UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

For the quarterly period ended July 31, 2004

OR

For the transition period from                     to                    

Commission file number 0-19526

Goody’s Family Clothing, Inc.

(Exact name of registrant as specified in its charter)

(865) 966-2000

(Registrant’s telephone number, including area code)

(Former name, former address and former fiscal year, if changed since last report.)

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

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

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Common Stock, no par value, 32,975,052 shares outstanding as of August 13, 2004.

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Goody’s Family Clothing, Inc.
Index to Form 10-Q
July 31, 2004

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PART 1 — FINANCIAL INFORMATION

Item 1 — Condensed Consolidated Financial Statements

Goody’s Family Clothing, Inc. and Subsidiaries

See accompanying Notes to Condensed Consolidated Financial Statements and Report of Independent Registered Public Accounting Firm.

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Goody’s Family Clothing, Inc. and Subsidiaries

See accompanying Notes to Condensed Consolidated Financial Statements and Report of Independent Registered Public Accounting Firm.

4

Goody’s Family Clothing, Inc. and Subsidiaries

See accompanying Notes to Condensed Consolidated Financial Statements and Report of Independent Registered Public Accounting Firm.

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Goody’s Family Clothing, Inc. and Subsidiaries

(1) Basis of presentation

The accompanying condensed consolidated financial statements of Goody’s Family Clothing, Inc. and subsidiaries (the “Company”) are unaudited and have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission for interim financial statements. In the opinion of the Company’s management, the accompanying unaudited condensed consolidated financial statements include all adjustments, consisting primarily of normal and recurring adjustments, necessary for a fair presentation of the Company’s financial position, results of operations and cash flows for the interim periods presented. Due to the seasonal nature of the Company’s business, the results of operations for the interim periods are not necessarily indicative of the results that may be achieved for the entire year. The condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto contained in the Company’s Annual Report on Form 10-K for its fiscal year ended January 31, 2004. Certain reclassifications have been made to the condensed consolidated financial statements of prior periods to conform to the current period presentation.

(2) Stock-Based Compensation

The Company has options outstanding under four stock option plans: the Goody’s Family Clothing, Inc. Amended and Restated 1991 Stock Incentive Plan (the “1991 Plan”), the Goody’s Family Clothing, Inc. Amended and Restated 1993 Stock Option Plan (the “1993 Plan”), the Goody’s Family Clothing, Inc. Amended and Restated 1997 Stock Option Plan (the “1997 Plan”) and the Amended and Restated Discounted Stock Option Plan for Directors (the “Directors’ Plan”).

The Company accounts for its stock option plans under the recognition and measurement principles of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related Interpretations. No stock-based employee compensation cost is reflected in net earnings, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. However, expense is recorded in connection with stock options issued under the Directors’ Plan to non-employee directors and this expense has been insignificant. Interim proforma information regarding net income and earnings per share is required by Statement of Financial Accounting Standards No. 148 (“SFAS 148”), “Accounting for Stock-Based Compensation — Transition and Disclosure — an Amendment of Financial Accounting Standards Board (“FASB”) Statement No. 123,” which requires that the information be determined as if the Company had accounted for its employee stock options granted under the fair value method of that statement. The following table illustrates the effect on net earnings and earnings per common share if the Company had applied the fair value recognition provisions of SFAS 148 to stock-based employee compensation (in thousands, except per share amounts):

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Goody’s Family Clothing, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements — continued
(Unaudited)

The weighted-average fair value of each stock option included in the preceding pro forma amounts was estimated using the Black-Scholes option-pricing model and is amortized over the vesting period of the underlying options.

