004
External sales	$	853,620		$	457,125		$	143,507		$	11,062		$	1,465,314
Intersegment sales		1,054			121,718			-			-			122,772
Operating earnings (loss)		49,818			32,144			(6,262	)		(19,224	)		56,476
Thirty-nine Weeks Ended November 1, 2003
External sales	$	831,634		$	418,950		$	142,296		$	5,381		$	1,398,261
Intersegment sales		693			100,718			-			-			101,411
Operating earnings (loss)		46,914			41,106			(2,534	)		(19,099	)		66,387

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

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

amounts have been reclassified to conform to the current year presentation. This reclassification had no effect on operating earnings, but resulted in a transfer of assets of $68.0 million and $47.1 million at October 30, 2004 and November 1, 2003, respectively, to the Other segment.
 
 

Note 5

Restructuring Reserves

Closure of Canadian Manufacturing Facility

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

• Severance and benefit costs for approximately 300 factory employees - $2.3 million

• Inventory markdowns to liquidate factory inventory - $1.6 million

• Cost to buy out leases prior to their normal expiration date - $0.6 million

The Company anticipates that the restructuring activities associated with the closure of the Canadian manufacturing facility will be substantially completed by the end of fiscal 2004.
 
 

Note 6.

Goodwill and Other Intangible Assets

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

The change between periods for the Naturalizer Retail segment reflects changes in the Canadian dollar exchange rate.
 
 

Note 7.

Share-Based Compensation

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

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

The Company issued 5,250 and 88,654 shares of common stock for the thirteen week periods, and 117,827 and 354,807 shares of common stock for the thirty-nine week periods, ended October 30, 2004 and November 1, 2003, respectively, for stock options exercised and restricted stock grants.

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

Note 8.

Retirement and Other Benefit Plans

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

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

In connection with the Agreement, the Company incurred approximately $1.3 million of issuance costs, which, together with remaining unamortized debt issuance costs of approximately $2.7 million associated with the original bank credit agreement, will be amortized over the five-year term of the Agreement.
 
 

Note 10.

Commitments and Contingencies

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

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

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

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

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

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

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

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

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

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

The Company is contingently liable for lease commitments of approximately $10 million in the aggregate, which primarily relate to the Cloth World and Meis specialty retailing chains, which were sold in prior years. In order for the Company to incur any liability related to these lease commitments, the current owners would have to default. At this time, the Company does not believe this is reasonably likely to occur.

ITEM 2

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

 

OVERVIEW

Overall, the Company's third quarter results were disappointing as net earnings declined from the third quarter last year in spite of an increase in net sales. Consolidated net sales rose 4.3% to $514.8 million for the third quarter of fiscal 2004, as compared to $493.4 million for the third quarter of the prior year. Net earnings were $18.8 million, or $1.01 per diluted share, for the third quarter compared to $21.2 million, or $1.13 per diluted share, for the third quarter of last year.

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

• Famous Footwear's net sales increased 3.3% to $311.7 million in the third quarter compared to $301.6 million last year. Same-store sales declined 0.4%. However, operating earnings increased to $24.8 million in the third quarter compared to $23.4 million in the third quarter of the prior year.

• Our Wholesale Operations segment's operating earnings declined in the third quarter to $10.4 million compared to $15.5 million in the third quarter last year. Operating earnings were negatively affected by continuing weakness in our children's business, lower sales of Naturalizer product, provisions for minimum royalty guarantees on license agreements, a higher provision for allowances to department store customers, an operating loss within the Bass division, and higher inventory markdowns.

• Our Naturalizer Retail operations experienced a 0.2% increase in net sales to $49.9 million in the third quarter, compared to $49.8 million in the third quarter of the prior year. Same-store sales were down 2.8% for the quarter, reflecting overall retail weakness. As a result, we incurred an operating loss of $1.5 million in the third quarter compared to an operating loss of $0.2 million in the third quarter of the prior year.

• As a result of our lower earnings in the third quarter, compensation costs associated with stock-based and incentive compensation plans were $8.6 million lower than last year's third quarter.

• We maintained our strong balance sheet position. Inventories at quarter-end are $410.0 million, up from $376.6 million last year due to additional stores at Famous Footwear, higher Dr. Scholl's inventory and the addition of Bass. Our current ratio, the relationship of current assets to current liabilities, increased to 2.3 to 1 from 2.2 to 1 at year end and at the end of the third quarter of last year. Our debt-to-capital ratio, the ratio of our debt obligations to the sum of our debt obligations and shareholders' equity, at the end of the quarter increased to 26.9% from 25.8% at the end of the year-ago quarter.

