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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

Commission file number 000-21543

WILSONS THE LEATHER EXPERTS INC.

(763) 391-4000

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   [X]   No   [  ]

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

As of September 2, 2003, there were 20,658,936 shares of common stock, $0.01 par value per share, outstanding.

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WILSONS THE LEATHER EXPERTS INC.
INDEX

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WILSONS THE LEATHER EXPERTS INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share amounts)

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

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WILSONS THE LEATHER EXPERTS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)

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

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WILSONS THE LEATHER EXPERTS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)

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

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WILSONS THE LEATHER EXPERTS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)

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

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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 August 2, 2003, Wilsons Leather operated 607 permanent retail stores located in 45 states and the District of Columbia, including 477 mall stores, 109 outlet stores and 21 airport stores. The Company, which regularly supplements its permanent mall stores with seasonal stores during its peak selling season from October through January, operated 284 seasonal stores in 2002 and plans to operate approximately 225 seasonal stores this fiscal year.

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 August 2, 2003, 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.

     As more fully described in Note 3 to the Company’s Consolidated Financial Statements in its 2002 Annual Report on Form 10-K, El Portal Group, Inc., Bentley’s Luggage Corp. and Florida Luggage Corp. (the “Travel Subsidiaries”) were liquidated during 2002 and were presented as discontinued operations effective November 19, 2002. The consolidated financial statements have been reclassified to segregate the net investment in, and the liabilities and operating results of, the Travel Subsidiaries for all prior periods presented. Prior to the liquidation, the Travel Subsidiaries were reported as a separate operating segment. See also Note 3 to the Consolidated Financial Statements (Unaudited) contained herein.

     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 accounting principles generally accepted in the United States of America, have been condensed or omitted in these interim statements pursuant to such rules and regulations. Although management believes that the accompanying disclosures are adequate to make the information presented not 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 2002 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 necessarily indicative of the results that may be expected for the fiscal year ending January 31, 2004.

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     CUMULATIVE EFFECT OF A CHANGE IN ACCOUNTING PRINCIPLE

     On February 3, 2002, new accounting rules for business combinations and accounting for goodwill and other intangibles, Statement of Financial Accounting Standards (“SFAS”) No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets, became effective for the Company. As a result and from that day forward, goodwill is no longer amortized against earnings and goodwill balances are subject to impairment review on at least an annual basis.

     Under the transitional provisions of SFAS No. 142, the Company’s goodwill related to the Travel Subsidiaries was tested for impairment during the second quarter of 2002 using a February 2, 2002 measurement date. Each of the Company’s reporting units was tested for impairment by comparing the fair value of each reporting unit with its carrying value. A reporting unit is the same as, or one level below, an operating segment. For purposes of the Company, reporting units were defined as Wilsons and the Travel Subsidiaries. Fair value was determined based on a valuation study performed by an independent third party which primarily considered the discounted cash flow method, “guideline company” (comparable companies) and similar transaction methods. As a result of the Company’s impairment test, the Company recorded a pretax impairment loss to reduce the carrying value of goodwill of the Travel Subsidiaries by $26.3 million to its implied fair value. Impairment was due to a combination of factors including acquisition price, post-acquisition capital expenditures and operating performance. The cumulative effect of this accounting change, net of a $1.7 million tax benefit, was originally reported in the Company’s Statement of Operations for the year to date period ended August 3, 2002.

     FISCAL YEAR

     Wilsons Leather’s fiscal year ends on the Saturday closest to January 31. The periods ended January 31, 2004, February 1, 2003, and February 2, 2002, are referred to herein as fiscal years 2003, 2002 and 2001, respectively.

     USE OF ESTIMATES

     The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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.

     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 August 2, 2003, and February 1, 2003, the LIFO cost of inventories approximated the first-in, first-out cost of inventories. The inventory cost includes the cost of merchandise and freight. 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 and fashion trends, current aging, current and anticipated retail markdowns and class or

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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.

     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 SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, 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.