(3) Credit arrangements

In May 2001, the Company entered into a five-year, $130,000,000 syndicated revolving loan and security agreement that provides for cash borrowings for general corporate purposes, including a $95,000,000 sub-facility for the issuance of letters of credit. Borrowings under this credit facility are limited by collateral formulas, based principally upon the Company’s eligible inventories. The credit facility is secured primarily by the Company’s inventories, receivables and cash and cash equivalents. The borrowing base was $184,089,000 at July 31, 2004, which excludes cash and most of cash equivalents and only gives credit for specified percentages of inventory and receivables. The amount available to draw under the credit facility at July 31, 2004 was approximately $86,473,000. If availability (as calculated pursuant to the credit facility) falls below $25,000,000, the Company would be required, for a period of time, to comply with a financial covenant requiring it to maintain minimum levels of tangible net worth based on formulas. The Company’s availability did not fall below $25,000,000 during the twenty-six weeks ended July 31, 2004, or August 2, 2003 and therefore the Company was not required to comply with this financial covenant. The credit facility also contains certain discretionary provisions that enable the lender to reduce availability. The credit facility bears interest at LIBOR plus an applicable margin or the prime rate. In June 2003, the credit facility was amended to permit cash dividends in any fiscal year on the common stock in an amount not to exceed (i) $3,500,000 (but not to exceed $10,000,000 in the aggregate during the remaining term of the credit facility) plus (ii) 50% of the Company’s consolidated net income for the immediately preceding fiscal year. In June 2003, the lenders agreed to waive any events of default which could be deemed to have occurred by reason of the Court’s decision in the Hilfiger Matter described below. At July 31, 2004, the Company had no borrowings and $25,350,000 in letters of credit (not yet reflected in accounts payable) outstanding under the facility. These letters of credit generally have terms of less than one year and are primarily used to facilitate the purchase of import merchandise.

(4) Contingencies

Class Action Proceeding

In February 1999, a lawsuit was filed in the United States District Court for the Middle District of Georgia and was served on the Company and Robert M. Goodfriend, its Chairman of the Board and Chief Executive Officer, by 20 named plaintiffs, generally alleging that the Company discriminated against a class of African-American employees at its retail stores through the use of discriminatory selection and compensation procedures and by maintaining unequal terms and conditions of employment. The plaintiffs further alleged that the Company maintained a racially hostile working environment.

On February 28, 2003, a proposed Consent Decree was filed with the District Court for its preliminary approval. The proposed Consent Decree sets forth the proposed settlement of the class action race discrimination lawsuit. Ultimately, class action certification was sought in the lawsuit only with respect to alleged discrimination in promotion to management positions and the proposed Consent Decree is limited to such claims. Generally, the proposed settlement provides for a payment by the Company in the aggregate amount of $3.2 million to the class members (including the named plaintiffs) and their counsel, as well as the Company’s implementation of certain policies, practices and procedures regarding, among other things, training of employees. The Company’s employer liability insurance underwriter has funded $3.1 million of such payment to a third-party administrator. The proposed Consent Decree explicitly provides that it is not an admission of liability by the Company and the Company continues to deny all of the allegations. On April 30, 2003, the District Court granted preliminary approval of the proposed Consent Decree, and a hearing was held on June 30, 2003, regarding the adequacy and fairness of the proposed settlement. On March 3, 2004, the United States District Court for the Middle District of Georgia issued an Order granting final approval of the Consent Decree. On or about February 23, 2004, a purported class member filed an appeal with the U.S. Court of Appeals for the Eleventh Circuit (the “Eleventh Circuit”), alleging, among other things, misconduct on the part of the District Court and the plaintiff’s/appellant’s counsel; the Eleventh Circuit dismissed this appeal on March 5, 2004. On or about March 12, 2004, a Motion to set aside the dismissal was filed with the Eleventh Circuit. On May 28, 2004, the Eleventh Circuit dismissed all appeals regarding this matter. Pursuant to the terms of the March 3, 2004 Order, the District Court will maintain jurisdiction of this matter until July 2006 to monitor the parties’ compliance with the Consent Decree.