CONSOLIDATED RESULTS

 

Net Sales
Net sales increased $21.4 million, or 4.3%, to $514.8 million in the third quarter of 2004 as compared to $493.4 million in the third quarter of the prior year. This increase is primarily attributable to a $10.1 million increase at Famous Footwear and the acquisition of the Bass footwear license at the beginning of fiscal 2004.

Net sales increased $67.0 million, or 4.8%, to $1,465.3 million in the first nine months of 2004 as compared to $1,398.3 million in the first nine months of the prior year. The increase is primarily attributable to the acquisition of the Bass footwear license at the beginning of 2004, which contributed over one half of the increase. In addition, the net sales improvement was driven by sales gains within our Santana and LifeStride lines and from new Famous Footwear stores.

Gross Profit
Gross profit increased $3.3 million, or 1.6%, to $208.0 million for the third quarter of 2004 as compared to $204.7 million in the third quarter of the prior year. As a percent of net sales, our gross profit rate decreased to 40.4% in the third quarter from 41.5% in the third quarter of the prior year as a result of more aggressive promotions and pricing at Famous Footwear to capture more sales during the critical back-to-school period, higher provisions for allowances to our department store customers, and higher inventory markdowns in our wholesale operations.

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

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

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

costs related to the Bass footwear line of approximately $5.1 million, increased selling and administrative costs associated with the Bass footwear line, and our ongoing investments in talent, systems and infrastructure intended to position the Company for future growth. Offsetting these factors were benefits from reduced compensation costs associated with stock-based and incentive compensation plans of $9.7 million compared to last year.

Interest Expense
Interest expense decreased $0.2 million, or 12.2%, to $2.0 million in the third quarter as compared to $2.2 million in the third quarter of the prior year. The decrease in interest expense is due to lower interest rates. On July 21, 2004, the Company amended and restated its credit agreement, which resulted in more favorable interest rates during the third quarter.

Interest expense decreased $1.1 million, or 14.1%, to $6.6 million in the first nine months of 2004 as compared to $7.7 million in the first nine months of the prior year due to more favorable interest rates.

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

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

FAMOUS FOOTWEAR

Net Sales
Net sales increased $10.1 million, or 3.3%, to $311.7 million in the third quarter of 2004 as compared to $301.6 million in the third quarter of the prior year. This increase is attributable to higher sales from new stores, offset by a modest same-store sales decline of 0.4% reflecting lower traffic counts. During the third quarter of 2004, we opened 16 new stores and closed

17, resulting in 914 stores at the end of the third quarter as compared to 908 at the end of the third quarter of the prior year. Sales per square foot were $49, up slightly from $48 in the year ago period.

Net sales increased $22.0 million, or 2.6%, to $853.6 million in the first nine months of 2004 as compared to $831.6 million in the first nine months of the prior year. While same-store sales for the first nine months of 2004 were down 0.2% compared to the first nine months of the prior year, sales from net new stores totaled $23.3 million. We opened 54 new stores and closed 33 during the first nine months of 2004, resulting in 914 stores at the end of the third quarter.

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

Gross Profit
Gross profit increased $3.0 million, or 2.3%, to $137.1 million in the third quarter of 2004 as compared to $134.1 million in the third quarter of the prior year. As a percentage of net sales, there was a slight decrease in the gross profit rate to 44.0% in the third quarter of 2004 from 44.4% in the third quarter of the prior year. This decline was due to more aggressive promotions used to drive sales during the critical back-to-school period.

Gross profit increased $10.8 million, or 2.9%, to $379.9 million in the first nine months of 2004 as compared to $369.1 million in the first nine months of the prior year. The gross profit increase of 2.9% is primarily attributed to the 2.6% increase in net sales. As a percent of net sales, our gross profit rate increased slightly to 44.5% in the first nine months of 2004 as compared to 44.4% in the first nine months of the prior year.

Selling and Administrative Expenses
Selling and administrative expenses increased $1.6 million, or 1.5%, to $112.3 million for the third quarter of 2004 as compared to $110.7 million in the third quarter of the prior year. This increase is primarily attributable to increased marketing costs, partially offset by reduced compensation costs associated with stock-based and incentive compensation plans. As a percentage of net sales, selling and administrative costs decreased to 36.0% from 36.6% last year as the division tightly controlled expenses.

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

Operating Earnings
Operating earnings increased $1.4 million, or 5.9%, to $24.8 million for the third quarter of 2004 as compared to $23.4 million in the third quarter of the prior year. This increase was driven by the $10.1 million increase in net sales, partially offset by the decline in the gross profit rate.