     For stores to be closed that are under long-term leases, the Company records a liability for the future minimum lease payments and related ancillary costs, from the date of closure to the end of the remaining lease term, net of estimated cost recoveries that may be achieved through subletting properties or through favorable lease terminations, discounted using a risk-adjusted rate of interest. This liability is recorded at the time the store is closed. At August 2, 2003, and February 1, 2003, the Company had $0.3 and $0.4 million, respectively, accrued for store lease terminations.

     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 costs of goods sold, buying and occupancy costs. Revenue for gift certificate 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 (“FOB”) 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 rates is recognized in income in the period that includes the enactment date.

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     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 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):

     STOCK-BASED COMPENSATION

     As permitted by SFAS No. 123, Accounting for Stock-Based Compensation, 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, 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):

     The pro forma amounts shown above may not be indicative of the effects on reported net loss. The fair value of each option granted is estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions used for grants in 2003 and 2002:

     NEW ACCOUNTING PRONOUNCEMENTS

     In January 2003, the Financial Accounting Standards Board (“FASB”) published Interpretation No. 46, Consolidation of Variable Interest Entities, which the Company refers to as FIN 46, to clarify the conditions under which assets, liabilities and activities of another entity should be consolidated into the financial statements of a company. FIN 46 requires the consolidation of a variable interest entity (including a special purpose entity such as that utilized in an accounts receivable securitization transaction) by a company that bears the majority of the risk of loss from the variable interest entity’s activities or is entitled to receive a majority of the variable interest entity’s residual returns or both. The provisions of FIN 46 are required to be adopted in fiscal 2003. The adoption of FIN 46 has not had a material impact on the Company’s consolidated financial statements.

     In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. This statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or asset in some circumstances). Many of those instruments were previously classified as equity. The statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The Company does not currently expect that this statement will have a material impact on its consolidated financial statements.

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     In December 2002, the Emerging Issues Task Force (“EITF”) issued EITF 00-21, Revenue Arrangements with Multiple Deliverables. This issue addresses certain aspects of the accounting for arrangements under which a company will perform multiple revenue generating activities. In some arrangements, the different revenue generating activities (deliverables) are sufficiently separable, and there exists sufficient evidence of their fair values to separately account for some or all of the deliverables (that is, there are separate units of accounting). In other arrangements, some or all of the deliverables are not independently functional, or there is not sufficient evidence of their fair values to account for them separately. This issue addresses when and, if so, how an arrangement involving multiple deliverables should be divided into separate units of accounting. This issue does not change otherwise applicable revenue recognition criteria. The provisions of EITF 00-21 are effective beginning in the third quarter of 2003. The Company does not expect the adoption of EITF 00-21 to have a material impact on current revenue recognition.

3. DISCONTINUED OPERATIONS

     In November 2002, the Company liquidated the Travel Subsidiaries, which consisted of 135 stores, due to their large operating losses. In accordance with SFAS No. 144, the Travel Subsidiaries have been presented as a discontinued operation effective November 19, 2002, and the consolidated financial statements were reclassified to segregate the assets, liabilities and operating results of the Travel Subsidiaries for all periods presented.

     Beginning on November 19, 2002, and continuing through the fourth quarter of 2002, the Company liquidated the inventory and fixed assets of the Travel Subsidiaries. The Travel Subsidiaries and certain of their affiliates entered into an Agency Agreement with a joint venture comprised of Hilco Merchant Resources, LLC and Hilco Real Estate, LLC (collectively “Hilco”) to liquidate the inventory in such stores and exit the store leases. Pursuant to the Agency Agreement, Hilco paid the Company a guaranteed amount of 85% of the cost value of the inventory, subject to certain adjustments. Hilco was responsible for all expenses related to the sale. In addition, Hilco assisted in negotiations to exit certain leases.

     The following represents the summary operating results of the Travel Subsidiaries presented as discontinued operations (in thousands):

     The current assets and liabilities of the Travel Subsidiaries as of August 2, 2003, and February 1, 2003, were as follows (in thousands):

     In May 2003, the Company sold its Miami, Florida distribution center for net proceeds of $2.5 million. This facility was an asset acquired in the Bentley’s Luggage Corp. acquisition. The $2.4 million in net assets held for sale was reported as “Current assets of discontinued operations” at February 1, 2003. The net proceeds from the sale decreased cash used by discontinued operations for the period.

