SOLO SERVE CORP, 10-K, 1998-05-01

SOLO SERVE CORP
10-K, 1998-05-01
VARIETY STORES

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<PAGE> 1

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED JANUARY 31, 1998

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

Commission file number 0-19994

SOLO SERVE CORPORATION
------------------------------------------------------
(Exact name of registrant as specified in its charter)

Delaware 74-2048057
------------------------------ ------------------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)

1610 Cornerway Blvd., San Antonio, Texas 78219
----------------------------------------------
(Address of Principal Executive Offices)

(210) 662-6262
--------------
(Registrant's telephone number, including area code)

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
None

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Common Stock, par value $.01 per share

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 if 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 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. [ ]

The aggregate market value of the voting stock (which consists of
shares of Common Stock and Preferred Stock) held by non-affiliates of the
registrant as of April 29, 1998 cannot be determined because there is not an
active trading market for the Company's stock. See Item 5 of this Report.

The number of shares of the issuer's Common Stock, par value $.01 per
share, and Preferred Stock, par value $.01 per share, outstanding as of April
29, 1998, were 3,565,812 and 679,203 shares, respectively. Affiliates of the
registrant held 2,038,595 shares of the Common Stock, and all of the shares of
Preferred Stock, outstanding on April 29, 1998.

<PAGE> 2

FORM 10-K
TABLE OF CONTENTS

Item 1. Business.............................................................................. 3

Item 2. Properties............................................................................ 10

Item 3. Legal Proceedings..................................................................... 11

Item 4. Submission of Matters to a Vote of Security Holders................................... 11

Item 4a. Executive Officers of the Company..................................................... 11

PART II

Item 5. Market for Registrant's Common Equity and Related Stockholder Matters................. 12

Item 6. Selected Financial Data............................................................... 13

Item 7. Management's Discussion and Analysis of Financial Condition and Results of
Operations.......................................................................... 14

Item 8. Financial Statements.................................................................. 20

Item 9. Changes in and Disagreement with Accountants on Accounting and Financial
Disclosure.......................................................................... 20

PART III

Item 10. Directors and Executive Officers...................................................... 21

Item 11. Executive Compensation................................................................ 21

Item 12. Security Ownership of Certain Beneficial Owners and
Management.......................................................................... 21

Item 13. Certain Relationships and Related Transactions........................................ 21

PART IV

Item 14. Exhibits, Financial Statement Schedules, and Reports on
Form 8-K............................................................................ 22

Index to Financial Statements and Schedules...................................................... F-1
</TABLE>

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PART I

ITEM 1. BUSINESS

GENERAL

Solo Serve Corporation, a Texas corporation (the "Company" or "Solo
Serve"), operates a chain of off-price retail stores offering a wide selection
of name-brand and other merchandise at prices significantly below those of
traditional department and specialty stores. Solo Serve stores offer a wide
variety of fashion apparel for the entire family, as well as fragrances,
hosiery, shoes in certain locations and quality home furnishings. The Company
currently operates 27 Solo Serve stores in Texas and Louisiana.

The Company was formed in Texas in 1979 to acquire all of the assets of
Solo Serve Company and was reincorporated in Delaware in December 1991. Prior to
February 9, 1996, Solo Serve Corporation common stock was quoted on the NASDAQ
National Market System under the symbol "SOLOQ." The Company was notified by
NASDAQ that the Company's common stock would no longer be eligible for trading
on the NASDAQ Stock Market effective February 9, 1996 because the Company's
request for an exception from the quantitative maintenance criteria required for
inclusion in the NASDAQ National Market System had been denied. Following
delisting from NASDAQ/NMS, the Company's common stock began trading on the
over-the-counter market and the quotes are carried in the "pink sheets." The
Company's common stock is not actively traded.

