SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

Commission file number 000-21543

Wilsons The Leather Experts Inc.

(Exact name of registrant as specified in its charter)

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

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

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

Common stock, $.01 par value

(Title of Class)

     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 þ         No o

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

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

     The aggregate market value of the voting common equity held by non-affiliates of the registrant was $87,273,366 based on the closing sale price for the common stock on the last business day of the registrant’s most recently completed second fiscal quarter as reported by the Nasdaq National Market. For purposes of determining such aggregate market value, all executive officers and directors of the registrant are considered to be affiliates of the registrant. This number is provided only for the purpose of this report on Form 10-K and does not represent an admission by either the registrant or any such person as to the status of such person.

     The number of shares outstanding of the registrant’s common stock, $.01 par value, was 38,895,464 at April 4, 2005.

DOCUMENTS INCORPORATED BY REFERENCE

     Portions of the definitive Proxy Statement of Wilsons The Leather Experts Inc. for the Annual Meeting of Shareholders to be held on June 2, 2005 (the “Proxy Statement”), which will be filed within 120 days after the registrant’s fiscal year ended January 29, 2005, are incorporated by reference into Part III of this Annual Report on Form 10-K (“Form 10-K”). The Compensation Committee Report, the Audit Committee Report, and the stock performance graph contained in the registrant’s Proxy Statement are expressly not incorporated by reference in this Form 10-K.

WILSONS THE LEATHER EXPERTS INC.

FORM 10-K

For the fiscal year ended January 29, 2005

TABLE OF CONTENTS

PART I

      When we refer to “we,” “our,” “us” or “Wilsons Leather,” we mean Wilsons The Leather Experts Inc. and its subsidiaries, including its predecessor companies. Unless otherwise indicated, references to our fiscal year mean the year ended on the Saturday closest to January 31. The periods that will end or have ended on January 28, 2006, January 29, 2005, January 31, 2004, February 1, 2003, February 2, 2002, and February 3, 2001, are referred to herein as 2005, 2004, 2003, 2002, 2001, and 2000, respectively. The year ended February 3, 2001, consisted of 53 weeks as compared to 52 weeks for all other years presented in this Form 10-K.

Disclosure Regarding Forward-Looking Statements

      The information presented in this Form 10-K under the headings “Item 1. Business” and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” contains certain forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Such forward-looking statements are based on the beliefs of our management as well as on assumptions made by and information currently available to us at the time such statements were made and relate to, among other things, expected demand for our products, financing requirements, merchandising strategy, capital expenditures, store operations, new store internal rate of return and competition. Although we believe these statements are reasonable, readers of this Form 10-K should be aware that actual results could differ materially from those projected by such forward-looking statements as a result of a number of factors, many of which are outside of our control, including those set forth under “—Risk Factors,” beginning on page 11 of this Form 10-K. Readers of this Form 10-K should consider carefully the factors listed under “—Risk Factors,” as well as the other information and data contained in this Form 10-K. All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements set forth under “—Risk Factors” in this section. The words “anticipate,” “believe,” “estimate,” “expect,” “intend,” “plan,” “target,” “may,” “will,” “project,” “should,” “continue” and similar expressions or the negative thereof, as they relate to us, are intended to identify such forward-looking statements. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

Overview

      We are the leading specialty retailer of quality leather outerwear, accessories and apparel in the United States. Our multi-channel store locations are designed to target a broad customer base with a superior level of customer service. Through our worldwide leather sourcing network and in-house design capabilities, we are able to consistently provide our customers with quality, fashionable merchandise at attractive prices. Our business structure results in shorter lead times, allowing us to react quickly to popular and emerging fashion trends and customer preferences, rapidly replenish fast-selling merchandise and minimize fashion risk.

      As of January 29, 2005, we operated a total of 436 stores located in 45 states, including 311 mall stores, 109 outlet stores and 16 airport locations. Each year we supplement our permanent stores with temporary seasonal stores during our peak selling season, which totaled 102 in 2004. Our mall stores average approximately 2,600 total leased square feet and feature a large assortment of classic and contemporary leather outerwear, accessories and apparel. Our outlet stores operated primarily under the Wilsons Leather Outlet^tm name, average approximately 4,000 total leased square feet and offer a combination of clearance 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-related 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 busiest airports in the United States.

Financial Strategy

      Our financial strategy for the next year is to increase sales and margins by enhancing the productivity of our existing store base, to continue to strengthen our overall capital position by reducing our costs and working capital needs and to maintain an appropriate financial structure, which was established in 2004. Key elements of implementing this strategy include:

      Increase Sales and Margins. We are employing aggressive marketing strategies and targeted advertising to build customer urgency, drive foot traffic into our stores, generate sales and establish Wilsons Leather as a shopping destination. We believe that reinvigorating our mall store business remains both our biggest near-term challenge and our best opportunity to maximize profitability. Additionally, we are implementing targeted promotional activities to ensure our pricing is competitive, while maintaining acceptable margin levels through obtaining lower initial product costs, increasing opportunistic purchases, and selectively increasing average unit retail prices where and when appropriate. Finally, we will continue to focus our efforts on increasing our growing accessories business and ensuring our men’s and women’s garments appeal to our targeted customer base.

      Improve Balance Sheet and Enhance Cash Position. We are focused on conserving cash through tight expense controls throughout the organization, maintaining a lean corporate headquarters organization, improving inventory management and limiting new store growth until we improve the profitability of our existing store base. Capital expenditures for 2005 are capped at $10.0 million, with the majority of the funds being allocated to certain lease-required store remodels and investments in fixtures to further drive our accessories business.

      Maintain Rational Store Count. We had a net reduction of 24 stores in 2004, following a net reduction of 158 stores in 2003, including the 111 liquidation stores discussed in “—Reorganization and Partial Store Liquidation” below. In 2005, we plan to open five stores (primarily outlets) where we have pre-existing commitments and close approximately 15 additional locations (primarily related to natural lease terminations) for a net reduction of 10 stores. In 2005 and beyond, we will continue to analyze our store profitability on a market-by-market basis and work to close underperforming stores to minimize our financial risk.

      During the last three years, in support of our overall financial strategy, the following three major actions were taken: 1) we discontinued operations for the Travel Subsidiaries, 2) we conducted a reorganization and partial store liquidation, and 3) we obtained additional financing.

Discontinued Operations

      In October 2000, we acquired the El Portal Group, Inc. (“El Portal”), a specialty retailer of premium travel products and accessories with 38 stores based in Las Vegas, Nevada. In April 2001, we acquired Bentley’s Luggage Corp., including its subsidiary, Florida Luggage Corp. (collectively “Bentley’s”), a specialty retailer of travel products with 106 stores based in Miami, Florida. We operated these two chains for 24 and 19 months, respectively, with unsatisfactory financial results and, as a result, on November 19, 2002, we announced the liquidation of all 135 stores operated by El Portal and Bentley’s (the “Travel Subsidiaries”). The Travel Subsidiaries business is classified as discontinued operations in our consolidated financial statements and in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Fiscal years 2001 and 2000 were reclassified to present discontinued operations for the Travel Subsidiaries.

Reorganization and Partial Store Liquidation

      On January 22, 2004, we announced that we would liquidate up to 100 underperforming mall and outlet stores (subsequently revised to 111 stores— the “liquidation stores”) and eliminate approximately 950 store-related positions. We retained a third party liquidator and real estate firm to assist in this process. The liquidation stores were selected based on strategic criteria, including negative sales and earnings trends, projected real estate costs, location, and financial conditions within the market. In addition, we announced the

elimination of approximately 70 positions at our corporate headquarters in Brooklyn Park, Minnesota and our distribution center in Las Vegas, Nevada and the closure of our distribution center in Las Vegas, Nevada.

      For these actions we incurred charges related to the restructuring and partial store liquidation of $27.4 million and $8.6 million, during 2004 and 2003, respectively. These charges were primarily related to the transfer of inventory to an independent liquidator in conjunction with the closing of the liquidation stores, lease termination costs, accelerated depreciation, asset write-offs related to store closings, severance, including payments under our agreements with David L. Rogers and Joel N. Waller, performance bonuses due former officers of the Company, retention bonuses, and other restructuring costs. In 2004, $17.4 million of these charges were recorded in selling, general and administrative expenses and $13.8 million of these charges were recorded in depreciation and amortization, and were partially offset by $3.8 million of gross margin earned on the liquidation sales. In 2003, $2.8 million of these charges were recorded in selling, general and administrative expenses and $2.3 million of these charges were recorded in depreciation and amortization, in addition to the $3.5 million gross margin loss realized on the liquidation sales. The liquidation sales were completed in April 2004, and as of May 1, 2004, all the liquidation stores had been closed. As of October 30, 2004, we had successfully negotiated all of the lease terminations. The overall net cash outlay for the restructuring costs was slightly negative.

Additional Financing

      On April 25, 2004, we entered into an agreement to issue 17,948,718 shares of our common stock (the “Equity Financing”) to three institutional investors at a price of $1.95 per share. The transaction closed on July 2, 2004, with gross proceeds before offering expenses of $35.0 million. As additional consideration for the investors’ commitment, on April 25, 2004, we issued two million warrants exercisable for five years to the investors upon signing the Equity Financing agreement, and at closing issued an additional two million warrants exercisable for five years, all at an exercise price of $3.00 per share of common stock. On July 9, 2004, we repurchased $22.0 million of the 11¹/4% Senior Notes due August 15, 2004 (the “11¹/4% Senior Notes”) with proceeds from the Equity Financing and used $8.6 million of the proceeds from the Equity Financing to repay the balance of the 11¹/4% Senior Notes at maturity. The balance of the proceeds has been used for general working capital purposes.

      General Electric Capital Corporation and a syndicate of banks have provided us with a senior credit facility, which was amended on November 1, 2002, January 31, 2003, April 11, 2003, January 21, 2004, April 15, 2004, April 27, 2004, March 2, 2005, and April 4, 2005, that provides for borrowings of up to $150.0 million in aggregate principal amount, including a $25.0 million Term B promissory note and a $75.0 million letter of credit subfacility. We prepaid $5.0 million of the Term B promissory note with no pre-payment penalty on March 3, 2005. With the completion of the Equity Financing described above, and the subsequent repayment of the 11¹/4% Senior Notes in full at maturity, the senior credit facility expiration date was extended to June 28, 2008, at which time all borrowings, including the Term B promissory note, will become due and payable.

Merchandise Strategy

      The elements of our merchandise strategy combine to create an assortment of products that appeal to consumers from a broad range of socio-economic, demographic and cultural profiles. We perform internal market research at least annually, and we will continue to survey our current and potential customers each year to update our customer demographics. We believe that our strategy will continue to position us as the leading specialty retailer of quality leather outerwear, accessories and apparel and strengthen our brand position. The principal elements of our merchandise strategy include:

      Increase the Merchandising of Accessories. We are focused on continuing to increase the penetration of our accessories business within our retail concepts with an added emphasis on handbags. To support our objective of generating demand and sales throughout the year, we have expanded the accessories assortment in our stores. Through the development of new product styles and other merchandising activities, we plan to utilize accessories as an additional way of attracting more female customers into our stores. These products

complement our outerwear and apparel selection and lead to higher “add-on” sales. Our accessories business has proven to be less seasonal and has grown into the largest segment of our business. We believe that further increasing our accessories business will offer us an opportunity to limit the risk inherent in our business and reduce our seasonality.

      Grow Brand Recognition. Our goal is to promote the Wilsons Leather brand through a variety of in-store visual presentations at our national network of stores, newspaper advertising, direct mail promotions and our e-commerce site. Reflecting our strength as a mass-market retailer, we are expanding the power of the Wilsons Leather brand by focusing our marketing and merchandising on both classic and colorful fashion-forward styles designed to reach a much broader market. We will continue to market to our customers’ ethnic backgrounds, ages, income levels and fashion requirements.