     The following summarizes the Travel Subsidiaries’ disposal reserve activity during the year to date period ended August 2, 2003, (in thousands):

Discontinued operations reserves

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4. OTHER COMPREHENSIVE LOSS

     The Company reports accumulated other comprehensive income (loss) as a separate item in the shareholders’ equity section of the consolidated balance sheet. Other comprehensive income (loss) consists of foreign currency translation adjustments. For the quarters ending August 2, 2003, and August 3, 2002, the amounts were de minimis.

5. LONG-TERM DEBT

     Long-term debt at August 2, 2003, and February 1, 2003, consisted of the following (in thousands):

     SENIOR NOTES

     On August 18, 1997, the Company issued $75.0 million of 11 1/4% senior notes due August 15, 2004, (the “11 1/4% Senior Notes”). Interest on the 11 1/4% Senior Notes is payable semiannually in arrears on February 15 and August 15 of each year. The Company repurchased $44.4 million of the 11 1/4% Senior Notes in the years 1998 through 2000. As of February 1, 2003, and August 2, 2003, the outstanding balance on the 11 1/4% Senior Notes was $30.6 million. The terms and conditions for these notes are more fully discussed in Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in this Form 10-Q filing.

     TERM B PROMISSORY NOTE AND REVOLVING CREDIT AGREEMENT

     General Electric Capital Corporation and a syndicate of banks have provided the Company with a senior credit facility, which was amended on April 11, 2003, that provides for borrowings of up to $205 million in aggregate principal amount, including a $25 million Term B promissory note and a $75 million letter of credit subfacility. The terms and conditions of this facility and the Term B promissory note are more fully discussed in Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in this Form 10-Q filing.

     At August 2, 2003, there were $17.2 million in borrowings under the revolver and at February 1, 2003, there were no borrowings under the revolver. At August 2, 2003, and February 1, 2003, there were $15.6 and $15.2 million in letters of credit outstanding, respectively. The Term B promissory note had a balance of $25.0 million on August 2, 2003, and February 1, 2003.

6. LEGAL PROCEEDINGS

     In January 2003, a class action was brought on behalf of current and former store managers of Wilsons Leather in California regarding their classification as exempt from overtime pay. In July 2003, the Company reached a confidential settlement of the class action through mediation, and court approval of the settlement is pending. A charge of $1.9 million related to this settlement was taken during the second quarter.

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7. SUPPLEMENTAL BALANCE SHEET INFORMATION

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

     The following discussion of the financial condition and results of operations of Wilsons The Leather Experts Inc. and wholly owned subsidiaries should be read in conjunction with our most recent audited consolidated financial statements and related notes included in our 2002 Annual Report on Form 10-K.

     The consolidated financial statements for all periods present the Travel Subsidiaries segment as discontinued operations. See Note 3 to the Consolidated Financial Statements (Unaudited) contained herein. Unless otherwise indicated, the following discussion relates only to the continuing operations of Wilsons Leather.

     OVERVIEW

     We are the leading specialty retailer of quality leather outerwear, accessories and apparel in the United States. Our multiple store formats are designed to reach a broad customer base with a superior level of customer service. Utilizing our integrated worldwide leather sourcing network and in-house design capabilities, we are consistently able to provide our customers high-quality, fashionable merchandise at attractive prices and minimize fashion risk by reacting quickly to popular and emerging fashion trends and customer preferences and rapidly replenishing fast-selling merchandise.

     We recently kicked off a creative marketing campaign called “Discover,” which is a platform to communicate the quality, value, and features of our products. This campaign, which has a four-pronged approach to build brand awareness and to communicate merchandise attributes, will reach our customers through store signage and product tags, external media such as newspaper inserts, and direct mail.

     As of August 2, 2003, we operated a total of 607 permanent retail stores located in 45 states and the District of Columbia, including 477 mall stores, 109 outlet stores and 21 airport stores. Each year we supplement our permanent stores with seasonal stores during our peak selling season, which totaled 284 in 2002. We plan to open approximately 225 seasonal stores in 2003.