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Goody’s Family Clothing, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements — continued
(Unaudited)

Hilfiger Matter, Sun Matter and Related Insurance Matters

In July 2000, Tommy Hilfiger Licensing, Inc. (“Hilfiger”) commenced an action against the Company in the United States District Court for the Northern District of Georgia, alleging, among other things, counterfeiting and trademark infringement (the “Hilfiger Matter”). A bench trial for the Hilfiger Matter concluded on March 13, 2003, and on May 9, 2003, the Court rendered its decision, awarding damages to Hilfiger in the amount of approximately $11.0 million, plus reasonable attorney’s fees and costs.

In June 2002, Hilfiger brought an action against Sun Apparel, Inc. (“Sun”), a Goody’s denim supplier, alleging trademark infringement arising out of Sun’s manufacture of the allegedly infringing labels that gave rise to Hilfiger’s trademark infringement claims against Goody’s (the “Sun Matter”). Goody’s had agreed to pay for the defense of the Sun Matter because of certain indemnification obligations it had to Sun.

At the time the Hilfiger Matter commenced, the Company’s primary liability insurer indicated that it would reimburse Goody’s for its legal fees and expenses. In February 2003, after several unsuccessful attempts to obtain such reimbursement, Goody’s filed an insurance coverage action against the insurers. Following the commencement of such action, the primary insurer agreed to reimburse Goody’s for a substantial portion of its past and future legal expenses. However, the insurance carriers reserved their rights regarding their obligations to indemnify Goody’s against damages resulting from the Hilfiger claims and the Sun Matter and the carriers asserted certain defenses against their indemnity obligations. On May 13, 2003, Fireman’s Fund Insurance Company (“Fireman’s Fund”), the excess layer (umbrella insurance) carrier, commenced an action against Goody’s in the Chancery Court for Knox County, Tennessee, seeking a declaratory judgment against Goody’s declaring that it has no duty to indemnify Goody’s in the Hilfiger Matter (the Goody’s suit against the insurers and the Fireman’s Fund suit against the Company are collectively referred to herein as the “Insurance Matters”).

The Company recorded a pretax charge of $7,996,000 during the thirteen weeks ended May 3, 2003, for legal claims and related legal fees in connection with the Hilfiger Matter and related matters.

In June 2003, the Company reached a settlement agreement with Hilfiger, resolving all outstanding issues arising out of the Hilfiger Matter. Under the settlement, the Company agreed to make an $11.0 million cash payment to Hilfiger. The settlement amount also encompassed the settlement of the Sun Matter. In June 2003, the Company also reached an agreement in principle with its insurance carriers regarding the Insurance Matters and a definitive settlement agreement with its insurance carriers was executed in July 2003. The settlement enabled the Company to reverse $4,441,000 ($0.08 per diluted share after taxes) of the pretax charge of $7,996,000 ($0.15 per diluted share after taxes) in the second quarter of fiscal 2003.

Other Matters

In addition, the Company is a party to various other legal proceedings arising in the ordinary course of its business. The Company has various insurance policies in place in the event of unfavorable outcomes from such proceedings. The insurance companies’ level of, and willingness to, support their coverage could vary depending upon the circumstances of each particular case. As such, there can be no assurance as to the level of support available from insurance policies. The Company does not currently believe that the ultimate outcome of all such pending legal proceedings, individually or in the aggregate, would have a material adverse effect on the Company’s financial position, results of operations or cash flows.

(5) Intangible Assets

The Company purchased the Duck Head trademarks and four related licenses from TSI Brands Inc., and its parent corporation, Tropical Sportswear Int’l Corporation during the second quarter of fiscal 2003 for $4,000,000, and total acquisition costs were ultimately $4,103,000. In accordance with FASB Statement No. 142, “Goodwill and Other Intangible Assets,” the Company performed a valuation of the trademarks during fiscal 2003 and determined that the asset has an indefinite life and no impairment charge was necessary.