      Optimize Merchandise Assortment. We are currently evaluating our merchandise assortment to optimize our mix and price points. We continue to utilize our outlet channel to more effectively clear mall merchandise in order to keep our mall stores fresh and up to date. We will rebalance our focus on fashion versus basic. During 2004, we over-responded to trends in color and fashion during the fourth quarter holiday selling season. We have learned that we have different customers during different times of the year (with the holiday selling season tending to be more basic) and we will plan and execute accordingly.

      Target Core Customer Base. Our primary focus this past year was to tailor our price points and varieties of merchandise to grow with customers throughout their lives. We target customers ages 18 to 37, and we are working to ensure that our stores are assorted with the products they want. Our market research indicated that the median age of our high-potential, high-volume core customer is 28 years of age. We are intensifying our efforts to improve our customer focus and rebuild consumer loyalty by delivering fashion-right leather merchandise that fits the lifestyle needs of our customers at prices they find attractive.

      Capitalize on Worldwide Sourcing Network. We are able to leverage our worldwide sourcing network to benefit our stores. Our staff of in-house designers combines industry experience with the latest fashion trends to produce product lines that are both classic and fashion-forward. We have established strong relationships with suppliers globally and our design team works closely with our suppliers to ensure seamless development of leather styles, colors and finishes. We have a staff of 45 professionals in Asia and the sub-continent, South America, and Europe to ensure that our designs are manufactured quickly with consistent, quality standards. We believe that our control of design and sourcing results in shorter lead times than our competitors’, reducing inventory requirements and fashion risk and permitting in-season reorders.

      Pursue Multiple Store Formats. Our distribution network of multiple store formats allows us to specifically tailor our stores with a wide selection of merchandise at multiple price points and to optimize raw materials usage, inventory flow and sales across all channels. We operate our stores in malls, outlet centers, airports, and on an e-commerce site. We believe we are creating a new level of excitement throughout our mall stores, creatively using marketing and promotions, and making sure that we have the optimal leather merchandise assortment in our mall stores. Our outlet stores enable us to effectively manage inventories, drive year-round sales, extend our brand and build our customer base. We also operate temporary seasonal stores in malls during our peak selling season to complement our existing store base. These seasonal stores provide us with opportunities to drive incremental sales, test new markets and further strengthen the Wilsons Leather brand nationally. In the future, we plan to evaluate and test new growth vehicles, compatible new store concepts and new product offerings.

Product Design and Merchandising

      Our mission is to tailor our merchandising to a targeted customer base by offering a broad selection of quality merchandise at attractive prices. We offer approximately 3,400 styles of leather outerwear, accessories, and apparel throughout our stores. The accessories consist primarily of gloves, handbags, wallets, briefcases, computer cases, planners and belts. Our merchandising staff, including buyers and designers, continually monitors emerging trends and changing consumer preferences and utilizes information provided by our customers to ensure that we maintain a consistent and up-to-date selection of products. To further minimize our inventory risk and maximize our sales performance, our merchandising team utilizes our flexible

merchandise management information system to test new merchandise in many of our stores before making large commitments and purchase orders with our suppliers.

      We believe that our integrated worldwide sourcing and in-house design capabilities enable us to gain numerous competitive advantages. As new market trends are identified, we make merchandise design decisions to ensure that key features of fashion merchandise are incorporated in future designs. Our in-house design staff will create and develop designs to ensure a consistent quality, theme and image. As part of the design process, we also consider the anticipated retail prices and profit margins of the merchandise, the availability of leather and raw materials and the capabilities of the factories that will manufacture the merchandise.

      Some key elements for merchandising our stores include:

      We believe that the name and reputation of the Wilsons Leather brand assures customers they are purchasing quality and fashionable merchandise. Approximately 90.0% of the merchandise in our stores is designed and sold under our proprietary labels: M. Julian®, Maxima®, Pelle Studio® and Wilsons Leather^tm. We additionally offer a limited selection of other designer brands such as Kenneth Cole® and Andrew Marc® in our stores to highlight the value of our proprietary labels.

      The following table sets forth the percentages of net sales by major merchandise category from 2002 to 2004:

Sourcing and Quality Assurance

      We have developed strong and long-standing relationships with our manufacturers and tanneries. In 2004, approximately 84.0% of our leather garments and accessories were manufactured by over 70 independently owned manufacturing facilities throughout Asia and India. Our relationships, coupled with our significant purchasing power, enable us to achieve economies of scale and ensure that we can consistently maintain our quality and obtain sufficient manufacturing capacity when needed.

      We believe that our extensive knowledge of the world’s leather markets is critical in mitigating price fluctuations in the cost of raw leather during times of high volatility. While we do not normally obtain possession of a significant level of raw material, we assist tanneries and factories in sourcing raw material from all over the world, ensuring broad access to the marketplace. However, from time to time we purchase supplies of leather to take advantage of market opportunities to ensure reserves of quality materials at acceptable prices. Raw leather is primarily sourced in Italy and South Korea, with additional product sourced from South America, Australia, China and New Zealand. Our buying strategies, coupled with our expertise in leather development, enable us to purchase entire lots of raw leather and use varying grades of raw leather in different products, providing us with significant price advantages.

      Our sourcing infrastructure and strong relationships with our suppliers allow us to effectively control merchandise production without owning manufacturing facilities. Our designers and buyers work closely with our sourcing team to identify and develop leather styles, colors and finishes. We have a staff of 45 professionals located in China, India, Hong Kong, South Korea, and South America who are primarily responsible for overseeing the production and quality assurance process in overseas factories and are supervised by the sourcing team at our corporate headquarters. Their responsibilities include inspecting leather at the tanneries, coordinating the production capacity, matching product samples to our technical specifications, and providing technical assistance and quality assurance through inspection in the factories.

      Our merchandising department works closely with our overseas personnel to coordinate order fulfillment. We have consistently maintained our merchandise production cycle at approximately 90 days. We believe this production cycle is shorter than that of our competitors and allows us to better control our production needs and reorder faster-selling merchandise during our peak selling season. We believe that this strategy results in more effective and efficient inventory management and gives us the ability to manage production as the business climate changes, thus reducing our need for markdowns on merchandise at the end of our peak selling season.

Store Formats and Locations

      As of January 29, 2005, we operated 436 retail stores located in 45 states, including 311 mall stores, 109 outlet stores and 16 airport locations. We regularly supplement our permanent mall stores with temporary seasonal stores during our peak selling season. Between October 2004 and January 2005, we operated 102 seasonal stores.

      Our e-commerce site at www.wilsonsleather.com offers leather outerwear, accessories and apparel, as well as company background and financial information.

      Store Locations as of January 29, 2005:

      Site Selection for Store Openings and Closings. We use a detailed process to identify favorable store locations in existing or new markets. Within each targeted market, we identify potential sites for new and replacement stores by evaluating market dynamics. Our site selection criteria include:

      Our cross-functional review committee approves proposed store projects, including new sites and lease renewals. We periodically evaluate our stores to assess the needs for remodeling or the timing of possible closure based on economic factors. We use our knowledge of market areas and rely upon the familiarity of our name and our national reputation with landlords to enhance our ability to obtain prime store locations and negotiate favorable lease terms. In 2005, we plan to open five stores (primarily outlets) and close approximately 15 stores (primarily related to natural lease terminations).

      We maintain a dedicated staff with extensive experience in opening and closing our temporary seasonal stores, which we leverage in our other concepts. Once a seasonal store site is selected and the lease is executed, we are usually able to open a store within three days.

      Our real estate, store planning and executive management teams analyze the performance and profitability of our stores and markets to assess the potential for new and replacement stores and to identify underperforming stores. We estimate that our average net investment in our permanent mall stores is approximately $378,000 and approximately $355,000 for our outlet stores, including inventory and capital investment and excluding any landlord compensation, which is recorded as deferred rent. In 2005, we expect new stores to generate a three-year internal rate of return of approximately 15% and have an average discounted cash payback period of two to three years. We cannot ensure that our future store openings will meet these expectations.

      The following chart highlights the number of stores, by format, opened or closed in each of the last three years:

      Mall Stores. We operated 311 permanent mall stores as of January 29, 2005, in 43 states. Our mall stores showcase a full range of leather outerwear, accessories and apparel primarily under our proprietary labels. These stores average approximately 2,600 total leased square feet and are located in all types of

shopping malls, serving diverse demographics. A typical mall store will carry a selection of approximately 1,400 different styles of our merchandise.

      We further supplement our permanent mall stores with temporary seasonal stores to better capitalize on our peak selling season. In 2004, we operated 101 seasonal mall stores. We plan to operate approximately 125 seasonal mall stores in 2005. Our temporary seasonal stores provide us the opportunity to test prospective mall locations and are generally located in malls where there is not a permanent store. A typical seasonal store will carry approximately 1,800 styles of our merchandise.

      Outlet Stores. Our 109 outlet stores are located in 36 states and operate under the names Wilsons Leather Outlet^tm and The Wallet Works^tm. To maintain brand image, we generally locate outlet stores in large outlet centers in areas away from our permanent mall stores. Our Wilsons Leather Outlet stores offer clearance items and special outlet-only merchandise as well as certain key in-season products. Wilsons Leather Outlet stores average approximately 4,000 total leased square feet and generally carry approximately 2,600 styles of merchandise. Our Wallet Works stores average 1,400 square feet and carry mainly accessories. We currently operate two Wallet Works stores. We operated one seasonal outlet store during 2004 and do not plan to operate any seasonal outlet stores in 2005.

      Airport Stores. We launched our airport stores in an effort to showcase our Wilsons Leather brand and accessories. Our 16 airport stores play an instrumental role in growing brand awareness and showcasing our products to millions of travelers who pass by our airport stores each year. These stores average approximately 700 total leased square feet and carry approximately 950 of our best-selling styles, primarily accessories.

      e-commerce. Our e-commerce site “www.wilsonsleather.com” offers an extension of our store experience and is intended to increase brand awareness, strengthen the relationship with our customers, make our merchandise more accessible to our customers and facilitate cross-marketing with our stores. We are also using e-mail as a means of reaching out to our customers. The e-commerce site features key in-season merchandise as well as promotional merchandise and has been revamped to decrease the cost structure and improve customer service. In 2004, we had 3.1 million visitors at our www.wilsonsleather.com e-commerce site, compared to 2.5 million in 2003, and we achieved $4.2 million in on-line sales, which equates to an essentially flat year-over-year comparison. We plan to continue to invest prudently in the development and maintenance of our on-line presence, with the Internet serving as an additional shopping format for our customers, as well as a vehicle for building brand awareness. During 2004, we out-sourced the administration and marketing of our e-commerce site to a third party vendor who performs similar services for other specialty retailers.

      Store Operations. Our store operations are organized by region. The mall, outlet and airport stores are divided into four regions, with each region subdivided into districts. Each district manager is responsible for anywhere from 8 to 17 stores. Individual stores are staffed by a manager, an assistant manager, and a complement of full- and part-time sales associates whose numbers fluctuate based upon expected and actual sales. A typical store manager has an average of four years experience with our company. Store managers are responsible for sales and other operations including hiring and associate training, visual display and inventory control. All other aspects of store operations are administered centrally by our corporate offices. Temporary seasonal stores have a dedicated staff with the same responsibilities as the staff of our permanent stores. Temporary seasonal stores also provide an opportunity to develop and assess the skills of associates being considered for future permanent store management positions.