     Our Wilsons Leather mall stores average approximately 2,600 total leased square feet and feature a large assortment of both classic and fashion-forward leather outerwear, accessories and apparel. Our outlet stores are operated primarily under the Wilsons Leather Outlet name, average approximately 3,900 total leased square feet, and offer a combination of clearance-priced merchandise from our mall stores, special outlet-only merchandise and key in-season goods. Our airport stores average approximately 700 total leased square feet, feature travel products as well as leather accessories, and provide us the opportunity to showcase our products and the Wilsons Leather brand to millions of potential customers each year in some of the world’s busiest airports. Our proprietary labels, including M. Julian®, Maxima®, Pelle Studio® and Wilsons Leather™, are positioned to appeal to identified customer lifestyle segments.

     Comparable store sales decreased 5.6% in the three months ended August 2, 2003, compared to an increase of 1.9% in the same period of the prior year. Comparable store sales

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decreased 2.2% in the year to date period ended August 2, 2003, compared to a 4.5% decrease in the same period of the prior year. A store is included in the comparable store sales calculation after it has been opened and operated by us for more than 52 weeks. The percentage change is computed by comparing total net sales for comparable stores as thus defined at the end of the applicable reporting period with total net sales from comparable stores for the comparable period in the prior year.

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 appears on page 22 of our Annual Report on Form 10-K for the year ended February 1, 2003. No material changes occurred to these policies in the periods covered by this report.

RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED AUGUST 2, 2003, COMPARED TO THE THREE MONTHS ENDED AUGUST 3, 2002

     Net sales decreased 5.5% to $59.8 million in the three months ended August 2, 2003, from $63.2 million in the comparable period last year. The $3.4 million sales decrease was due to reduced sales volumes, a decline in comparable store sales and the general state of the economy.

     We opened 3 stores and closed 8 stores in the three months ended August 2, 2003, compared to opening 4 stores and closing 7 stores in the comparable period last year. As of August 2, 2003, we operated 607 stores compared to 617 stores at August 3, 2002.

     Cost of goods sold, buying and occupancy costs increased to 95.0% as a percentage of net sales in 2003, from 94.1% of net sales in 2002, primarily due to a decrease in sales volume. The 0.9% increase in cost of goods sold, buying and occupancy costs as a percentage of sales represented a $2.7 million decrease in total cost as compared to 2002. This $2.7 million decrease from 2002 was due to: (1) $2.4 million in lower cost of goods sold due to both the lower sales volume and higher margin goods being sold in 2003 as compared to 2002, and (2) a $0.3 million decrease in markdowns, freight and handling costs.

     Selling, general and administrative expenses increased to $32.5 million in 2003 from $32.4 million in 2002, and increased as a percentage of net sales to 54.4% from 51.3% primarily due to a year over year sales decrease. The $0.1 million increase was primarily due to: (1) a $1.9 million charge related to the settlement of a class action, offset by (2) $1.8 million in cost savings realized due to reduced staff levels at our headquarters and continued expense control at the store level.

     Depreciation and amortization increased to $4.0 million in 2003 from $3.8 million in 2002, and increased as a percentage of net sales to 6.7% from 6.0%. The increase resulted from depreciation on a higher base of assets resulting from recent additions and from accelerated depreciation of $0.1 million of assets related to stores we plan to close later in 2003.

     As a result of the above, the operating loss increased to a net loss of $33.5 million, or 56.1% of net sales, in 2003 from a loss of $32.4 million, or 51.3% of net sales, in 2002.

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     Net interest expense increased to $2.5 million in 2003 from $2.4 million in 2002 due to higher interest rates on long-term debt and higher debt acquisition costs from refinancing, partially offset by reduced short-term borrowings.

     The income tax benefit was $14.4 million in 2003 compared to $13.9 million in 2002. The effective rate of 40% remained constant from 2002 to 2003.

     Net loss from continuing operations for 2003 was $21.6 million compared to $20.9 million in 2002.

     Loss from discontinued operations was $0.0 million in 2003 compared to $6.2 million in 2002.