On July 21, 1994, the Company filed a petition under Chapter 11 of the
Bankruptcy Code ("Chapter 11") in the United States Bankruptcy Court for the
Western District of Texas (the "Bankruptcy Court"). On July 6, 1995, the
Bankruptcy Court approved a Proposed Plan of Reorganization (the "Plan") jointly
sponsored by the Official Committee of Unsecured Creditors and Texas Commerce
Bank San Antonio, N.A. ("TCB"), which became effective on July 18, 1995. On the
effective date of the Plan, the Company issued 1,388,889 shares of convertible
Preferred Stock for an aggregate consideration of $2.5 million. All of the
shares of Preferred Stock were purchased by General Atlantic Corporation
("GAC"), the Company's largest stockholder. On April 17, 1996, the Bankruptcy
Court entered the Final Decree, which administratively closed Solo Serve's
Chapter 11 bankruptcy case.

In October 1997 and March 1998 certain members of Company management
(the "Management Holders") acquired a total of 1,964,686 shares of the Company's
Common Stock from GAC. This represented all of GAC's shares of Common Stock and
709,686 of its shares of Preferred Stock, which were converted into shares of
Common Stock at the time of the sale. GAC continues to own 679,203 shares of the
Company's Preferred Stock, which represents approximately 16% of the aggregate
voting stock of Solo Serve and all of the Company's issued and outstanding
shares of Preferred Stock.

Currently the Company has a significant net operating loss
carryforward. Under applicable law and regulations, the Company's ability to
utilize its net operating loss carryforward to offset future earnings could be
severely limited if the Company experiences an ownership change as defined in
Section 382 of the Internal Revenue Code of 1986. The above mentioned equity
infusion by GAC and stock acquisition by the Management Holders have not caused
an ownership change as defined in Section 382. However, the Company's ability to
utilize its net operating loss carryforward could be adversely affected if a
purchaser were to acquire five percent (5%) or more of the Company's stock. The
Management Holders and GAC have entered into a Stockholders Agreement which
provides that no party thereto will sell, exchange, transfer or otherwise
dispose of shares of the Company's Common Stock or Preferred Stock owned by such
stockholder without the prior written consent of the other parties thereto and
no party will exercise incentive stock options or other rights to acquire
capital stock or will otherwise acquire capital stock of the Company without the
prior written consent of the others. The Stockholders Agreement provides that
the certificates representing shares of capital stock of the Company

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currently held by the parties, as well as any additional shares issued to the
parties, shall each bear a legend evidencing the existence of the Stockholders
Agreement and the restrictions upon transfer contained therein. The Stockholders
Agreement terminates on March 17, 2001 unless terminated earlier or extended by
agreement of all parties.

The Company's business has been affected by a number of factors,
including increased competition in its principal markets, weakness in the
apparel industry, unfavorable economic conditions in certain markets and other
factors, many of which are not within the Company's control. Increased
promotional activities by other retailers as well as the opening of additional
store locations in the Company's principal markets have resulted in significant
sales decreases. The Company has maintained inventory at planned levels;
however, the Company has experienced and continues to experience an unstable
credit environment, principally with third party factors, which has from time to
time resulted in constraints on the Company's ability to receive certain
merchandise at optimum times and in optimum quantities. Continuing unfavorable
business conditions and financial performance could heighten vendor and factor
concern regarding the Company's creditworthiness, which could adversely affect
the Company's ability to receive sufficient trade credit support to acquire
adequate levels of inventory in the future. No assurance can be given that the
Company will be successful in its efforts to improve sales and operations and
reverse operating trends. Because of these uncertainties, any investment in the
Company's common stock should be considered speculative.

THE SOLO SERVE STORE

The Solo Serve stores are designed to create a departmentalized
atmosphere through merchandise presentation and abundant in-store signing. The
Company seeks to create an attractive, comfortable shopping environment that
draws customers' attention to the broad assortment of value-priced branded
merchandise.