      A core aspect of our corporate culture is to focus on employee training and customer service. We emphasize sales associate training to ensure each associate has knowledge of our merchandise and the customer segments that the various labels are designed to serve. Our associates receive ongoing training in the unique properties of leather, the appropriate methods of care for the various leather finishes and the product specifications and details of our merchandise. In addition, we train associates to perform minor repairs in the store for customers free of charge.

      We regularly evaluate our customer service performance through customer comment cards, direct surveys of customers who return merchandise and mall intercept and telephone interview surveys. We also

periodically conduct customer focus groups. Issues relating to policy, procedure or merchandise are frequently reviewed to improve service and quality.

Distribution

      Merchandise for our stores is shipped directly from merchandise vendors or overseas manufacturers to our distribution center located in Brooklyn Park, Minnesota and, until it was closed in January 2004, our distribution center in Las Vegas, Nevada. We are party to a 15-year operating lease, with a five-year option to extend, for our 289,000 square-foot distribution center in Brooklyn Park, Minnesota that is equipped with automated garment-sorting equipment and hand-held radio frequency scanners for rapid bar code scanning and enhanced merchandise control. Approximately 30% of the merchandise received in the distribution center is immediately sent to our stores through cross-docking, which allows for minimal handling and storage. Additional merchandise is stored in the distribution center to replenish stores weekly with key styles and to build inventory for the peak selling season. Through the integration of merchant and distribution systems, we are able to replenish goods frequently to ensure that stores maintain an appropriate level of inventory. In addition, we are party to a three-year operating lease for a 45,600 square-foot distribution center in Maple Grove, Minnesota that we utilized in fiscal 2004 to support the distribution of merchandise to our seasonal stores. We plan to use the Maple Grove, Minnesota distribution center to support our seasonal store program in fiscal 2005. As was mentioned in “—Reorganization and Partial Store Liquidation,” we ceased distribution activities and closed the Las Vegas, Nevada distribution center in January 2004.

Marketing and Advertising

      Our marketing strategy is to position Wilsons Leather as the preferred retailer of quality leather products for our target customer, capitalizing on our position as the leading specialty retailer of leather outerwear, accessories and apparel in the United States. Through compelling fashion photo imagery in our stores and store fronts, the Wilsons Leather brand identity and current fashion trends are communicated to customers. Our airport stores showcase the Wilsons Leather brand to millions of travelers annually in some of the busiest airports in the United States. Our e-commerce site makes our merchandise more accessible to customers, increases brand awareness and facilitates cross-marketing efforts with our brick-and-mortar stores.

      Going forward, we will work toward creating a more efficient, focused and defined presentation in our stores and find fresh and creative ways to position our products to pull shoppers across the lease line. Our messages to our customers will be clearer and more concise. Our windows will be simplified and will have a more coordinated call to action for our customers.

      We are marketing to specific lifestyles and offer outerwear, accessories and apparel ranging from classic to contemporary styling. Targeting customers between the ages of 18 and 37 is a key marketing initiative. Recent market research indicates that those consumers are high-potential, high-volume customers. In addition, we believe cross-channel brand marketing will be an important driver in our future success. By leveraging our various selling formats— malls, outlets, airports and our e-commerce site— we intend to strengthen Wilsons Leather in the marketplace as the fashion leather leader.

      Our marketing efforts extend to our corporate partners as well. In a move to target more than 75 million NASCAR fans, we launched an exclusive line of Dale Earnhardt Incorporated products. The products, including leather jackets and accessories bearing the marks of Dale Earnhardt Jr., the Dale Earnhardt Legacy^tm program and NASCAR®, are sold exclusively throughout Wilsons Leather stores nationwide. The official launch of the program was promoted and advertised in leading NASCAR publications in the spring of 2003. In addition, we launched an exclusive line of Tony Stewart® products through Joe Gibbs Racing, Inc. Our NASCAR licensed products have been popular with our customers and we expect to continue to enhance this product line.

      We circulated freestanding inserts in various newspapers during our seasonal promotional period during 2004 and expect to continue to make use of this form of promotion in key markets across the United States during 2005.

Information Systems

      Since 2000, we have invested more than $20.9 million in improving our information systems, completing the replacement of major operating platforms in the functional areas of merchandising, finance, human resources, manufacturing and store point-of-sale and back-office systems. These systems provide all levels of our organization access to information, powerful analytical tools to improve our understanding of sales and operating trends and the flexibility needed to anticipate future business needs. We believe that our current systems, which are fully scalable to accommodate future growth, are adequate to meet our operational plans over the next several years.

      Our point-of-sale and back-office systems have been designed to, among other things, free store associates’ time so that they can focus on serving our customers. Our point-of-sale system gives each store the ability to view inventory at other store locations, automates store operations, human resource and inventory management documentation and enables customer information collection. On a daily basis, we obtain sales and inventory data from stores, facilitating merchandising decisions regarding the allocation of inventory, pricing and inventory levels. Our connection to our overseas product sourcing offices provides both field management and home office personnel access to pertinent business information. The continuous flow of information to and from our overseas personnel permits us to control inventory better, plan manufacturing capacity, regulate merchandise flow and ensure product consistency among manufacturers.

Competition

      The retail leather outerwear, accessories and apparel industry is both highly competitive and fragmented. We believe that the principal bases upon which we compete are selection, style, quality, price, value, store location and service. We compete with a broad range of other retailers, including specialty retailers, department stores, mass merchandisers and discounters and other retailers of leather outerwear, accessories and apparel. We have found that we have different competitors during different times of the year. For example, our competition with department stores increases during the holiday gift giving season. During 2003 and 2004, we faced increased competition from mass merchandisers and discounters.

Trademarks

      We conduct our business under various trade names, brand names, trademarks and service marks in the United States, including M. Julian®, Maxima®, Pelle Studio®, Wilsons The Leather Experts^tm, Tannery West®, Georgetown Leather Design^tm, WalletWorks^tm, Wilsons Leather^tm, Handcrafted by Wilsons The Leather Experts^tm, and Vintage by Wilsons The Leather Experts^tm.

Employees

      As of January 29, 2005, we had 3,707 associates working for our company. Of these, 255 were corporate office and distribution center associates, 3,328 were full-and part-time associates in our base stores and 124 were seasonal associates in our seasonal stores. During our peak selling season, from October through January, we typically employ approximately 130 additional seasonal associates in our distribution center, approximately 1,900 additional seasonal associates in our base stores and 500 additional seasonal associates in our seasonal stores. We consider our relationships with our associates to be good. None of our associates are governed by collective bargaining agreements.

Available Information

      Our Internet address is www.wilsonsleather.com. We make available free of charge through our Internet Web site our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) of the Exchange Act, as amended, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission. Our Code of Business Ethics and Conduct and our Board of Directors Committee charters are also available via our Web site.

Risk Factors

      The risks and uncertainties described below are not the only ones facing our company. Additional risks and uncertainties also may impair our business operations. If any of the following risks actually occur, our business, financial condition and results of operations would likely suffer.

      Most of our stores are located in enclosed shopping malls and regional outlet centers. Our ability to sustain or increase the level of sales depends in part on the continued popularity of malls and outlet centers as shopping destinations and the ability of malls and outlet centers, tenants and other attractions to generate a high volume of customer traffic. Many factors beyond our control may decrease mall traffic, including, among other things, economic downturns, the closing of anchor department stores, weather, concerns of terrorist attacks, construction and accessibility to strip malls or alternative shopping formats (such as catalogs, e-commerce or discount stores). Any changes in consumer preferences and shopping patterns could adversely affect our financial condition and operating results.

      The retail leather outerwear, accessories and apparel markets are highly competitive and fragmented. We compete with a broad range of other retailers, including other specialty retailers, department stores, mass merchandisers and discounters, many of which have greater financial and other resources. Increased competition may reduce sales, increase operating expenses, decrease profit margins and negatively affect our ability to obtain site locations, sales associates and other employees. During 2003 and 2004, we faced increased competition from mass merchandisers and discounters. There can be no assurance that we will be able to compete successfully in the future and, if we are unable to do so, our business, financial condition and operating results could be adversely affected.

      Meeting our future capital requirements depends on the sustained demand for our leather products. Many factors affect the level of consumer spending on our products, including, among others:

      Consumer purchases of discretionary items, such as our products, tend to decline during recessionary periods when disposable income is lower. The uncertain outlook in the United States’ economy has adversely affected consumer spending habits and mall traffic, caused us to accelerate store closings, and, during 2002 and 2003 resulted in lower than expected net sales on a quarterly and annual basis. Comparable store sales increased 0.6% in 2004, but were down 3.8% in the fourth quarter of 2004 due to a lower than anticipated sales volume during the holiday selling season.

      Our success depends on our ability to identify fashion and product trends as well as our ability to anticipate, gauge and react swiftly to changes in consumer demand. Our products must remain appealing for a broad range of consumers with diverse and changing preferences; however, our orders for products must be

placed in advance of customer purchases. We cannot be certain that we will be able to identify new fashion trends and adjust our product mix in a timely manner. If we misjudge market preferences, we may be faced with significant excess inventories for some products and missed opportunities for other products. In response, we may be forced to rely on additional markdowns or promotional sales to dispose of excess, slow-moving inventories, which may have a material adverse effect on our business, financial condition and results of operations.

      In addition, we cannot provide assurance that consumer sentiment toward and demand for leather will not change or that we will be able to react to any such changes effectively or at all. For example, certain countries, including the United States and Canada, that supply the hides used to make leather products have experienced outbreaks of certain highly publicized diseases, namely Bovine Spongiform Encephalopathy (“mad-cow” disease) and hoof-and-mouth disease. There can be no assurance that demand for our leather products will not decline as a result of the publicity regarding these diseases or new scientific findings with respect to such diseases. If we are unable to anticipate, gauge and respond to changes in demand or if we misjudge fashion trends, our business, financial condition and operating results could be harmed.

      Our comparable store sales increased nominally by 0.6% in 2004, but were down 3.8% in the fourth quarter. Comparable store sales declined 6.8% and 7.0% in 2003 and 2002, respectively. We had a net loss from continuing operations of $23.7 million (which included $27.4 million of charges related to the restructuring and partial store liquidation), $33.6 million and $14.3 million in 2004, 2003 and 2002, respectively. Our comparable store sales are affected by a variety of factors, including:

      An inability to generate comparable store sales increases in the future could have a material adverse effect on our business, financial condition and results of operations. Failure of results of operations to meet expectations of research analysts could decrease the price of our common stock.

      Our long-term operating results will depend, in part, on our ability to successfully open new stores and to effectively manage our existing business. Our ability to grow our business will be limited, however, if we are unable to improve the sales performance and productivity of our existing stores. Our future growth will also depend on our ability to:

      We cannot assure you that we will be able to achieve all or any of these objectives.

      The purchase of leather comprised approximately 56.1%, 59.5% and 62.8% of our costs of goods sold for leather apparel and 47.6%, 47.5% and 49.7% of the costs of goods sold for accessories in 2004, 2003 and 2002, respectively. A number of factors affect the price of leather, including the demand for leather in the shoe, furniture and automobile upholstery industries. In addition, leather supply is influenced by worldwide meat consumption and the availability of hides. Fluctuations in leather supply and pricing, which can be significant, may have a material adverse effect on our business, financial condition and results of operations.