RESULTS OF OPERATIONS FOR THE YEAR TO DATE PERIOD ENDED AUGUST 2, 2003, COMPARED TO THE YEAR TO DATE PERIOD ENDED AUGUST 3, 2002

     Net sales decreased 2.0% to $155.1 million in the year to date period ended August 2, 2003, from $158.3 million in the comparable period last year. The $3.2 million sales decrease was due to reduced sales volumes, a decline in comparable store sales and the general state of the economy.

     We opened 8 stores and closed 19 stores in the year to date period ended August 2, 2003, compared to opening 15 stores and closing 17 stores in the comparable period last year.

     Cost of goods sold, buying and occupancy costs increased to 86.4% as a percentage of net sales in 2003, from 83.8% of net sales in 2002, primarily due to an increase in markdowns representing 2.9% of sales. The 2.6% increase in cost of goods sold, buying and occupancy costs as a percentage of sales represented a $1.4 million increase in total cost as compared to 2002. This $1.4 million increase from 2002 was due to: (1) $4.2 million in higher markdowns to clear fall 2002 merchandise, (2) $0.4 million in higher buying and occupancy costs, resulting primarily from the sale/leaseback of the Brooklyn Park, Minnesota distribution center, which did not occur until the second quarter of 2002, (3) a $0.3 million increase in freight and handling costs, primarily due to the reallocation of clearance inventory, partially offset by (4) $3.5 million in lower cost of goods sold due to both the lower sales volume and higher margin goods being sold in 2003 as compared to 2002.

     Selling, general and administrative expenses decreased to $65.2 million in 2003 from $66.3 million in 2002, but increased as a percentage of net sales to 42.1% from 41.9%, primarily due to a year over year sales decrease. The $1.1 million decrease was primarily due to: (1) a $2.4 million decrease in store selling expenses, including but not limited to payroll expense, and (2) $1.9 million in cost savings realized due to reduced staff levels at our headquarters and continued expense control at the store level, partially offset by (3) a $1.9 million charge related to the settlement of a class action, (4) a $0.6 million increase in employee benefit costs, and (5) a $0.7 million increase in professional service fees.

     Depreciation and amortization increased to $8.3 million in 2003 from $7.6 million in 2002, and increased as a percentage of net sales to 5.4% from 4.8%. The increase resulted from depreciation on a higher base of assets resulting from recent additions and from accelerated depreciation of $0.4 million of assets related to stores we plan to close later in 2003.

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     As a result of the above, the operating loss increased to a net loss of $52.5 million, or 33.9% of net sales, in 2003 from a loss of $48.1 million, or 30.4% of net sales, in 2002.

     Net interest expense increased to $4.7 million in 2003 from $4.1 million in 2002 due to higher interest rates on long-term debt and higher debt acquisition costs, partially offset by decreased short-term borrowings.

     The income tax benefit was $22.9 million in 2003 compared to $20.9 million in 2002. The effective rate of 40% remained constant from 2002 to 2003.

     Net loss from continuing operations for 2003 was $34.3 million compared to $31.3 million in 2002.

     Loss from discontinued operations was $0.0 million in 2003 compared to $10.4 million in 2002.

     CUMULATIVE EFFECT OF A CHANGE IN ACCOUNTING PRINCIPLE

     On February 3, 2002, new accounting rules for business combinations and accounting for goodwill and other intangibles, SFAS No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets, became effective. As a result and from that day forward, goodwill is no longer amortized against earnings and goodwill balances are subject to impairment review on at least an annual basis.

     Under the transitional provisions of SFAS No. 142, our goodwill related to the Travel Subsidiaries was tested for impairment during the second quarter of 2002 using a February 2, 2002 measurement date. Each of our reporting units was tested for impairment by comparing the fair value of each reporting unit with its carrying value. A reporting unit is the same as, or one level below, an operating segment. For purposes of our company, reporting units were defined as Wilsons and the Travel Subsidiaries. Fair value was determined based on a valuation study performed by an independent third party which primarily considered the discounted cash flow method, “guideline company” (comparable companies) and similar transaction methods. As a result of the impairment test, we recorded a pretax impairment loss to reduce the carrying value of goodwill of the Travel Subsidiaries by $26.3 million to its implied fair value. Impairment was due to a combination of factors including acquisition price, post-acquisition capital expenditures and operating performance. The cumulative effect of this accounting change, net of a $1.7 million tax benefit, was originally reported in our Statement of Operations for the year to date period ended August 3, 2002.