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Shareholders
Goody’s Family Clothing, Inc.
Knoxville, Tennessee:

We have reviewed the accompanying condensed consolidated balance sheets of Goody’s Family Clothing, Inc. and Subsidiaries (the “Company”) as of July 31, 2004 and August 2, 2003, and the related condensed consolidated statements of operations for the thirteen and twenty-six week periods ended July 31, 2004 and August 2, 2003, and of cash flows for the twenty-six week periods ended July 31, 2004 and August 2, 2003. These interim condensed consolidated financial statements are the responsibility of the Company’s management.

We conducted our reviews in accordance with standards established by the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with auditing standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our reviews, we are not aware of any material modifications that should be made to such condensed consolidated interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.

We have previously audited, in accordance with auditing standards generally accepted in the United States of America, the consolidated balance sheet of the Company as of January 31, 2004, and the related consolidated statements of operations, shareholders’ equity, and cash flows for the year then ended (not presented herein); and in our report dated March 19, 2004, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of January 31, 2004, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

/s/Deloitte & Touche LLP
Atlanta, Georgia
August 18, 2004

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Item 2. — Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-looking Statements

This Quarterly Report contains certain forward-looking statements which are based upon current expectations, business plans and estimates and involve material risks and uncertainties including, but not limited to:

Any “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which generally can be identified by the use of forward-looking terminology such as “may,” “will,” “expect,” “estimate,” “anticipate,” “believe,” “target,” “plan,” “project,” or “continue” or the negatives thereof or other variations thereon or similar terminology, are made on the basis of management’s plans and current analysis of the Company, its business and the industry as a whole. Readers are cautioned that any such forward-looking statement is not a guarantee of future performance and involves risks and uncertainties, and that actual results may differ materially from those projected in the forward-looking statement as a result of various factors. The Company does not undertake to publicly update or revise its forward-looking statements even if experience or future changes make it clear that any projected results expressed or implied therein will not be realized. Additional information on risk factors that could potentially affect the Company’s financial results may be found in the Company’s public filings with the Securities and Exchange Commission. Certain of such filings may be accessed through the Company’s web site, http://www.goodysonline.com, then choose “SEC Filings.”

Critical Accounting Policies

The Company’s accompanying interim condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America, which require management to make estimates that affect the amounts of revenues, expenses, assets and liabilities reported. The critical accounting matters that are very important to the portrayal of the Company’s financial condition and results of operations and require some of management’s most difficult, subjective and complex judgments are described in detail in the Company’s Annual Report on Form 10-K for the fiscal year ended January 31, 2004. The accounting for these matters involves forming estimates based on current facts, circumstances and assumptions which, in management’s judgment, could change in a manner that would materially affect management’s future estimates with respect to such matters and, accordingly, could cause future reported financial condition and results of operations to differ materially from financial results reported based on management’s current estimates. There have been no material changes in the critical accounting policies during the twenty-six weeks ended July 31, 2004.

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Results of Operations

The following table sets forth unaudited results of operations, as a percent of sales, for the periods indicated:

Thirteen Weeks Ended July 31, 2004 Compared with Thirteen Weeks Ended August 2, 2003

Overview During the second quarter of fiscal 2004, the Company opened 5 new stores and remodeled 2 stores, bringing the total number of stores in operation at July 31, 2004 to 345, compared with 332 at August 2, 2003. During the second quarter of fiscal 2003, the Company opened five new stores and relocated or remodeled five stores. Net earnings for the second quarter of fiscal 2004 were $1,256,000, or 0.4% of sales, compared with net earnings for the second quarter of fiscal 2003 of $7,110,000, or 2.4% of sales. Net earnings for the second quarter of fiscal 2003 included a pretax credit of $4,441,000 associated with the Hilfiger Matter and related matters as discussed in Note 4 to the Notes to Consolidated Financial Statements.