      We import our leather garments and accessories from independent foreign contract manufacturers located primarily in China and India. We do not have long-term contracts or formal supply arrangements with our contract manufacturers. In 2004, 84.0% of our leather garments and accessories contracted for manufacture were purchased from foreign suppliers, with approximately 74.0% purchased from China and 8.0% purchased from India. Trade relations with China and India have, in the past, been unstable. If trade relations with these countries or any other country from which we source goods deteriorate, or if any new or additional duties, quotas or taxes are imposed on imports from these countries, leather purchase and production costs could increase significantly, negatively impacting our sales prices, profitability or the demand for leather merchandise. Further, we cannot predict whether any of the countries in which our products currently are manufactured or may be manufactured in the future will be subject to trade restrictions imposed by the United States government, including the likelihood, type or effect of any such restrictions, or whether any other conditions having an adverse effect on our ability to source products will occur. In addition, it will take time for us to transition our sourcing to other countries. Certain other risks related to foreign sourcing include:

      Any event causing a sudden disruption of imports from China, India or other foreign countries, including a disruption due to financial difficulties of a supplier, or a catastrophic event (such as, but not limited to, fires, tornadoes, floods or acts of terrorism) could have a material adverse effect on our business, financial condition and results of operations. In the event that commercial transportation is curtailed or substantially delayed due to a dockworkers’ strike or other similar work action, our business may be adversely impacted, as we may have difficulty shipping merchandise to our distribution center and stores.

      Since our leather outerwear and apparel products are most often purchased during the holiday season, we experience substantial fluctuations in our sales and profitability. We generate a significant portion of our sales

from October through January, which includes the holiday selling season. We generated 54.0% of our annual sales in that time period in 2004, and 27.0% in December alone. Because our profitability, if any, is historically derived in the fourth quarter, our annual results of operations have been, and will continue to be, heavily dependent on the results of operations from October through January.

      Given the seasonality of our business, misjudgments in fashion trends, the effects of war and other significant national and international events, or unseasonably warm or severe weather during our peak selling season could have a material adverse effect on our financial condition and results of operations. Our results of operations may also fluctuate significantly as a result of a variety of other factors, including:

      Covenants contained within our senior credit facility, as amended, require us to meet certain financial tests and limit capital expenditures. In addition, certain covenants and restrictions under our senior credit facility limit our ability to pay cash dividends or make other distributions, to acquire or merge with another entity, to make investments, loans or guarantees, to borrow additional funds or dispose of assets and to create liens or other encumbrances, possibly affecting our flexibility in planning for, and reacting to, changes in our business.

      The failure to comply with the covenants and restrictions contained in the senior credit facility could, if not cured or waived, result in a default permitting the senior lenders to accelerate payment of indebtedness (including letters of credit and the Term B promissory note) under the senior credit facility and allow them to pursue other remedies (including foreclosing their liens on our assets). As of January 29, 2005, and the date of this report, we were in compliance with or had received waivers for all of our covenants related to the senior credit facility.

      Our ability to meet our debt service obligations will be dependent upon our future performance, which will be subject to general economic conditions and financial, business and other factors affecting our operations. If we are unable to generate sufficient cash flow from operations in the future to service our debt, we may be required to refinance all or a portion of our existing debt 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.

      Our accounting policies and methods are fundamental to how we record and report our financial condition and results of operations. Our management must exercise judgment in selecting and applying many of these accounting policies and methods so that not only do they comply with U.S. generally accepted accounting principles, but also that they reflect management’s judgment as to the most appropriate manner in which to record and report our financial condition and results of operations. In some cases, management must select the accounting policy or method to apply from two or more alternatives, any of which might be

reasonable under the circumstances, yet might result in our reporting materially different amounts than would have been reported under a different alternative. Note 1, “Summary of significant accounting policies,” to our consolidated financial statements describes our significant accounting policies.

      We have identified two accounting policies as being “critical” to the presentation of our financial condition and results of operations because they require management to make particularly subjective and/or complex judgments about matters that are inherently uncertain and because of the likelihood that materially different amounts would be reported under different conditions or using different assumptions. These critical accounting policies relate to the valuation of inventory, and the valuation of property and equipment for impairment. Because of the uncertainty of estimates about these matters, we cannot provide any assurance that we will not:

For more information, refer to Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations— Critical Accounting Policies” in this report.

      We prepare our financial statements to conform with U.S. generally accepted accounting principles. These accounting principles are subject to interpretation by the American Institute of Certified Public Accountants, the Securities and Exchange Commission and various bodies formed to interpret and create appropriate accounting principles. A change in those principles could have a significant effect on our reported results and may affect our reporting of transactions completed before a change is announced. Changes to those rules or the questioning of current practices may adversely affect our reported financial results or the way we conduct our business. For example, in December 2004, the Financial Accounting Standards Board issued Statement of Accounting Standards No. 123 (Revised 2004) (“SFAS No. 123R” or the “Statement,”) Share-Based Payment. This Statement requires that, beginning in our third quarter of 2005, we must record a charge to earnings for employee stock option grants and other equity incentives. We cannot precisely determine the impact this will have on earnings. The ultimate amount of increased compensation expense will be dependent on the number of option shares granted during the year, their timing and vesting period and the method used to calculate the fair value of the awards, among other factors.

      Our success depends largely on the efforts and abilities of our current senior management team. The loss of service of any of these persons could adversely affect our business. We do not maintain key-man life insurance on any members of our senior management team.

      In connection with the equity financing completed on July 2, 2004, we issued 17,948,718 shares of our common stock and warrants to purchase four million shares of our common stock, subject to certain adjustments, to three institutional investors. Increasing the number of additional shares of common stock that may be eventually sold into the market by approximately 21.9 million shares could have a negative impact on the value of our shares. In addition, if we need to obtain additional financing, the terms on which we may obtain additional financing may be adversely affected.

      Our directors and executive officers, excluding Ted Weschler, a general partner of the general partner of Peninsula Investment Partners, L.P. (“Peninsula”), beneficially owned, in the aggregate, 9.6 percent of our

common stock as of April 4, 2005. As of April 4, 2005, Peninsula beneficially owned approximately 44.0 percent of our common stock. Either the directors and officers voting together or Peninsula voting alone would be able to exert significant influence over our business and affairs, including:

      In addition, the ownership concentration of our stock may limit liquidity and cause shareholders to experience price fluctuations when selling large blocks of our stock.

      Our stock price has been, and is expected to continue to be, highly volatile. There could be an immediate adverse impact on our stock price as a result of:

      In addition, the Nasdaq National Market has experienced extreme volatility that has often been unrelated to the performance of particular companies. Future market fluctuations may cause our stock price to fall regardless of our performance. Such volatility may limit our future ability to raise additional capital.

      The efficient operation of our business is heavily dependent on our information systems. In particular, we rely heavily on the automated sortation system used in our distribution center and the merchandise management system used to track sales and inventory. We also rely on a third-party package for our accounting, financial reporting and human resource functions. We depend on our vendors to maintain and periodically upgrade these systems so that these systems continue to support our business. The software programs supporting our automated sorting equipment and processing our inventory management information were licensed to us by independent software developers. The inability of these developers to continue to maintain and upgrade these software programs would disrupt our operations if we were unable to convert to alternate systems in an efficient and timely manner.

      In the event of war or acts of terrorism, or if either is threatened, our ability to obtain merchandise available for sale in our stores may be negatively affected. We import a substantial portion of our merchandise from other countries. If imported goods become difficult or impossible to bring into the United States, and if we cannot obtain such merchandise from other sources at similar costs, our sales and profit margins may be adversely affected.

      The majority of our stores are located in enclosed shopping malls and regional outlet centers. In response to the terrorist attacks of September 11, 2001, security has been heightened in public areas. Any further threat of terrorist attacks or actual terrorist events, particularly in public areas, could lead to lower customer traffic in

shopping malls and outlet centers. In addition, local authorities or mall management could close shopping malls and outlet centers in response to any immediate security concern. Mall closures, as well as lower customer traffic due to security concerns, could result in decreased sales that would have a material adverse effect on our business, financial condition and results of operations.

      Our corporate offices and distribution center are in one location. Our operations could be materially and adversely affected if a catastrophic event (such as, but not limited to, fires, tornadoes, floods or acts of terrorism) impacts the use of these facilities. There can be no assurance that we would be successful in obtaining alternative facilities in a timely manner if such a catastrophic event were to occur.

      The market price of our common stock could decline as a result of market sales by our existing shareholders or the perception that such sales will occur. These sales also might make it difficult for us to sell equity securities in the future at a time and at a price that we deem appropriate. As of January 29, 2005, 1,852,222 shares were subject to issuance upon the exercise of vested stock options previously granted by us, all of which would be freely tradable if issued, subject to compliance with Rule 144 in the case of our affiliates. In addition, 870,386 shares of our common stock have been reserved for issuance pursuant to our employee benefit plans.

      As of January 29, 2005, we operated 436 leased store locations. Substantially all of our stores were located in shopping malls, outlet malls or airport retail locations. Store leases with third parties are typically five to 10 years in duration. Most leases require us to pay annual minimum rent plus a contingent rent dependent on the store’s annual sales in excess of a specified threshold. As of January 29, 2005, of the 436 open leased Wilsons Leather stores, an affiliate of CVS New York, Inc. (“CVS”) (formerly Melville Corporation, the parent company to the predecessor companies) guaranteed approximately 22 leases, all of which were entered into before the 1996 management buyout.

      We are party to a 15-year operating lease, with a five-year option to extend, for a 289,000 square-foot distribution center and 69,000 square-foot corporate office space located in Brooklyn Park, Minnesota. In addition, we are party to a three-year operating lease for a 45,600 square-foot distribution center in Maple Grove, Minnesota that we utilized in fiscal 2004 to support the distribution of merchandise to our seasonal stores. We plan to use the Maple Grove, Minnesota distribution center to support our seasonal store program in 2005.

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

      None.

      The following table sets forth certain information concerning our executive officers as of April 1, 2005:

      Michael M. Searles has served as our Chief Executive Officer since December 2004 and as Chairman and Chief Executive Officer since February 2005. Prior to joining Wilsons Leather, Mr. Searles had been in private retail consulting from 2002 to November 2004. He served as Chairman of the Board and Chief Executive Officer of Factory 2-U Stores, Inc., an off-price apparel and home products retailer, from 1998 to 2002. Mr. Searles served in various positions at Montgomery Ward, a full-line department store chain, from 1996 to 1997, most recently as President, Merchandising and Marketing. Mr. Searles was President of Women’s Specialty Retail Group (now Casual Corner Group), then a division of United States Shoe Corporation, a manufacturing and retail apparel and footwear company, from 1993 to 1995. Mr. Searles also served as President of Kids “R” Us, a leading retailer of toys, baby products and children’s apparel from 1984 to 1993.

      Peter G. Michielutti has served as our Executive Vice President, Chief Financial Officer and Chief Operating Officer since 2004 and also served as our Executive Vice President and Chief Financial Officer from March 2003 to August 2004, responsible for finance, information systems, and real estate. Mr. Michielutti also served as our Senior Vice President and Chief Financial Officer from March 2001 to February 2003. Prior to joining Wilsons Leather, Mr. Michielutti held various positions with US Bancorp, a financial services holding company, from 1998 to 2001, most recently as Executive Vice President, Information Services and Operations. Mr. Michielutti held various positions with Fingerhut Companies, Inc., a direct marketing retail business, most recently as Executive Vice President and Chief Operating Officer from 1996 to 1998.

      Brian R. Bootay has served as our Vice President responsible for real estate and construction since October 2000. Prior to joining Wilsons Leather, Mr. Bootay was Vice President, Leasing at Venator Group Realty Corporation, a subsidiary of Venator Group, Inc., a specialty retailer of athletic footwear and apparel, from 1996 to 2000, and was Senior Vice President, Real Estate at CVS (formerly Melville Corporation), a diversified specialty retailer, from 1994 to 1996.