     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 for our distribution centers. 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 business conditions, 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

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discretionary items, such as our leather products, tend to decline during recessionary periods when disposable income is lower. The general slowdown in the United States economy and the uncertain economic outlook have adversely affected consumer spending habits and 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 existing debt or to obtain additional financing. There can be no assurance that any such refinancing or additional financing 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, which was amended on April 11, 2003, that provides for borrowings of up to $205 million in aggregate principal amount, including a $25 million Term B promissory note and a $75 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;

          •     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;

          •     plus, during the months of September, October and November and the first fifteen days of December, 2003 (or until we receive our anticipated tax refund, whichever is earlier), 85% of the amount we expect to receive as a tax refund, provided that prior to the filing of our tax return, such amount cannot exceed $2 million during the first week of September, $4 million during the second week of September or $6 million at any time after the second week of September; and provided further that after we file our tax return such amount cannot exceed $15.0 million;

          •     minus $10 million ($5 million from July 2003 through December 15, 2003, and during the months of August, September, October and November of 2004 and 2005).

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; and

          •     the total borrowings (i.e. the revolving credit portion of the facility and the Term B promissory note) cannot exceed the sum of 85% of the book value of credit card receivables, plus 95% (100% during August, September and October) of the appraised value of inventory (including inventory subject to trade letters of credit) as if sold on a going-out-of business basis;

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	•		from December 31, 2003, through March 31, 2004, we must have no borrowings under the revolving credit portion of the facility and outstanding letters of credit must be no greater than $20 million;
	•		from April 1, 2004, through May 15, 2004, borrowings under the revolving credit portion of the facility must be no greater than $15 million, and outstanding letters of credit must be no greater than $20 million; and
	•		from December 31, 2004, through March 31, 2005, we must have no borrowings under the revolving credit portion of the facility and outstanding letters of credit must be no greater than $40 million.

     As of August 2, 2003, we had $17.2 million in borrowings under the revolving credit facility and no other borrowings under the senior credit facility, except for the Term B promissory note, and we had $15.6 million in outstanding letters of credit.

     Interest is payable on revolving credit borrowings at variable rates determined by LIBOR plus 3.25%, except as noted in the next sentence, or the “prime” rate plus 2.0% (commercial paper rate plus 3.25% if the loan is made under the “swing line” portion of the revolver). Borrowings in an amount that is available to us only because we have included our anticipated tax refund in determining availability will bear interest at the prime rate plus 5%. Interest is payable on the $25 million Term B promissory note at a variable rate equal to the “prime” rate plus 4%, plus an additional 5% 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. If we have any borrowings that are only available to us because we have included our anticipated tax refund in determining availability, we will pay a fee of $150,000. The senior credit facility expires in June 2005, at which time all borrowings, including the Term B promissory note, become due and payable. Prepayment of the Term B promissory note is subject to a 2% prepayment fee if prepaid on or after July 1, 2002, but on or prior to November 30, 2003, and a 1% prepayment fee thereafter. The revolving credit portion of the facility is subject to a 1% prepayment fee under most circumstances. The Term B promissory note is prepayable only with the consent of the senior lenders under the senior credit facility.

     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; prepay, repurchase or pay any principal on any 11 1/4% Senior Notes, referred to below, except pursuant to a permitted refinancing; create liens or other encumbrances; or pay cash dividends or make other distributions. We are currently in compliance with all covenants under the senior credit facility.