Merchandise departments are well-signed, easily distinguished and
typically configured around a "racetrack" aisle designed to optimize the
customer's visual impressions of the quality and quantity of the store's
merchandise. Display fixtures along with capacity racks are used to highlight
the store's broad merchandise assortment. In-store signs and product displays
highlight famous designers' and manufacturers' names and reinforce the Company's
value pricing. Store entrances are designed to create a brand, price, fashion
and service statement specifically geared to appeal to the customer profile of
each store which usually features fragrance showcases, prominent branded men's
and women's apparel and a customer service desk. In the fourth quarter of fiscal
1997 and continuing into fiscal 1998, the Company has continued to refine its
analysis of sales and margin results by department and category of product and
their performance in relationship to space location and allocation of selling
square footage. Management believes the adjustments in store fixtures,
department location and selling square footage made as a result of its analysis
were instrumental in the Company's improved margin and sales over prior year
late in the fourth quarter of fiscal 1997.

Solo Serve stores have historically been located in metropolitan areas
in large strip shopping centers. Solo Serve stores typically vary in size from
25,000 to 30,000 total square feet, with an average of approximately 23,000
square feet of selling space and a 3,000-square-foot storage facility. In July
and October 1997, the Company opened two new stores in Texas markets smaller
than those historically served by the Company. The Company faces less direct
competition from larger off-price retailers, traditional department and
specialty stores in these smaller markets and can operate under a lower
occupancy expense structure than that generally experienced in stores located in
metropolitan areas. Management believes that the early results of these two
stores indicate that future expansion into these type of markets can be
successful and plans to seek attractive opportunities for new stores in these
types of markets in fiscal 1998.

The Company has entered into an agreement whereby the landlord will
buyout and terminate the lease of one under-performing store in Austin, Texas.
The Company previously closed a store in Shreveport, Louisiana in July 1997, but
remained subject to continuing lease payment obligations for the term of the
lease. Due to changing market conditions in Shreveport, the Company intends to
relocate the assets of the Austin store to the Shreveport, Louisiana location
and reopen the store in June 1998.

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MERCHANDISING STRATEGY

The Company emphasizes nationally-recognized branded merchandise in its
stores, which the Company prices significantly below traditional department and
specialty stores. The Company seeks to manage the inventory in its Solo Serve
stores to achieve a high turnover rate and to provide the stores with fresh
merchandise on a frequent basis. Discount prices and high inventory turnover are
made possible by an opportunistic purchasing strategy which consists primarily
of branded goods purchased at incentive prices, of in-season cancellations by
major retailers, manufacturers' overruns, end-of-season closeouts, occasional
acquisitions of end-of-season inventory from well-known and upscale retail
companies, and an efficient distribution system permitting quick delivery of new
merchandise to the stores. First quality, name-brand merchandise remains the
primary focus of the Solo Serve store's product offering, but purchases of
selected irregulars, which are subject to strict quality control, permit the
Company to reinforce Solo Serve's "price-value" message. Through frequent
promotions and a changing variety of quality, off-price merchandise in the
stores, the Company seeks to frequently attract the knowledgeable,
value-conscious customer into the store.

The Company's broadest merchandise selection is in apparel for women,
men and children. Women's merchandise lines include dresses, separates,
coordinates, activewear, and outerwear and is further segmented into juniors,
misses, petites and plus sizes. Handbags, sleep and lounge wear, intimate
apparel and casual and dress shoes in some stores complement the women's apparel
group. Men's apparel includes name brand product in dress shirts, ties, basics,
casual sportswear, activewear, dress slacks, jeans, and outerwear. The
children's department also features name brand product and is designed to offer
exceptional values for families with young children. Children's merchandise
lines include a wide selection of infants' and toddlers' apparel and basics;
girls' sportswear, dresses, lingerie, sleep wear, active wear, basics and
outerwear in sizes 4 to 6x and 7 to 14; and boys' tops, bottoms, jeans,
activewear, basics and outerwear in sizes 4 to 7 and 8 to 20.

During 1997 the Company expanded its product offering of domestics,
home decor and gifts. This department now offers a wider assortment of name
brand bedding, linens, glassware, decorative accents, furniture and gift items
than in years past. Also, the Company has expanded the square footage of the
department, upgraded the display fixtures and in some cases relocated the
department to a more prominent position on the selling floor.