Sales Sales for the second quarter of fiscal 2004 were $294,632,000, a 0.2% increase from the $294,039,000 in sales for the second quarter of fiscal 2003. This increase of $593,000 consisted of a $6,817,000 increase in additional net sales from new stores, transition stores and sales from stores that were subsequently closed, offset by a $6,224,000 decrease in comparable store sales. Comparable store sales for the second quarter of fiscal 2004 decreased 2.2% compared with the second quarter of fiscal 2003. Sales for the second quarter of fiscal 2004 were negatively affected by (i) unusually wet weather in June, (ii) a shift in sales tax holidays in four states from the second quarter of fiscal 2003 to the third quarter of fiscal 2004, and (iii) an overbalance of seasonal receipts in the first quarter versus the second quarter of fiscal 2004. Sales of private-label merchandise, which includes the Company’s exclusive Duck Head lines launched March 14, 2004, increased to approximately 32.4% of total merchandise sales for the second quarter of fiscal 2004 from 26.5% of total merchandise sales for the same period in the prior year.

Gross profit Gross profit for the second quarter of fiscal 2004 was $87,963,000, or 29.8% of sales, a $2,020,000 increase from the $85,943,000 in gross profit, or 29.2% of sales, for the second quarter of fiscal 2003. The 0.6% increase in gross profit as a percent of sales in the second quarter of fiscal 2004 compared with the second quarter of fiscal 2003 resulted from an 0.8% increase in merchandise margins, offset by a 0.2% increase in occupancy costs due to the decrease in comparable store sales and the resulting lack of leverage as a percentage of sales. The improvement in gross profit was partially attributable to increased private-label sales, which produce higher gross margins, overall, than the Company’s branded merchandise offerings.

Selling, general and administrative expenses Selling, general and administrative expenses for the second quarter of fiscal 2004 were $86,037,000, or 29.2% of sales, an increase of $11,175,000 from $74,862,000, or 25.5% of sales, for the second quarter of fiscal 2003. Selling, general and administrative expenses increased by 3.7%, as a percent of sales, for the second quarter of fiscal 2004 compared with the second quarter of fiscal 2003. Selling, general and administrative expenses in the second quarter of fiscal 2003, excluding the pretax credit of $4,441,000 related to the previously reported settlements of the Hilfiger litigation, were $79,303,000 or 27.0% of sales. Selling, general and administrative expenses increased by 2.2%, as a percent of sales, for the second quarter of fiscal 2004 compared with the second quarter of fiscal 2003 (excluding the settlements of the Hilfiger litigation in the second quarter of fiscal 2003). The 2.2% increase relates primarily to (i) a 0.5% increase in the provision for health care costs, (ii) a 0.4% increase in workers’ compensation expense, (iii) a 0.3% increase in legal expenses, (iv) a 0.2% increase in professional fees, primarily related to compliance with Section 404 of the Sarbanes-Oxley Act of 2002, (v) a 0.2% increase in payroll expense, net of a 0.6% decrease in the accrual of performance

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bonuses, (vi) a 0.1% increase in depreciation expense, and (vii) a 0.5% increase in all other selling, general and administrative expenses.

Income taxes The provision for income taxes for the second quarter of fiscal 2004 was $746,000, for an effective tax rate of 37.26% of earnings before income taxes, compared with a provision for income taxes of $4,175,000, for an effective tax rate of 37.00% of earnings before income taxes, for the second quarter of fiscal 2003.

Twenty-six Weeks Ended July 31, 2004 Compared with Twenty-six Weeks Ended August 2, 2003

Overview During the twenty-six weeks ended July 31, 2004, the Company opened 10 new stores, relocated 1 store and remodeled 7 stores, bringing the total number of stores in operation at July 31, 2004 to 345, compared with 335 at January 31, 2004 and 332 at August 2, 2003. During the corresponding period of the previous fiscal year, the Company opened 5 new stores, relocated or remodeled 10 stores and closed 1 store. Net earnings for the twenty-six weeks ended July 31, 2004 were $9,319,000, or 1.6% of sales, compared with net earnings for the twenty-six weeks ended August 2, 2003 of $8,973,000, or 1.6% of sales. Net earnings for the twenty-six weeks ended August 2, 2003 included a pretax charge of $3,555,000 related to the previously reported settlements of the Hilfiger Matter and related matters as discussed in Note 4 to the Notes to Consolidated Financial Statements.