     The senior credit facility also contains a requirement that we either amend, refund, renew, extend or refinance the outstanding 11 1/4% Senior Notes on or before June 15, 2004, so that no principal payment with respect to any such amended, refunded, renewed, extended or refinanced notes is due on or before September 1, 2005. We are required to provide our lenders a plan for achieving such amendment, refunding, renewal, extension or refinancing by April 30, 2004. The terms of any refunded, renewed, extended or refinanced notes cannot be more burdensome than the terms of the 11 1/4% Senior Notes and the rate of interest with respect to any such notes cannot exceed the sum of the rate of interest on United States treasury obligations of like tenor at the time of such refunding, renewal, refinancing or extension plus 7% per annum.

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     We plan to use the senior credit facility for our immediate and future working capital needs. Peak borrowings typically occur from October through December and outstanding letters of credit typically peak from August through September. We are dependent on the senior credit facility to fund working capital and letter of credit needs. We believe that borrowing capacity under the senior credit facility, together with current and anticipated cash flow from operations, will be adequate to meet our working capital and capital expenditure requirements during the term of the senior credit facility, provided that we either amend, refund, renew, extend or refinance the outstanding 11 1/4% Senior Notes on or before June 15, 2004, so that no principal payment with respect to any such amended, refunded, renewed, extended or refinanced notes is due on or before September 1, 2005.

     On August 18, 1997, we completed a private offering of $75 million of 11 1/4% Senior Notes to certain institutional buyers. Interest on the 11 1/4% Senior Notes is payable semi-annually in arrears on February 15 and August 15 of each year. The 11 1/4% Senior Notes mature on August 15, 2004, and are callable after August 15, 2001, at a defined premium. The 11 1/4% Senior Notes are our general unsecured obligations and rank senior in right of payment to all of our existing and future subordinated indebtedness and rank on equal terms in right of payment with all of our other current and future unsubordinated indebtedness. During 2000 and 1999, we repurchased $13.3 million and $26.1 million, respectively, of our 11 1/4% Senior Notes. As of August 2, 2003, we had $30.6 million of our 11 1/4% Senior Notes outstanding.

     In January 2002, we sold 1,900,000 shares of common stock to an institutional investor in a private placement for a price of $11.00 per share for net proceeds of approximately $20.0 million. In April 2002, affiliates of the institutional investor exercised the option to purchase 100,000 shares of our common stock at a purchase price of $11.00 per share. The sale was completed on April 12, 2002, for net proceeds of approximately $1.0 million.

     On April 30, 2002, we sold 900,000 shares of our common stock in a private placement at a purchase price of $11.00 per share, for net proceeds of approximately $9.9 million. On June 10, 2002, the purchasers in the April private placement exercised the option to purchase an additional 100,000 shares of our common stock at a purchase price of $11.00 per share. The sale was completed on June 13, 2002, for net proceeds of approximately $1.1 million.

     On June 21, 2002, we completed a sale/leaseback transaction for our headquarters facility and distribution center in Brooklyn Park, Minnesota, for net proceeds of $12.5 million. A portion of the net proceeds from the sale/leaseback, $4.8 million, was used to pay down the Term B promissory note from $25.0 million to $20.2 million. The remainder of the proceeds was used for general corporate purposes.

     On November 4, 2002, pursuant to the First Amendment to Fourth Amended and Restated Credit Agreement with General Electric Capital Corporation and the syndicate, we reborrowed $4.8 million of the Term B promissory note, which brought the outstanding balance to $25.0 million.

     On November 19, 2002, we announced the liquidation of the stores operated by our Travel Subsidiaries, as described in Note 3 to the Consolidated Financial Statements on page F-14 of our 2002 Annual Report on Form 10-K. See also Note 3 of the Consolidated Financial Statements (Unaudited) contained herein.

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     CASH FLOW ANALYSIS

     Operating activities of continuing operations for the year to date period ended August 2, 2003, resulted in cash used of $38.4 million compared to cash used of $80.0 million in the corresponding period of 2002.