      Betty A. Goff has served as our Vice President responsible for human resources since February 1992 and served as our Director of Executive Recruitment and Placement from October 1987 to February 1992. Prior to joining Wilsons Leather, Ms. Goff served in various human resource management positions with Fingerhut Corporation, a subsidiary of Fingerhut Companies, Inc., a general merchandise catalog retailer, from 1983 to 1987, and most recently as Manager, Staffing and Employment from 1984 to 1987.

      Stacy A. Kruse has served as our Vice President responsible for finance and treasury since August 2004 and served as our Director of Finance and Treasurer from April 2003 to July 2004, and Director of Business Planning & Analysis and Treasurer from June 2001 to March 2003. Prior to joining Wilsons Leather, Ms. Kruse was Director of Finance (Information Systems) at US Bancorp, a financial services company, from 1999 to 2001 and in various positions at Carlson Marketing Group, a marketing services company, from 1995 to 1999, most recently as Director of Operations (Loyalty Division) from 1996 to 1999.

      Jeffrey W. Orton has served as our Chief Information Officer and Vice President responsible for information systems and logistics since October 1997, and served as our Director of Strategic Analysis from March 1997 to October 1997, and Director of Business Process Reengineering from September 1993 to March 1997. Prior to joining Wilsons Leather, Mr. Orton held various positions at United States Shoe Corporation, a manufacturing and retail apparel and footwear company, from 1986 to 1993, and most recently as Director of Footwear Retail Systems from 1992 to 1993.

      Arthur J. Padovese has served as our Vice President responsible for store sales since February 2003 and Vice President responsible for outlets from October 2000 to January 2003. Prior to joining Wilsons Leather, Mr. Padovese was an independent management consultant serving as Chief Operating Officer and Chief Financial Officer at Appraisal Enhancement Services, a property appraisal company, from 1999 to 2000, an investment banker for Green Tree Capital, a financial services company, from 1998 to 2000, and was co-founder of Jungle Adventures International Inc., a developer of entertainment centers, in 1998. He also served as President of Prints Plus, Inc., a specialty retailer, from 1986 to 1997.

      Steven R. Waller has served as our Vice President responsible for sourcing since January 1999, and served as our Director of Product Development from September 1998 to January 1999. Prior to joining Wilsons Leather, Mr. Waller served in various operations and import positions with G-III Apparel Group, Ltd., a leather and non-leather apparel manufacturer and distributor, most recently as Director of Imports from 1987 to 1998. Mr. Waller is the son of Joel N. Waller, a director of the company.

      Teresa L. Wright has served as our Vice President responsible for merchandising since June 2004 and served as our General Merchandise Manager (outlets) from November 2000 to May 2004, and Division Merchandise Manager from November 1997 to October 2000, and Buyer from December 1996 to October 1997. Prior to joining Wilsons Leather, Ms. Wright held various merchandising positions at Marshall Field’s, a department store retailer, from 1986 to 1996, and most recently as Senior Buyer from 1993 to 1996.

PART II

Market Information

      Our common stock, $.01 par value, trades on the Nasdaq National Market under the symbol WLSN. The closing price of our common stock on April 4, 2005, was $4.60. The following table presents the high and low market prices from February 2, 2003 through January 29, 2005.

      There were 83 record holders of our common stock as of April 4, 2005.

Dividends

      We have not declared any cash dividends since our inception in May 1996. In addition, our loan agreements contain certain covenants limiting, among other things, our ability to pay cash dividends or make other distributions. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources.”

Purchases of Equity Securities

      We did not purchase any shares of our common stock during the fourth quarter of 2004.

      The selected historical consolidated financial data set forth below should be read in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements of the Company, beginning on page F-1 of this report. The selected historical consolidated financial data has been derived from our audited consolidated financial statements. Certain amounts included in the selected historical consolidated financial data for fiscal years 2000 through 2003 have been reclassified to conform with the 2004 financial statement presentation. See Note 2, “Reclassification of financial statements,” included in Item 8, “Financial Statements and Supplementary Data” beginning on page F-13 of this report for a more detailed description of these reclassifications.

SELECTED HISTORICAL CONSOLIDATED FINANCIAL AND OPERATING DATA

(In thousands except per share amounts and operating data)

SELECTED HISTORICAL CONSOLIDATED FINANCIAL AND OPERATING DATA— (Continued)

(In thousands except per share amounts and operating data)

      The following discussion of our financial condition and results of operations should be read in conjunction with our selected historical consolidated financial data and consolidated financial statements and notes thereto appearing elsewhere in this Form 10-K. The consolidated financial statements for all periods present the Travel Subsidiaries segment as discontinued operations. See “—Discontinued Operations” below. Unless otherwise indicated, the following discussion relates only to Wilsons Leather’s continuing operations.

Overview

      We measure performance using such key operating statistics as comparable store sales, sales per square foot, gross margin percentage and store operating expenses, with a focus on labor, as a percentage of sales. These results translate into store operating contribution and store cash flow, which we use to evaluate overall performance on an individual store basis. Store operating contribution is calculated by deducting a store’s operating expenses from its gross margin and is measured as a percentage of sales. Store operating contribution gives us an overall measure as to whether or not individual locations and markets are meeting our financial objectives.

      In addition, general and administrative expenses are monitored in absolute amount, as well as on a percentage of sales basis. We continue to monitor product costing and promotional activity, which allows us to generally maintain acceptable margin levels. Our gross margins are influenced by the mix of merchandise between outerwear and accessories in our total sales.

      We also measure and evaluate investments in our retail locations, including inventory and property and equipment. Inventory performance is primarily measured by inventory turns, or the number of times store inventory turns over in a given period, and amounts of owned inventory at various times based on payment terms from our vendors. The most significant investments in property and equipment are made at the time we open a store.

      At January 29, 2005, we operated 436 stores located in 45 states, including 311 mall stores, 109 outlet stores and 16 airport locations. We also operated 102 temporary seasonal stores during 2004 to better capitalize on our peak selling season from October through January.

      During the last three years, in support of our overall financial strategy, the following three major actions were taken: 1) we discontinued operations for the Travel Subsidiaries, 2) we conducted a reorganization and partial store liquidation, and 3) we obtained additional financing. These actions are described in greater detail below.

      We generate a significant portion of our sales from October through January, which includes the holiday selling season. We generated 54.0% of our annual sales in that time period in 2004, and 27.0% in December alone. As part of our strategy to improve operating margins and maximize revenue and profitability during non-peak selling seasons, we have increased the number of outlet locations since 2000, which are less seasonal, and modified our product mix to emphasize accessories. Accessory sales grew as a percentage of sales to 35.6% in 2004 from 33.6% in 2003 and 31.6% in 2002, largely as a result of fresh, new styles designed to match our customers’ lifestyle needs.

      Comparable store sales increased 0.6% in 2004 and decreased 6.8% and 7.0% in 2003 and 2002, respectively. 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. The 111 liquidation stores are not included in comparable store sales for the month of January 2004 and all of fiscal 2004. Loss from continuing operations as a percentage of sales was (5.4%), (6.4%) and (2.5%), in 2004, 2003 and 2002, respectively.

      The following table contains selected information for each of our store formats for 2004.

      The following table contains selected information for each of our store formats for 2003.

      We intend the discussion of our financial condition and results of operations that follows to provide information that will assist in understanding our consolidated financial statements, the changes in certain key items in those consolidated financial statements from year to year, and the primary factors that accounted for those changes, as well as how certain accounting principles, policies and estimates affect our consolidated financial statements.

Reclassification of Financial Statements

      On February 7, 2005, the Office of the Chief Accountant of the Securities and Exchange Commission (the “SEC”) issued a letter to the American Institute of Certified Public Accountants expressing its views regarding certain operating lease accounting issues and their application under U.S. generally accepted accounting principles (“GAAP”). In light of this letter, we initiated a review of our lease-related accounting methods and determined that our methods of accounting for: (1) leasehold improvements funded by landlord incentives, and (2) rent expense prior to commencement of operations and rent payments, while in line with common industry practice, were not in accordance with GAAP. However, these misstatements had no impact on our net income or loss for any period and, as a result, we reclassified certain amounts within our consolidated financial statements for each of the fiscal years ended January 31, 2004, and February 1, 2003, the first three quarters of fiscal 2004 and all four fiscal quarters of 2003.

      We had historically accounted for leasehold improvements funded by landlord incentives as reductions in the cost of related leasehold improvements reflected in the consolidated balance sheets and the capital expenditures reflected in investing activities in the consolidated statements of cash flows. We determined that the appropriate interpretation of Financial Accounting Standards Board (the “FASB”) Technical Bulle-

tin No. 88-1, “Issues Relating to Accounting for Leases,” requires these incentives to be recorded as deferred rent liabilities in the consolidated balance sheets and as a component of operating activities in the consolidated statements of cash flows. This resulted in a reclassification of the deferred rent amortization from depreciation and amortization expense to rent expense, which is included in cost of goods sold, buying and occupancy costs in the consolidated statements of operations. We also reclassified lease incentives to operating activities, which were previously included as a reduction of the cost component of capital expenditures in investing activities in the consolidated statements of cash flows.

      Additionally, we had historically recognized rent holiday periods on a straight-line basis over the lease term commencing on the related retail store opening date. The store opening date coincides with the commencement of business operations, which is the first intended use of the property. We re-evaluated FASB Technical Bulletin No. 85-3, “Accounting for Operating Leases with Scheduled Rent Increases,” and determined that, consistent with the letter issued by the Office of the Chief Accountant, the lease term should include the pre-opening period of construction, renovation, fixturing and merchandise placement (the “build-out period,” typically one to two months prior to store opening). However, we have elected to capitalize these construction period rent expenses and amortize them over the term of the lease. We did not previously have a policy or practice to expense or capitalize rent costs during the construction period. In order to properly state the rent expense related to the build-out period, we are required to record additional deferred rent in other accrued expenses and other long-term liabilities and to adjust property, plant and equipment, net in the consolidated balance sheets, as well as reclassifying a portion of the previously reported rent expense to depreciation.

      See Note 2, “Reclassification of financial statements,” contained in our consolidated financial statements, for a more detailed description of these reclassifications. The accompanying discussion in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” gives effect to these corrections.

Critical Accounting Policies

      Our significant accounting policies are described in Note 1, “Summary of significant accounting policies,” contained in our consolidated financial statements beginning on page F-7 of this report. We believe that the following discussion addresses our critical accounting policies, which are those that are most important to the portrayal of our financial condition and results of operations and require management’s most difficult, subjective and complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.

      We value our inventories, which consist primarily of finished goods held for sale 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 January 29, 2005, and January 31, 2004, the LIFO cost of inventories approximated the first-in, first-out (“FIFO”) cost of inventories. The inventory cost includes the cost of merchandise, freight, duty, sourcing overhead, and other merchandise-specific charges. A periodic review of inventory quantities on hand is performed to determine if inventory is properly stated at the lower of cost or market. Factors related to current inventories such as future consumer demand, fashion trends, current and anticipated retail markdowns, and class or type of inventory are analyzed to determine estimated net realizable values. A provision is recorded to reduce the cost of inventories to the estimated net realizable values, if required. Any significant unanticipated changes in the factors noted above could have a significant impact on the value of our inventories and our reported operating results.

      Our property and equipment consists principally of store leasehold improvements and store fixtures and are included in the “Property and equipment” line item in our consolidated balance sheets in our consolidated financial statements. These long-lived assets are recorded at cost and are amortized using the straight-line method over the lesser of the applicable store lease term or the estimated useful life of the leasehold

improvements. The typical initial lease term for our stores is 10 years. Computer hardware and software and distribution center equipment are amortized over three to five years and 10 years, respectively. We review long-lived assets for impairment whenever events, such as decisions to close a store or changes in circumstances, indicate that the carrying value of an asset may not be recoverable. If the undiscounted future cash flows from the long-lived assets are less than the carrying value, we recognize a loss for a particular market of stores impaired equal to the difference between the carrying value and the asset’s fair value, which is indicated by the discounted future cash flows using a risk-adjusted rate of return. We recorded a charge of $1.0 million for impaired assets during the fourth quarter of 2002. During 2003 and 2004, we did not record an impairment charge based on our impairment testing. In addition, decisions to close stores during the year have and will result in accelerated depreciation over the revised useful life of those store assets. Most store closures (excluding the 111 liquidation stores) occur upon the lease expiration.