Sales Sales for the twenty-six weeks ended July 31, 2004 were $597,510,000, a 3.5% increase from the $577,051,000 in sales for the twenty-six weeks ended August 2, 2003. This increase of $20,459,000 consisted of $15,194,000 in additional net sales from new stores, transition stores and sales from stores that were subsequently closed and $5,265,000 in comparable store sales. Comparable store sales for the twenty-six weeks ended July 31, 2004 increased 0.9% compared with the corresponding period of the previous fiscal year. Sales of private-label merchandise, which includes the Company’s exclusive Duck Head lines launched March 14, 2004, increased to approximately 32.8% of total merchandise sales for the twenty-six weeks ended July 31, 2004, from 29.4% of total merchandise sales for the same period in the prior year.

Gross profit Gross profit for the twenty-six weeks ended July 31, 2004 was $180,918,000, or 30.3% of sales, a $9,159,000 increase from the $171,759,000 in gross profit, or 29.8% of sales, for the twenty-six weeks ended August 2, 2003. The 0.5% increase in gross profit as a percent of sales for the twenty-six weeks ended July 31, 2004 compared with the twenty-six weeks ended August 2, 2003 resulted primarily from an increase in merchandise margins. The improvement in gross profit was partially attributable to increased private-label sales, which produce higher gross margins, overall, than the Company’s branded merchandise offerings.

Selling, general and administrative expenses Selling, general and administrative expenses for the twenty-six weeks ended July 31, 2004 were $166,327,000, or 27.9% of sales, an increase of $8,431,000 from $157,896,000, or 27.4% of sales, for the twenty-six weeks ended August 2, 2003. Selling, general and administrative expenses, excluding the pretax charge of $3,555,000 related to the previously reported settlements of the Hilfiger litigation during the twenty-six weeks ended August 2, 2003, were $154,341,000 or 26.7% of sales. Selling, general and administrative expenses increased by 1.2%, as a percent of sales, for the twenty-six weeks ended July 31, 2004 compared with the twenty-six weeks ended August 2, 2003 (excluding the settlements of the Hilfiger litigation in the second quarter of fiscal 2003). The 1.2% increase relates primarily to (i) a 0.4% increase in the provision for health care costs, (ii) a 0.2% increase in workers’ compensation expense, (iii) a 0.2% increase in legal fees, (iv) a 0.1% increase in professional fees, primarily related to compliance with Section 404 of the Sarbanes-Oxley Act of 2002, and (v) a 0.5% increase in all other selling, general and administrative expenses, offset by (vi) a 0.2% decrease in payroll expense, net of a 0.4% decrease in the accrual of performance bonuses.

Income taxes The provision for income taxes for the twenty-six weeks ended July 31, 2004 was $5,532,000, for an effective tax rate of 37.25% of earnings before income taxes, compared with a provision for income taxes of $5,270,000, for an effective tax rate of 37.00% of earnings before income taxes, for the twenty-six weeks ended August 2, 2003.

Liquidity and Capital Resources

Financial Position The Company’s primary sources of liquidity are cash flows from operations, including credit terms from vendors and factors, and borrowings under its credit facility discussed below. At July 31, 2004, January 31, 2004 and August 2, 2003, the Company’s working capital was $141,023,000, $135,522,000 and $119,260,000, respectively. The increase in working capital from August 2, 2003 to July 31, 2004 was $21,763,000 and the increase from January 31, 2004 to July 31, 2004 was $5,501,000.