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

NATURALIZER RETAIL

Net Sales
Net sales increased $0.1 million, or 0.2%, to $49.9 million in the third quarter of 2004 as compared to $49.8 million in the third quarter of the prior year. The favorable impact of the Canadian exchange rate improved net sales by $1.0 million, but was offset by a same-store sales decline of 2.8%. For our Canadian stores, same-store sales increased 2.4%, while domestic stores experienced a same-store decline of 5.7%. During the third quarter of 2004, we opened 4 new stores and closed 3 resulting in 381 stores at the end of the third quarter of 2004 as compared to 383 at the end of the third quarter of the prior year. Sales per square foot declined to $81 from $85 in the year ago period.

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

Gross Profit
Gross profit decreased $0.3 million, or 1.2%, to $23.9 million in the third quarter of 2004 as compared to $24.2 million in the third quarter of the prior year. As a percentage of net sales, our gross profit rate declined to 47.9% in the third quarter from 48.6% in the year ago quarter. This decline was driven by lower initial markups resulting from more promotional pricing.

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

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

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

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

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

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

WHOLESALE OPERATIONS

Net Sales
Net sales increased $8.6 million, or 6.2%, to $148.7 million in the third quarter of 2004 as compared to $140.1 million in the third quarter of the prior year, due primarily to sales of Bass footwear. The division also experienced an increase of 20.6% in its Mens & Athletics business and an increase of 19.4% in its Lifestride business as compared to the year ago quarter. These increases were offset by continued weakness in the Children's division, which declined 19.0%, and the Naturalizer business, which declined 9.8%, as compared to the year ago quarter.

Net sales increased $38.1 million, or 9.1%, to $457.1 million in the first nine months of 2004 as compared to $419.0 million in the first nine months of the prior year. This increase was primarily due to sales of Bass footwear. In addition, we have experienced solid sales gains in our Lifestride and Mens & Athletics businesses. Our Lifestride business has increased by 11.1% and our Men's and Athletics' business has posted a 4.6% sales gain. Offsetting these increases were weakness in our

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

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

Gross profit increased $5.9 million, or 4.3%, to $143.7 million in the first nine months of 2004 as compared to $137.8 million in the first nine months of the prior year. As a percent of net sales, our gross profit rate decreased to 31.4% in the first nine months of 2004 as compared to 32.9% in the first nine months of the prior year. The decline in our gross profit rate is principally due to higher allowances granted to our department store customers.

Selling and Administrative Expenses
Selling and administrative expenses increased $4.5 million, or 15.1%, to $34.4 million for the third quarter of 2004 as compared to $29.9 million in the third quarter of the prior year, due primarily to increased selling and administrative costs associated with the Bass footwear line. Excluding costs associated with Bass marketing, marketing costs increased $2.0 million compared to the third quarter last year. Partially offsetting these increases were benefits from reduced compensation costs associated with stock-based and incentive compensation plans.

Selling and administrative expenses increased $14.9 million, or 15.4%, to $111.6 million in the first nine months of 2004 as compared to $96.7 million in the first nine months of the prior year. This increase is due to transition and assimilation costs related to the Bass footwear line of approximately $5.1 million and increased selling and administrative costs associated with the Bass footwear line. Partially offsetting these factors were benefits from reduced compensation costs associated with stock-based and incentive compensation plans.

Operating Earnings
Operating earnings decreased $5.1 million, or 32.9%, to $10.4 million for the third quarter of 2004 as compared to $15.5 million in the third quarter of the prior year. This decrease is due to weakness in our Children's and Naturalizer products, lower gross profit rates and the operating loss within the Bass division.

Operating earnings decreased $9.0 million, or 21.8%, to $32.1 million in the first nine months of 2004 as compared to $41.1 million in the first nine months of the prior year. This decrease is due to weakness in our Children's and Naturalizer businesses, Bass transition and assimilation costs and the operating loss within the Bass division.
 
 

OTHER SEGMENT

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

Net Sales
Net sales of Shoes.com increased $2.5 million to $4.5 million in the third quarter of 2004 as compared to $2.0 million in the third quarter of the prior year. Net sales increased $5.7 million to $11.1 million in the first nine months of 2004 as compared to $5.4 million in the first nine months of the prior year. This increase reflects continuing strong sales growth due to increased Web site traffic and improved conversion rates.

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

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

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

LIQUIDITY AND CAPITAL RESOURCES

Borrowings