Solo Serve stores also offer an extensive and in-depth selection of
prestige fragrances in a department store format under an exclusive supply
agreement (the "Model Agreement") with a major fragrance supplier, Model
Imperial, Inc. ("Model"). The Company operates the department in its stores and
sells Model's fragrances. Under the terms of the Model Agreement, the Company
supplies staffing and receives a commission on actual sales. Although the
Company retains some discretion over merchandise mix, Model is primarily
responsible for the ultimate selection and pricing of fragrances. Model filed
for protection from its creditors under Chapter 11 on July 18, 1996. On
September 15, 1997 the court approved Model's plan of reorganization. The
Company has not experienced any disruption in its supply of fragrances from
Model.

The Company had granted a license to an independent licensee to operate
fine jewelry departments in the 12 San Antonio Solo Serve stores. Under the
license agreement, which was to expire August 31, 1999, the licensee agreed to
pay to the Company a base rental amount and a percentage of its sales in excess
of specified amounts. These jewelry departments typically occupied 200 square
feet of selling space in each of the 12 San Antonio stores. In February 1998,
the Company terminated the agreement and entered into an agreement with another
entity to operate similar departments in six of the San Antonio stores.

During fiscal 1998, management plans to continue placing special
emphasis on merchandising and marketing specifically to the econo-socio-ethnic
background of the trade area and customer base of individual stores. This
includes, but is not limited to, market-specific or store-specific tailoring of
the product offerings, including price points, sizing, brands, assortments,
categories, and promotions. Additionally, greater emphasis will continue to be
placed on planning of stock levels and allocating of product by category and
price points to meet the needs of the individual store and its customer base.
Management believes that these efforts and a reduction in turnaround time in its
distribution center will increase sales, reduce overall inventory levels and
enhance cash flow.

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PRICING STRATEGY

The Company's pricing strategy is designed to provide exceptional value
to its customers. Solo Serve stores offer merchandise at prices significantly
below those charged by traditional department and specialty stores. Most price
tickets display the Solo Serve selling price as well as the comparable selling
price of the item at traditional department or specialty stores. In addition,
the ticket clearly identifies whether the item is first quality or an irregular.
Pricing decisions are made centrally by the Company's staff of buyers, subject
to review by the general merchandise manager. Management periodically monitors
its competitors' prices in order to ensure that the Company's prices remain
competitive. The Company's management information systems provide ongoing
information enabling the Company's buyers to track sales by unit and category
and adjust current prices when appropriate. During 1997, management reduced
promotional pricing activity and increased selective initial markups as compared
to historical levels.

The Company's advertised promotions are designed to permit Solo Serve
customers to realize additional savings over the already discounted prices,
encourage customers to visit the stores regularly and reinforce Solo Serve's
image as a dependable source of quality goods at substantial savings. Price
reductions are taken on fashion merchandise to maximize inventory turnover and
offer additional value opportunities to customers. Management periodically
reviews and adjusts its pricing strategies and promotional activities in an
effort to more effectively convey its price/value message and encourage frequent
visits to its stores.

PROMOTIONAL STRATEGY

In the fourth quarter of fiscal 1997, the Company initiated a new
marketing strategy that involves direct mail and a frequent shopper program. The
Company utilized internal resources and external consultants to develop a
database of people who shop in the Company's stores, and began marketing to them
through special direct mail promotions. Customers who are members of the
frequent shopper program, Solo Savers Club, receive special discounts one day
each week and on their birthday, are eligible for special monthly prize
drawings, and receive advance notice of special promotional events. During 1998,
the Company plans to expand its database, target potential new customers, and
increase its use of direct mail promotions and special events to encourage
frequent shopping at Solo Serve and customer loyalty. The above strategy will
continue to be supported by an advertising and promotional program designed
principally to reinforce Solo Serve's image as a value-priced retailer for the
entire family. Some advertising will continue to be directed at the general
population through newspaper advertisements, special promotional events,
television and radio and be focused on advertising specific merchandise or
categories offered at opportunistic or at discounted prices. The Company will
continue to strive to encourage frequent shopping from customers by presenting
the customer with an ever-changing mix of merchandise. Media promotions are
reinforced by in-store signage highlighting famous designers' and manufacturers'
names and by pricing statements comparing Solo Serve's prices to those of
department and specialty stores.

