POSSIBILITIES

ANNUAL REPORT

$ 1 4 . 1 5 $ 1 2 . 9 4 $ 9 . 5 1

$ 1 1 . 5 0

2004

2ndQtr3rdQtrEOY

$ 1 3 . 6 6 $ 1 9 . 4 2 $ 1 7 . 1 3

$ 2 3 . 1 6

2005

$ 2 2 . 9 7 $ 2 4 . 1 7 $ 2 6 . 2 1

$ 3 4 . 9 6

2006

Our vision is to democratizefashion and design in footwearand accessories to the world.

Dear Stockholders:

The year 2006 was an amazing year for Payless in so many ways. As an organization, we refo-cused ourselves around the marketplace and the customer. We crafted a strategy that lever-aged our strengths and clariﬁed our opportunities. Then, together as a team and individuallyas team members, we went about bringing that strategy to life with great passion and carefulthought. We executed. The results were solid 3.5% comparable store sales growth, record salesfor the Payless store brand, gross margin expansion to a historically high level, operating proﬁtfrom continuing operations up 41%, and realizing a value creating ROIC. Importantly, we havebuilt a foundation for success in the years to come. All of these accomplishments contributedto a 47% increase in our share price.

Matthew E. Rubel

Chief Executive Ofﬁcer and President

Our vision at Payless is to democratizefashion and design in footwear and acces-sories to the world. It is simple, focusedand inclusive. In an elevated manner, ourmission is to become the ﬁrst choice forstyle and value in footwear and acces-sories. Consistent with this vision andmission, we have developed a set of per-formance objectives that will guide ourstrategy for the years to come.The path for our team is focused on a strat-egy centered around creating an emo-tional connection with our customers.

1stQtr2ndQtr3rdQtrEOY1stQtr2ndQtr3rdQtrEOY1stQtr

Closing stock price for Payless ShoeSource Inc. on last day of the ﬁscal quarter.

Our mission is to become the ﬁrst choice for styleand value in footwear andaccessories.

In 2006, we did this so well that our brand differ-entiation scores went up 59 points. This was sostartling, we sent the results back to see if theywere correct. They were. The customer seesthe difference at Payless and is buying morefrom us because of it. Over time, this will leadto higher conversion rates and increased trafficin our stores.The most important and sustainable elementsof our strategy are to build a customer-focusedorganization and infrastructure. We are commit-ted to building an organization of great people.We have revitalized our talent identification anddevelopment process. We have strengthenedour people development initiatives by level,function, and individual. We have injected over30 new senior executives into the organizationfrom the world’s best retailers and footwearcompanies. These individuals, paired with ourstrong, talented and experienced long-timeassociates, have created a dynamic yet well-grounded organization.A recent internal survey indicates that over 95%of our leadership understands and has con-fidence in our strategy and over 90% under-stands their role in executing the strategy. Thisis a credit to the team and shows how alignedwe are throughout our company.The four pillars of our core strategy all showedprogress, contributed to our results and re-vealed even more opportunities for the future.