The $21,763,000 increase in working capital from August 2, 2003 to July 31, 2004, consists primarily of (i) $18,006,000 in earnings, (ii) $8,390,000 from the purchase of the Company’s interests in certain split-dollar life insurance policies, (iii)

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$1,933,000 from the issuance of common stock through the exercise of stock options, offset by, (iv) a $5,494,000 net change in property and equipment, and (v) dividends paid of $2,624,000.

The $5,501,000 increase in working capital from January 31, 2004 to July 31, 2004, consists primarily of (i) $9,319,000 in earnings, (ii) $691,000 from the issuance of common stock through the exercise of stock options, partially offset by (iii) a $4,659,000 net change in property, plant and equipment, and (iv) dividends paid of $1,316,000.

In May 2001, the Company entered into a five-year, $130,000,000 syndicated revolving loan and security agreement that provides for cash borrowings for general corporate purposes, including a $95,000,000 sub-facility for the issuance of letters of credit. Borrowings under this credit facility are limited by collateral formulas, based principally upon the Company’s eligible inventories. The credit facility is secured primarily by the Company’s inventories, receivables and cash and cash equivalents. The borrowing base was $184,089,000 at July 31, 2004, which excludes cash and most of cash equivalents and only gives credit for specified percentages of inventory and receivables. The amount available to draw under the credit facility at July 31, 2004 was approximately $86,473,000. If availability (as calculated pursuant to the credit facility) falls below $25,000,000, the Company would be required, for a period of time, to comply with a financial covenant requiring it to maintain minimum levels of tangible net worth based on formulas. The credit facility also contains certain discretionary provisions that enable the lender to reduce availability. The credit facility bears interest at LIBOR plus an applicable margin or the prime rate. In June 2003, the credit facility was amended to permit cash dividends in any fiscal year on the common stock in an amount not to exceed (i) $3,500,000 (but not to exceed $10,000,000 in the aggregate during the remaining term of the credit facility) plus (ii) 50% of the Company’s consolidated net income for the immediately preceding fiscal year. In June 2003 the lenders agreed to waive any events of default which could be deemed to have occurred by reason of the Court’s decision in the Hilfiger Matter.

At July 31, 2004, January 31, 2004 and August 2, 2003, the Company had (i) no cash borrowings under the credit facility and (ii) letters of credit outstanding not yet reflected in accounts payable of $25,350,000, $28,908,000 and $25,105,000, respectively. There were no cash borrowings at any time during the twenty-six weeks ended July 31, 2004 and August 2, 2003. Letters of credit outstanding averaged $36,923,000 during the twenty-six weeks ended July 31, 2004, compared with $38,497,000 during the twenty-six weeks ended August 2, 2003. The highest balance of letters of credit outstanding during the twenty-six weeks ended July 31, 2004, was $43,473,000 in July 2004 compared with $47,428,000 in February 2003 during the twenty-six weeks ended August 2, 2003.

Cash Flows Cash provided by operating activities was $2,200,000 and $4,408,000 for the twenty-six weeks ended July 31, 2004 and August 2, 2003, respectively. Cash used for increases in inventory during the twenty-six weeks ended July 31, 2004 and August 2, 2003, was $42,003,000 and $37,463,000, respectively. Inventories on a per square foot basis were $25.17 and $23.51 at July 31, 2004 and August 2, 2003, respectively, which represents a 7.1% increase on a per square foot basis. While inventory levels remain above plan at the end of the second quarter, the inventory increases from the end of the fiscal year and from the end of the second quarter last year were primarily attributable to (i) the result of a sales shortfall from plan, (ii) additional merchandise to support the March 14, 2004 launch of the new Duck Head sportswear lines, (iii) the July 2004 introduction of the new Duck Head Jeans Company denim lines, (iv) expand certain other merchandise offerings including assortments for automatically replenished basic merchandise and special size categories, and (v) merchandise for new and relocated stores opening after the end of the second fiscal quarter of 2004. Additionally, as it relates to the comparison with year-end inventory levels, the inventory balance at the