     The $38.4 million of cash used in operating activities for the year to date period ended August 2, 2003, was comprised of: (1) a $9.5 million increase in deferred income tax, (2) a net loss from continuing operations of $34.3 million, (3) a $7.5 million increase in prepaids due to timing of rent payments, an increase in prepaid insurance due to a policy renewal during the second quarter and prepaid raw leather product, (4) a $3.4 million increase in refundable/payable income taxes and other liabilities primarily due to net operating losses, including a $9.9 million tax refund, (5) a $4.9 million decrease in accrued expenses and accounts payable due to the seasonality of the business, and (6) a $0.8 million increase in accounts receivable, offset by (7) a $12.6 million decrease in inventories due to clearance sales, (8) a $9.1 million non-cash adjustment for depreciation and amortization expense, and (9) $0.5 million in cash provided by various other operating activities.

     We had $80.0 million in cash used by operating activities during the same period last year as a result of: (1) a $28.8 million increase in inventories, (2) a net loss from continuing operations of $31.3 million, (3) an $8.3 million increase in prepaid expenses due to the timing of August 2002 rent payments, and an increase in prepaid insurance due to a policy renewal during the second quarter, (4) a $21.6 million change in income taxes refundable/payable and other liabilities due to reduced income, and (5) a $5.8 million change in deferred taxes, offset by (6) $8.2 million in non-cash adjustments for depreciation and amortization and loss on disposal of assets, (7) $0.2 million in cash provided by various other operating activities, (8) a $4.7 million decrease in accounts receivable, and (9) a $2.8 million increase in accounts payable and accrued expenses.

     Investing activities of continuing operations for the year to date period ended August 2, 2003, were comprised of $4.4 million in capital expenditures and additions to other assets used primarily for the construction of new stores and the renovation of and improvements to existing stores. Investing activities during the same period last year were comprised of $4.2 million in capital expenditures and additions to other assets used primarily for the construction of new stores and the renovation of and improvements to existing stores, offset by $12.5 million in cash provided by a sale/leaseback of the headquarters facility. For 2003, capital expenditures are capped at $10.0 million.

     Cash provided by financing activities of continuing operations for the year to date period ended August 2, 2003, was $22.9 million, which was primarily $23.6 million provided by revolver financing and checks written in excess of cash balances, and $0.3 million from the issuance of common stock and exercise of stock options, partially offset by $1.0 million used for debt acquisition costs. Cash provided by financing activities during the same period last year was $52.1 million. This included $45.6 million provided by revolver financing and checks written in excess of cash balances, and $12.7 million from the issuance of common stock and exercise of stock options, offset by $4.8 million used for repayment of long-term debt, and $1.4 million used for debt acquisition costs.

     OFF-BALANCE-SHEET ARRANGEMENTS

     We have no off-balance-sheet 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.

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     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.

     RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

     In January 2003, the FASB published Interpretation No. 46, Consolidation of Variable Interest Entities, which we refer to as FIN 46, to clarify the conditions under which assets, liabilities and activities of another entity should be consolidated into the financial statements of a company. FIN 46 requires the consolidation of a variable interest entity (including a special purpose entity such as that utilized in an accounts receivable securitization transaction) by a company that bears the majority of the risk of loss from the variable interest entity’s activities or is entitled to receive a majority of the variable interest entity’s residual returns or both. The provisions of FIN 46 are required to be adopted in fiscal 2003. The adoption of FIN 46 has not had a material impact on our consolidated financial statements.

     In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. This statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or asset in some circumstances). Many of those instruments were previously classified as equity. The statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. We do not currently expect that this statement will have a material impact on our consolidated financial statements.

     In December 2002, the Emerging Issues Task Force (“EITF”) issued EITF 00-21, Revenue Arrangements with Multiple Deliverables. This issue addresses certain aspects of the accounting for arrangements under which a company will perform multiple revenue generating activities. In some arrangements, the different revenue generating activities (deliverables) are sufficiently separable, and there exists sufficient evidence of their fair values to separately account for some or all of the deliverables (that is, there are separate units of accounting). In other arrangements, some or all of the deliverables are not independently functional, or there is not sufficient evidence of their fair values to account for them separately. This issue addresses when and, if so, how an arrangement involving multiple deliverables should be divided into separate units of accounting.

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     This issue does not change otherwise applicable revenue recognition criteria. The provisions of EITF 00-21 are effective beginning in the third quarter of 2003. We do not expect the adoption of EITF 00-21 to have a material impact on current revenue recognition.