Results of Operations

      OVERVIEW

      In evaluating our financial performance and operating trends, management considers information concerning our operating loss, net loss, basic and diluted loss per share and certain other information before liquidation and restructuring costs that are not calculated in accordance with GAAP. See Note 4, “Reorganization and partial store liquidation,” to our consolidated financial statements beginning on page F-17 of this report. A reconciliation of these non-GAAP financial measures to GAAP numbers for the year-to-date periods ended January 29, 2005, and January 31, 2004, is included in the tables below. We believe that the non-GAAP numbers calculated before liquidation and restructuring costs provide a useful analysis of our ongoing operating trends and in comparing operating performance period to period. We evaluate these non-GAAP numbers calculated before liquidation and restructuring costs on a quarterly basis in order to measure and understand our ongoing operating trends. Our management incentive bonuses were based on an earnings before tax measure calculated before liquidation and restructuring costs.

WILSONS THE LEATHER EXPERTS INC. AND SUBSIDIARIES

Reconciliation of GAAP Consolidated Statement of Operations to

Adjusted Statement of Operations for the year ended January 29, 2005

(In thousands, except per share amounts)

(Unaudited)

WILSONS THE LEATHER EXPERTS INC. AND SUBSIDIARIES

Reconciliation of GAAP Consolidated Statement of Operations to

Adjusted Statement of Operations for the year ended January 31, 2004

(In thousands, except per share amounts)

(Unaudited)

      The following tables contain selected information from our historical consolidated statements of operations, expressed as a percentage of net sales. These numbers are presented both “as reported” and excluding the liquidation and restructuring costs (i.e., the adjusted figures presented in the tables above):

      Net Sales. Net sales decreased 15.3% to $441.0 million in 2004 from $521.0 million in 2003. Included in the 2004 and 2003 sales were approximately $20.8 million and $3.3 million, respectively, in sales resulting from the liquidation of 111 stores that began in the fourth quarter of 2003 and ended in April of 2004. See Note 4, “Reorganization and partial store liquidation,” contained in our consolidated financial statements. When adjusted to remove the liquidation sales, net sales decreased 18.8% to $420.3 million in 2004 from $517.7 million in 2003. These decreased sales levels are primarily reflective of the 26.5% decline in average store count as partially offset by a comparable store sales increase of 0.6% in 2004 compared to a decrease of 6.8% in 2003.

      The increase in comparable store sales in 2004 was primarily driven by special clearance and promotional sales in the second and third quarters of 2004, when we posted comparable store sales increases of 11.0% and 7.2%, respectively, offset by the comparable store sales decrease of 3.8% in the fourth quarter of 2004 as a result of lower than anticipated volume during the holiday selling season. Comparable store sales do not include sales for the liquidation stores.

      We opened five stores and closed 29 stores during 2004, compared to opening 17 stores and closing 175 stores (including the 111 liquidation stores) in 2003. As of January 29, 2005, we operated 436 stores compared to 460 stores (excluding the 111 liquidation stores) as of January 31, 2004. Our selling square footage in 2004 decreased 4.6% to 1,004,000 from 1,052,400 in 2003. We operated 102 seasonal stores during the 2004 holiday selling season as compared to 229 seasonal stores during 2003.

      Cost of Goods Sold, Buying and Occupancy Costs. Cost of goods sold, buying and occupancy costs decreased $74.2 million, or 19.8%, to $299.7 million in 2004 from $373.9 million in 2003. This decrease was driven by both the lower sales volume as well as a $28.7 million decrease in buying and occupancy costs discussed below. Gross margin in total dollars decreased by $5.7 million, or 3.9%, to $141.4 million in 2004 from $147.1 million in 2003 as a result of the decreased sales discussed above, as partially offset by the decrease in cost of goods sold, buying and occupancy costs.

      Gross margin as a percentage of net sales increased 380 basis points in 2004 compared to 2003. The improvement in gross margin as a percentage of net sales was primarily due to $28.7 million in decreased buying and occupancy costs. The improvement in buying and occupancy costs was largely driven by: (1) an improvement of $26.8 million in occupancy costs as a result of the 26.5% decline in average store count, (2) a $1.4 million decrease in distribution center costs due to the closure of the Las Vegas, Nevada distribution center in January of 2004, and (3) a $0.5 million decrease in other merchandising costs. The gross margin improvement was also driven by reduced delivery costs of $1.5 million due to fewer stores open and a lower level of clearance goods as a result of the liquidation process.

      Gross margin as a percentage of net sales, excluding liquidation and restructuring charges (which totaled a positive $3.8 million in 2004 and a negative $3.5 million in 2003) increased to 32.7% in 2004 compared to 29.1% in 2003. This increase is primarily a result of the improvements in buying and occupancy costs as discussed above.

      Selling, General and Administrative Expenses. SG&A expenses decreased to $129.2 million in 2004 from $150.7 million in 2003, and increased as a percentage of net sales to 29.3% from 28.9%. However, SG&A as a percentage of net sales, excluding liquidation and restructuring charges (which totaled $17.4 million and $2.8 million, respectively, in 2004 and 2003) decreased to 26.6% in 2004 compared to 28.6% in 2003. This reduction is a result of the improvement in controlling store related expenses, the closing of underperforming stores and the overhead reductions implemented in January 2004, all discussed below.

      The $21.4 million decrease in total SG&A spending was primarily due to: (1) a $19.6 million decrease in store selling expenses due to tighter cost control and the 26.5% decline in average store count, (2) a $7.6 million decrease in other store and field sales management expenses also due to a lower average store count, (3) a $0.6 million decrease in e-commerce expenses due to fewer functionality improvements over the prior year and the outsourcing of our e-commerce operations in the third quarter of 2004, (4) a $1.9 million decrease in legal expenses related to a charge of $1.9 million taken in the second quarter of 2003 in connection

with a class action lawsuit, (5) a $1.9 million decrease in other administrative costs related to a reduced store count and other cost-saving initiatives, and (6) a $4.4 million decrease in sales promotion expenses as a result of less spending on direct advertising as compared to 2003. These expense reductions were offset by a $14.6 million increase over the prior year for liquidation and restructuring costs related primarily to lease termination costs, asset write-offs related to store closings, severance, including payments under our agreements with David L. Rogers and Joel N. Waller, performance bonuses due former officers of the Company, retention bonuses and other restructuring costs.

      Depreciation and Amortization. Depreciation and amortization increased to $30.6 million in 2004, from $22.4 million in 2003, and increased as a percentage of net sales to 6.9% from 4.3%. The $8.3 million increase was primarily the result of $11.5 million of additional accelerated depreciation recorded in 2004 as compared to 2003 primarily related to the liquidation stores, partially offset by $3.2 million in decreased administration and store depreciation as a result of headcount and related asset reductions at our headquarters and closures of two distribution centers in the fourth quarter of 2003, as well as a lower level of store assets related to the reduced store count.

      Depreciation and amortization, excluding liquidation and restructuring efforts (which totaled $13.8 million and $2.3 million in 2004 and 2003, respectively), decreased to $16.9 million, or 4.0% of net sales, in 2004 compared to $20.1 million, or 3.9% of net sales in 2003. As mentioned above, the decreased total dollars relates to a lower level of administration and store assets. The slight increase as a percentage of net sales is a result of the lower net sales volume.

      Operating Loss. As a result of the above, the operating loss decreased $7.4 million to $18.5 million in 2004 compared to $25.9 million in 2003, or (4.2)% of net sales in 2004 compared to (5.0)% of net sales in 2003. This was largely due to an $18.8 million increase in liquidation and restructuring costs, which was more than offset by: (1) $36.1 million in lower SG&A expenses, (2) $3.2 million in favorable depreciation expense due to a lower asset base, and (3) a $13.1 million decrease in gross margin due to the lower net sales as offset by the decreased buying and occupancy costs.

      Excluding the liquidation and restructuring charges, an operating profit of $8.9 million was reported in 2004 as compared to an operating loss of $17.3 million in 2003. This improvement reflects the restructuring and store closing initiatives as well as the impact of our improved gross margin percentage.

      Interest Expense. Interest expense decreased by $3.5 million to $7.4 million in 2004 compared to $10.9 million in 2003. This improvement was primarily due to: (1) interest savings from the repurchase of $22.0 million of the 11¹/4% Senior Notes in the second quarter of 2004 and repayment of $8.6 million of the 11¹/4% Senior Notes at maturity in the third quarter of 2004, (2) reduced levels of revolver borrowings, and (3) reduced amortization of debt issuance costs. These savings were partially offset by a $0.5 million write-off of debt issuance costs related to the amended senior credit facility, which reduced our revolving line of credit borrowing capacity from $180.0 million to $125.0 million. The liquidation and restructuring activities did not impact interest expense.

      Income Tax Benefit. We recorded an income tax benefit of $2.2 million during 2004 as compared to an income tax benefit of $3.2 million in 2003. In 2003, a valuation allowance was recorded against the net deferred tax assets exclusive of the LIFO reserve due to continued sustained losses in 2003. The $2.2 million and $3.2 million tax benefits recorded in 2004 and 2003, respectively, were due to a reduced tax basis related to our LIFO inventory reserve as a result of a change in the level and mix of our inventory.

      Income from Discontinued Operations. We reported $173,000 in income from discontinued operations, net of tax, in 2004, which represents the reversal of the discontinued operations liability at the end of 2004 that was no longer required.

      Net Loss. As a result of the above, the net loss for 2004 was $23.6 million as compared to $33.6 million for 2003. The decreased net loss over the prior year was primarily due to the increased liquidation and restructuring charge of $18.8 million, as offset by the decreased SG&A, depreciation and interest expenses and decreased gross margin contribution and income tax benefit (all discussed above). Excluding the liquidation

and restructuring charges, net income was $3.8 million in 2004 as compared to a net loss of $25.0 million in 2003.

      Net Sales. Net sales decreased 8.8% to $521.0 million in 2003 from $571.5 million in 2002. The $50.5 million sales decrease was due to: (1) a $32.9 million decrease related to a 6.8% comparable store sales decrease, (2) a $13.0 million decrease from the full-year impact of 2002 and 2003 store closures, (3) a $14.0 million decrease from lower seasonal store sales, and (4) a $0.1 million decrease in e-commerce sales volume. These decreases were partially offset by a $9.5 million increase due to the full-year impact of 2002 and 2003 store openings that were not accounted for as part of comparable store sales.

      The primary causes for the net sales decrease were threefold: (1) lack of promotional programs in the mall stores that could have brought more mall customers into the stores during the holiday season, (2) the continuation of a sluggish economy, and (3) changes in consumer shopping preferences trending away from traditional mall stores in favor of mass merchandisers and discounters.

      Included in 2003 sales was approximately $3.3 million in sales resulting from the liquidation of 111 stores that began in the fourth quarter of 2003 and ended in April of 2004. See Note 4, “Reorganization and partial store liquidation,” contained in our consolidated financial statements. When adjusted to remove the liquidation store sales, net sales decreased 9.4% to $517.7 million in 2003 from $571.5 million in 2002. The primary causes for this decrease are described above.