The Company maintains an in-house advertising department that currently
produces substantially all of the Company's print advertising and in-store
signage. Computerized graphics technology is used to produce camera-ready print
media, which management believes results in more timely and cost effective
production than would be possible with third-party providers.

VENDOR RELATIONSHIPS AND PURCHASING STRATEGY

In an effort to ensure a steady supply of brand-name and other
merchandise, the Company has developed long-standing relationships with certain
of its suppliers. The Company maintains a central buying staff in San Antonio.
Management believes that the San Antonio buyers are best able to understand the
preferences of customers in the Company's markets. These buyers make frequent
trips to New York (where the Company maintains an office without staff) and Los
Angeles, and are continually in contact with market and buying resources
throughout the country. The Company's buying staff is comprised of experienced
off-price buyers, some of whom also have experience with traditional department
stores. The buying staff is supervised by the general merchandise manager who
reports to the Chief Executive Officer.

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The Company actively pursues additional branded sources of supply and
is continually attempting to upgrade its merchandise assortments. During fiscal
year 1997, the Company purchased goods from approximately 1,500 vendors. By
purchasing closer to and during the selling season and later in the merchandise
buying cycle than department and specialty stores, the Company believes it is
able to take advantage of favorable market conditions. This purchasing strategy
enables the Company to interpret and react to important fashion developments
during the selling season. Favorable merchandise costs are also realized by
purchasing from vendors offering in-season cancellations by major retailers,
manufacturers' overruns, end-of-season close outs, product ranges and selected
irregulars. While the Company believes its relationships with its vendors are
generally satisfactory, no assurances can be given that an adequate supply of
merchandise at attractive prices will continually be available in the future for
all of the Company's departments or that there will not be delays or disruptions
in the flow of merchandise to the Company's stores. See "Management's Discussion
and Analysis."

INVENTORY MANAGEMENT AND MERCHANDISE DISTRIBUTION

The Company's current inventory management strategy is designed to
achieve high inventory turnover rates while enabling the Company to provide its
stores with fresh merchandise on a frequent basis and improving gross margin as
a percentage of sales. By closely monitoring sales, current inventory levels and
fashion trends and comparing them with on-order merchandise, the Company seeks
to manage its inventory turnover by making necessary purchasing adjustments.

The Company operates a 440,000 square-foot headquarters facility and
distribution center which is located on a 24-acre parcel of land in San Antonio,
Texas. This facility houses executive offices, central buying, advertising,
management information systems and administrative staff in 40,000 square feet of
office space and a 400,000 square-foot receiving, distribution and warehouse
area.

The Company uses a centralized distribution system in which all
merchandise is processed through its distribution center and allocated to the
Company's stores. Merchandise received at the distribution center is checked,
price-ticketed, assigned to individual stores, packed for delivery and shipped
floor ready. The Company utilizes its distribution personnel and systems to
assign merchandise to stores based primarily on store volume and known
historical customer purchasing patterns. The distribution system complements the
Company's promotional advertising strategy by prioritizing and processing
featured merchandise through the Company's distribution center on an expedited
basis. The Company uses its distribution facility to take advantage of assorted
merchandise lots and product ranges at deep discounts, which can be sorted and
priced at the distribution center.

The Company delivers merchandise from its distribution center to the
stores by means of contract carriers or the Company's trucks, typically twice
each week. The distribution center is conveniently located near major
north-south and east-west highways, facilitating efficient distribution to the
Company's stores.

MANAGEMENT INFORMATION SYSTEMS

The Company operates a computerized merchandise planning system that
management believes improves inventory management by allowing for timely
response to business trends, and the management of lower average store
inventories. The system allows personnel to manage inventory allocation and
store inventory planning by department and category. During 1997, the Company
began to utilize some of the information collected by the system to perform more
detailed analysis of sales by product category and market than had previously
been possible. Management believes this information improved buying and
allocating decisions during fiscal 1997, and that the Company's performance can
be improved by continued and expanded analysis available as additional
historical data is accumulated.