      We opened 17 stores and closed 175 stores (including the 111 liquidation stores) in 2003, compared to opening 34 stores and closing 35 stores in 2002. As of January 31, 2004, we operated 460 stores (excluding the 111 liquidation stores) compared to 618 stores at February 1, 2003. Our selling square footage in 2003 decreased 23.6% to 1,052,400 from 1,376,600 in 2002. We operated 229 seasonal stores during the 2003 holiday season as compared to 284 seasonal stores during 2002.

      Cost of Goods Sold, Buying and Occupancy Costs. Cost of goods sold, buying and occupancy costs decreased $27.9 million, or 6.9%, compared to 2002. The $27.9 million decrease from 2002 was due to: (1) $21.9 million in lower cost of goods sold due to lower sales volume in 2003 compared to 2002, (2) $3.7 million in lower buying and occupancy costs, largely due to cost saving initiatives, including rent reductions of approximately $1.4 million and a 4% lower average number of permanent stores operated (598 in 2003 compared to 623 in 2002), and (3) $2.3 million in reduced markdown expense. Despite these savings, cost of goods sold, buying and occupancy costs increased to 71.8% as a percentage of sales in 2003 from 70.3% as a percentage of net sales in 2002 due to the deleveraging effect of the $50.5 million reduction in sales volume. Gross margin as a percentage of sales decreased 150 basis points in 2003 compared to 2002 reflecting the year-over-year fluctuations discussed above.

      Cost of goods sold, buying and occupancy costs decreased $34.7 million, or 8.6%, excluding liquidation and restructuring charges of $6.8 million recorded in 2003. Gross margin as a percentage of sales, excluding liquidation and restructuring charges of $3.5 million in 2003, decreased to 29.1% in 2003 compared to 29.7% in 2002, again reflective of the deleveraging effect of the lower sales volume.

      Selling, General and Administrative Expenses. Selling, general and administrative expenses decreased to $150.7 million in 2003 from $164.5 million in 2002, and increased as a percentage of net sales to 28.9% from 28.8%. The $13.8 million decrease was primarily due to: (1) a $10.2 million decrease in store selling expenses due to tighter cost control and a new method of hours allocation in the stores resulting in lower staffing levels during periods of slower sales, (these initiatives, when combined with a lower average store count, accounted for a $7.8 million reduction in payroll expense, which represented 76% of the $10.2 million in store selling expense savings), (2) a $4.5 million decrease in other administrative costs related to the reduced store count and corporate restructuring and cost-saving initiatives, (3) a $2.0 million decrease in other store expenses also due to a lower average store count, (4) a $1.9 million decrease in asset impairments and write-offs, offset by $0.6 million in increased costs for lease terminations to net a $1.3 million decrease over 2002, and (5) a $1.0 million decrease in recruiting, relocation and severance costs.

      These expense reductions were primarily offset by (1) a $2.2 million increase in general administrative costs for higher employee benefits costs primarily due to increased insurance costs and higher costs for consulting fees related to corporate restructuring and financing activities, offset by lower payroll expense in 2003 compared to 2002, (2) a $1.0 million increase in legal costs, and (3) a $2.0 million increase in various other miscellaneous costs and reduced transaction fees that offset selling expenses.

      SG&A decreased $16.6 million to $147.9 million in 2003 when adjusted to remove the liquidation and restructuring charges of $2.8 million. SG&A as a percentage of net sales excluding the liquidation and restructuring charges improved to 28.6% in 2003 from 28.8% in 2002.

      Depreciation and Amortization. Depreciation and amortization increased to $22.4 million in 2003 from $18.8 million in 2002, and increased as a percentage of net sales to 4.3% from 3.3%. The increase of $3.5 million was primarily the result of: (1) a $2.3 million increase in accelerated depreciation recorded in 2003 for increased planned store closures during 2003 and scheduled 2004 closures, primarily related to the liquidation and restructuring activities, as compared to the accelerated depreciation recorded in 2002 for 2002 and planned 2003 store closures, (2) an $0.8 million charge taken for the re-evaluation of asset lives for point-of-sale systems, (3) $0.3 million in increased amortization and depreciation of administrative assets due to higher asset levels in 2003 compared to 2002, and (4) $0.1 million in higher general store depreciation expense.

      Depreciation and amortization, excluding liquidation and restructuring efforts, which totaled $2.3 million in 2003, increased to $20.1 million from $18.8 million in 2002. This $1.3 million increase was primarily due to the $0.8 million charge for the re-evaluation of asset lives for point-of-sale systems and increased amortization and depreciation related to administrative assets.

      Operating Loss. As a result of the above, the operating loss was $25.9 million in 2003 compared to a $13.6 million operating loss in 2002, or (5.0)% of net sales in 2003 as compared to (2.4)% of net sales in 2002. Excluding liquidation and restructuring charges, an operating loss of $17.3 million was reported in 2003 as compared to a $13.6 million operating loss in 2002. The higher operating loss recorded in 2003, excluding the liquidation and restructuring charges, was primarily a function of the decreased sales volume and resulting lower gross margin dollars as offset by the decreased SG&A spending discussed above.

      Interest Expense. Net interest expense increased to $10.9 million in 2003 from $10.3 million in 2002 primarily due to $0.5 million of waiver fees paid to our senior lenders related to our EBITDA covenants in our senior credit facility during the fourth quarter of 2003. In addition, the decreased borrowings under the revolver during 2003 were offset by higher interest rates and increased debt issuance cost amortization. The liquidation and restructuring activities did not impact interest expense.

      Income Tax Benefit. The income tax benefit was $3.2 million in 2003 compared to $9.5 million in 2002. Due to sustained losses, we recorded a valuation allowance of $13.2 million in 2003 against our net deferred tax assets exclusive of the LIFO reserve. In 2002, we did not record a valuation allowance against our net deferred tax assets due to potentially unrealizable net operating carryforwards. This resulted in the effective rate being reduced from 40% in 2002 to 8.7% in 2003. The liquidation and restructuring activities did not impact interest expense.

      Net Loss from Continuing Operations. As a result of the above, the net loss from continuing operations for 2003 was $33.6 million compared to a net loss from continuing operations of $14.3 million in 2002. Excluding liquidation and restructuring charges, the net loss from continuing operations was $25.0 million for 2003 as compared to a $14.3 million loss recorded in 2002.

      Loss from Discontinued Operations and Cumulative Effect of a Change in Accounting Principle. There was no loss from discontinued operations in 2003 as compared to the loss from discontinued operations of $42.0 million in 2002. Included in the 2002 figure is $27.2 million in charges, net of tax, for the disposal of substantially all fixed assets, the markdown of inventory, and severance and lease termination costs for the Travel Subsidiaries in 2002, as well as $14.8 million in losses from operations prior to the announced liquidation. In addition, in 2002 there was a cumulative effect of a change in accounting principle charge of $24.6 million, net of tax, for the Travel Subsidiaries related to the implementation of Statement of Financial

Accounting Standards (“SFAS”) SFAS No. 142, Goodwill and Other Intangible Assets. See Note 3, “Discontinued operations,” contained in our consolidated financial statements for further details.

      Net Loss. As a result of the above, the net loss for 2003 was $33.6 million as compared to an $80.9 million net loss recorded in 2002. Excluding the liquidation and restructuring charges, the net loss for 2003 was $25.0 million as compared to the $80.9 million net loss recorded in 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 and efficiency for our distribution center. Our peak working capital needs typically occur during the period from August through early December as inventory levels are increased in advance of our peak selling season from October through January.

      General Electric Capital Corporation and a syndicate of banks have provided us with a senior credit facility, which was amended on November 1, 2002, January 31, 2003, April 11, 2003, January 21, 2004, April 15, 2004, April 27, 2004, March 2, 2005, and April 4, 2005, that provides for borrowings of up to $150.0 million in aggregate principal amount, including a $25.0 million Term B promissory note and a $75.0 million letter of credit subfacility. The maximum amount available under the revolving credit portion of the senior credit facility is limited to:

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

      As of January 29, 2005, we had no borrowings under the senior credit facility, except for the Term B promissory note, and we had $8.0 million in outstanding letters of credit.

      Through the third quarter of 2005, interest is payable on revolving credit borrowings at variable rates determined by LIBOR plus 1.50%, or the “prime” rate plus 0.25% (commercial paper rate plus 1.50% if the loan is made under the “swing line” portion of the revolver). Commencing with the fourth quarter of 2005, interest will be payable on revolving credit borrowings at variable rates determined by LIBOR plus

1.25%-1.75%, or the “prime” rate plus 0.0%-0.5% (commercial paper rate plus 1.25%-1.75% if the loan is made under the “swing line” portion of the revolver). The applicable margin will be adjusted quarterly on a prospective basis based on achievement of defined quarterly EBITDA targets. Interest is payable on the $25.0 million Term B promissory note at a variable rate equal to the “prime” rate plus 4%, plus an additional 2.75% payable pursuant to a separate letter agreement with General Electric Capital Corporation. We pay monthly fees on the unused portion of the senior credit facility and on the average daily amount of letters of credit outstanding during each month. With the completion of the Equity Financing (described below under “Additional Financing”) and subsequent repurchase and repayment of the 11¹/4% Senior Notes, the senior credit facility now expires on June 28, 2008, at which time all borrowings, including the Term B promissory note, become due and payable. We are allowed to prepay up to $10.0 million on the Term B promissory note portion of the senior credit facility on or before February 28, 2006, without penalty, subject to certain conditions. A total of $5.0 million was prepaid on March 3, 2005. Prepayment of the Term B promissory note (other than the potential prepayment of an additional $5.0 million on or prior to February 28, 2006) is subject to a 0.5% prepayment fee if prepayment is made on or prior to January 31, 2006. The revolving credit portion of the senior credit facility is subject to a 1.0% prepayment fee under most circumstances. The remaining $15.0 million of the Term B promissory note is prepayable only with the consent of the senior lenders under the senior credit facility.

      The senior credit facility contains certain restrictions and covenants, which, among other things, restrict our ability to make capital expenditures; acquire or merge with another entity; make investments, loans or guarantees; incur additional indebtedness; create liens or other encumbrances; or pay cash dividends or make other distributions. At January 29, 2005, we were in compliance with or had received waivers for all covenants related to the senior credit facility.

      We plan to use the senior credit facility for our immediate and future working capital needs. We are dependent on the senior credit facility to fund working capital and letter of credit needs. We believe that the borrowing capacity under the senior credit facility, together with cash on hand, current and anticipated cash flow from operations, cost reductions associated with the lower store count from the liquidation of stores and natural lease terminations and the proceeds from the Equity Financing discussed below, will be adequate to meet our working capital and capital expenditure requirements through 2005. For 2004, the peak borrowings and peak letters of credit outstanding under the senior credit facility (excluding the Term B promissory note) were $32.2 million and $26.9 million, respectively, and the average amount of borrowings and the average amount of letters of credit outstanding were $4.5 million and $12.9 million, respectively. For 2003, the peak borrowings and peak letters of credit outstanding under the senior credit facility (excluding the Term B promissory note) were $72.6 million and $28.9 million, respectively, and the average amount of borrowings and the average amount of letters of credit outstanding were $20.3 million and $12.7 million, respectively. For 2002, the peak borrowings and peak letters of credit outstanding under the senior credit facility (excluding the Term B promissory note) were $132.4 million and $34.2 million, respectively, and the average amount of borrowings and the average amount of letters of credit outstanding were $41.2 million and $19.4 million, respectively.

      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, “Discontinued operations,” contained in our consolidated financial statements.

      On January 22, 2004, we announced a reorganization and partial store liquidation as described in Note 4, “Reorganization and partial store liquidation,” contained in our consolidated financial statements.

      On April 25, 2004, we entered into an agreement to issue 17,948,718 shares of our common stock to three institutional investors at a price of $1.95 per share. The Equity Financing closed on July 2, 2004, with gross proceeds of $35.0 million before offering costs. As additional consideration for the investors’ commitment, on April 25, 2004, we issued two million warrants exercisable for five years to the investors upon signing the Equity Financing agreement, and at closing issued an additional two million warrants exercisable for five years, all at an exercise price of $3.00 per share of common stock. The proceeds of the offering were used to repay the 11¹/4% Senior Notes described above. The remaining balance of these funds was used for general working capital purposes. See “Additional Financing” below.

Cash Flow Analysis

      The following table summarizes our cash flow activity for fiscal 2004, 2003 and 2002:

      Operating Activities. Operating activities of continuing operations for 2004 and 2003 resulted in cash provided of $11.0 million and $31.5 million, respectively, compared to cash used of $36.2 million in 2002.

      The $11.0 million of cash provided by operating activities in 2004 was comprised of: (1) $34.0 million in non-cash adjustments for depreciation, amortization, property and equipment impairment, and restricted stock compensation expense (which increased by $7.7 million over 2003 primarily as a result of increased accelerated depreciation related to the liquidation and restructuring activities), (2) a $3.2 million decrease in inventories (due to a $14.6 million decrease in liquidation inventory offset by increased in-transit of new inventory receipts as of the end of 2004), (3) a $2.5 million decrease in accounts receivable due primarily to reduced credit card receivables as a result of the lower sales volume, (4) a $2.2 million increase in accounts payable and accrued expenses primarily due to increased accounts payable related to in-transit inventory as partially offset by decreased accrued expenses as a result of the overall headcount and store reduction in 2004, and (5) a $0.5 million decrease in prepaid expenses primarily related to decreased marketing pre-payments.

      These sources of cash were partially offset by: (1) a net loss from continuing operations of $23.8 million, (2) a $2.6 million decrease in our deferred income tax liability primarily related to our decreased LIFO inventory reserve, and (3) a $5.0 million decrease in our income tax and other liability accounts.

      The $31.5 million of cash provided by operating activities in 2003 was comprised of: (1) a $29.4 million decrease in inventories due to a strategic operating decision to keep inventory levels more tightly managed

than in previous years, (2) $26.3 million in non-cash adjustments for depreciation, amortization, property and equipment impairment, and restricted stock compensation expense, (3) a $12.9 million increase in deferred taxes, (4) a $5.0 million increase in taxes payable/ receivable and other liabilities primarily due to net operating losses, and (5) a $0.1 million decrease in prepaid assets.

      These sources of cash were primarily offset by: (1) a net loss from continuing operations of $33.6 million, (2) a $1.0 million increase in accounts receivable due to a higher mix of credit card sales at January 31, 2004, due to the 111 store liquidation sale that began in late January 2004 that only accepted cash and credit cards, and (3) a $7.6 million decrease in accounts payable and accrued expenses from a reduction in the volume of merchandise purchased and the lower level of general non-merchandise vendor purchases in 2003 compared to 2002.

      The $36.2 million of cash used by operating activities in 2002 was comprised of cash used for: (1) the net loss from continuing operations of $14.3 million, (2) a $25.7 million increase in inventories due to lower sales volumes than anticipated, (3) a $13.6 million decrease in taxes payable/ receivable and other liabilities primarily due to net operating losses, (4) a $10.8 million increase in deferred taxes, and (5) $0.9 million in cash used by various other operating activities.

      These operating uses were partially offset with cash provided by: (1) $21.9 million in non-cash adjustments for depreciation, amortization, property and equipment impairment, and restricted stock compensation expense, (2) a $3.7 million decrease in accounts receivable due to fewer tenant allowances resulting from a reduction in capital expenditures from 2001, and (3) a $3.5 million increase in accounts payable and accrued expenses primarily as a result of longer aging of payables.

      Investing Activities. Investing activities of continuing operations for 2004 were comprised of $4.8 million in capital expenditures primarily for the construction of new stores and the renovation of and improvements to existing stores, partially offset by $0.2 million from the proceeds on the sale of property and equipment. For 2005, capital expenditures are capped at $10.0 million by our debt agreements.

      Investing activities of continuing operations for 2003 were comprised of $9.4 million in capital expenditures primarily for the construction of new stores and the renovation of and improvements to existing stores, offset by $0.5 million from proceeds on the sale of property and equipment.

      Investing activities of continuing operations for 2002 were comprised of $9.9 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 net proceeds from the sale/leaseback of our headquarters facility in Brooklyn Park, Minnesota.

      Financing Activities. Cash provided by financing activities in 2004 was $0.2 million, as a result of $32.5 million in net proceeds from the Equity Financing completed on July 2, 2004, as offset by: (1) $30.6 million used to repurchase our 11¹/4% Senior Notes, (2) $0.6 million in reduced other borrowings, and (3) $1.2 million used for debt acquisition costs related to amendments to our senior credit facility in April 2004.

      Cash provided by financing activities of continuing operations in 2003 was $0.5 million, as a result of: (1) $1.1 million provided by the issuance of common stock from the exercise of stock options, and (2) $0.5 million provided by the issuance of notes payable to finance an information services maintenance agreement. These amounts were offset by: (1) $1.0 million used for debt acquisition costs for the refinancing of the senior credit facility in April 2003, and (2) $0.1 million used for the repayment of a note payable.

      Cash provided by financing activities of continuing operations in 2002 was $11.2 million, which consisted primarily of $13.2 million provided by the issuance of common stock from two private placement transactions and the exercise of stock options, offset by $2.1 million used for debt acquisition costs.

      Contractual Obligations and Commercial Commitments. We have entered into agreements that create contractual obligations and commercial commitments. These obligations and commitments will have an impact on future liquidity and the availability of capital resources. The tables noted below present a summary of these obligations and commitments:

Contractual Obligations

Payments Due by Period (in thousands)

Commercial Commitments

Amount of Commitment by Period (in thousands)

Off-Balance Sheet Arrangements

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

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.

Discontinued Operations

      In October 2000, we acquired El Portal, a 38 store chain of premium travel products and accessories located in Las Vegas, Nevada. In April 2001, we acquired Bentley’s, a 106 store chain of specialty luggage products based in Miami, Florida. During 2001 and 2002, we worked to integrate the operations of both

companies by consolidating the two corporate operations in Las Vegas, Nevada and moving all back-office processing to our headquarters in Brooklyn Park and Maple Grove, Minnesota. Due to substantial losses experienced by the Travel Subsidiaries during 2001 and 2002, on November 19, 2002, we announced the liquidation of all 135 stores operated by the Travel Subsidiaries. The Travel Subsidiaries and certain of their affiliates entered into an agreement with a joint venture comprised of Hilco Real Estate, LLC and Hilco Merchant Resources, LLC (collectively “Hilco”) to liquidate the remaining inventory of the Travel Subsidiaries and exit the store leases. As a result of this decision, the Travel Subsidiaries have been presented as discontinued operations effective November 19, 2002, and the consolidated financial statements were reclassified to separate the net investment in, and the liabilities and operating results of, the Travel Subsidiaries.

      During 2002, we received net proceeds totaling $13.9 million as a result of discontinued operations. We also recorded a $27.2 million charge, net of tax, related to the exit of the Travel Subsidiaries. This charge primarily included severance costs, inventory markdowns, a write-off of store fixed assets, and lease termination fees. For 2002, we recorded a loss on discontinued operations of $42.0 million (net of tax), including the $27.2 million charge for the closure of the Travel Subsidiaries and the $14.8 million net operating loss in the Travel Subsidiaries during 2002. For 2004, we recorded a gain on discontinued operations of the Travel Subsidiaries of $173,000, net of tax, related to the remaining discontinued operations liability at the end of 2004 that was no longer required. See Note 3, “Discontinued operations,” contained in our consolidated financial statements.

Reorganization and Partial Store Liquidation

      On January 22, 2004, we announced that we would liquidate up to 100 underperforming mall and outlet stores (subsequently revised to 111 stores) and eliminate approximately 950 store-related positions. We entered into an Agency Agreement with a joint venture comprised of Hilco Merchant Resources, LLC, Gordon Brothers Retail Partners, LLC and Hilco Real Estate, LLC (the “Hilco/Gordon Brothers Joint Venture”) to liquidate the inventory in the 111 stores and assist in the discussions with landlords regarding lease terminations in approximately 94 of these stores. Pursuant to the Agency Agreement, the Hilco/ Gordon Brothers Joint Venture guaranteed us an amount of 84.0% of the cost value of the inventory, subject to certain adjustments. The Hilco/ Gordon Brothers Joint Venture was responsible for all expenses related to the sale. In addition, we announced that we would eliminate approximately 70 positions at our corporate headquarters in Brooklyn Park, Minnesota and distribution centers located in Minnesota and Nevada, as well as the closure of our distribution center in Las Vegas, Nevada, to better align our financial structure with current business conditions. See Note 4, “Reorganization and partial store liquidation,” contained in our consolidated financial statements.

      For these actions we incurred charges related to the restructuring and partial store liquidation of $27.4 million and $8.6 million, during 2004 and 2003, respectively, primarily related to the transfer of inventory to an independent liquidator in conjunction with the closing of the liquidation stores, lease termination costs, accelerated depreciation, asset write-offs related to store closings, severance, including payments under our agreements with David L. Rogers and Joel N. Waller, performance bonuses due former officers of the Company, retention bonuses and other restructuring costs. In 2004, a total of $17.4 million and $13.8 million of these charges were recorded in selling, general and administrative expenses and depreciation and amortization, respectively, as partially offset by $3.8 million of gross margin earned on the liquidation sales. In 2003, a total of $2.8 million and $2.3 million of these charges were recorded in selling, general and administrative expenses and depreciation and amortization, respectively, in addition to the $3.5 million gross margin loss realized on the liquidation sales. The liquidation sales were completed in April 2004, and as of May 1, 2004, all the liquidation stores had been closed. As of October 30, 2004, we had successfully negotiated all of the lease terminations. The overall net cash outlay for the restructuring activities was slightly negative.

Additional Financing

      On April 25, 2004, we entered into an agreement to issue 17,948,718 shares of our common stock (the “Equity Financing”) to three institutional investors at a price of $1.95 per share. The transaction closed on

July 2, 2004, with gross proceeds before offering expenses of $35.0 million. As additional consideration for the investors’ commitment, on April 25, 2004, we issued two million warrants exercisable for five years to the investors upon signing the Equity Financing agreement, and at closing, issued an additional two million warrants exercisable for five years, all at an exercise price of $3.00 per share of common stock. On July 9, 2004, we repurchased $22.0 million of our 11¹/4% Senior Notes with proceeds from the Equity Financing. We repaid the remaining $8.6 million of the 11¹/4% Senior Notes at maturity with proceeds from the Equity Financing and have used the balance of these proceeds for general working capital purposes.

Quarterly Results

      The following table sets forth certain unaudited consolidated financial information from our historical consolidated statements of operations for each fiscal quarter of 2004 and 2003. This quarterly information has been prepared on a basis consistent with our audited consolidated financial statements appearing elsewhere in this Form 10-K and reflects adjustments which, in the opinion of management, consist of normal recurring adjustments necessary for a fair presentation of such unaudited quarterly results when read in conjunction with the audited consolidated financial statements and notes thereto. As more fully discussed in Note 2, “Reclassification of financial statements,” contained in our consolidated financial statements, we changed our accounting method for leasehold improvements funded by landlord incentives and adopted an accounting policy for rent costs during construction build-out periods. Our unaudited quarterly operating results for each fiscal quarter of 2004 and 2003, shown below, reflect these reclassifications (in thousands, except per share amounts):