During 1997 the Company piloted a new point of sale ("POS") cash
register system at three stores. The new system speeds customer check-out,
improves customer service, and enhances reporting capabilities. Subject to
securing acceptable financing, the Company plans to install the new system in
all of its stores during fiscal 1998.

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IMPACT OF YEAR 2000

An issue affecting most businesses today, including the Company, is
whether computer systems and applications will properly function from and after
the year 2000 (the "Year 2000 Issue"). The Year 2000 Issue is the result of
computer programs being written using two digits rather than four to define the
applicable year. Any information system that uses dates to function may
recognize a date using "00" as the year 1900 rather than the year 2000 or may
otherwise fail to process information accurately due to the Year 2000 Issue,
which could result in a system failure or miscalculations causing disruptions of
operations, including, among other things, a temporary inability to process
transactions or engage in normal business activities. The Company is in the
process of reviewing potential system problems related to the Year 2000 Issue,
and management believes that the Company will modify or replace significant
portions of its hardware and software to address the Year 2000 Issue, including
cash registers in the Company's stores. The Company is not yet able to estimate
the cost to of its compliance efforts with respect to the Year 2000 Issue.
Although no assurances can be made, management presently does not expect such
costs to have a material adverse effect on the future results of operations of
the Company.

The Company is contacting its significant suppliers to determine the
extent to which the Company's interface systems are vulnerable to those third
parties' failure to remediate their own Year 2000 Issues. However, there can be
no guarantee that the systems of the other companies on which the Company's
systems rely will be timely converted, or that the failure of such third party
systems to adequately address the Year 2000 Issue would not have an adverse
effect on the Company's ability to do business.

The Company will utilize both internal and external resources to
reprogram, upgrade and test its information systems Year 2000 Issue
modifications. The Company currently anticipates completing the Year 2000 Issue
project not later than February 28, 1999, which is prior to any anticipated
impact on its operating systems.

Management presently believes that with modifications to and
replacement of existing software and hardware, the Year 2000 Issue will not pose
significant operational problems for its information systems. If remediation
efforts are not timely made, if appropriate modifications are not made by the
Company's suppliers on a timely basis, or if the actual costs of the remediation
efforts exceed management's expectations, the Year 2000 Issue could have a
material adverse impact on the operations and financial results of the Company.

COMPETITION

The national apparel market is highly fragmented and competitive. In
addition to price, the Company believes the principal competitive factors in the
retail apparel industry are merchandise assortment, quality and presentation,
relationships with vendors, store location, operating costs, and customer
service. The Company faces significant competition for customers and merchandise
supply from other off-price apparel stores and discount stores. Many of these
competitors are units of large national or regional chains that have
substantially greater resources than the Company. Among other advantages, the
availability of greater resources permits large national and regional chains to
buy merchandise in larger lots and therefore at better prices; to leverage their
general and administrative expenses over a larger sales base; to selectively
adopt more aggressive pricing or promotional strategies in certain markets when
it is deemed to be advantageous from a competitive standpoint; and to establish
and maintain relationships with suppliers who provide access to certain higher
profile branded merchandise. Additionally, as certain larger national and
regional competitors open new stores, they have been able to secure locations in
new retail developments with better tenant mix and demographics than many Solo
Serve stores.

Historically, Solo Serve stores have competed with other off-price
stores by offering a large selection of name-brand merchandise at competitive
prices; with discount stores by offering higher-quality name-brand fashions at
comparable price points; and with traditional department stores by offering
similar name-brands at substantially reduced prices. In recent years larger
off-price chains have significantly expanded their presence in the Company's
historical markets. Moreover, the off-price apparel business has become more
competitive as traditional department stores have adopted more aggressive
pricing and promotional strategies and as discount stores have improved and
enhanced their merchandise selections while continuing to offer discount prices.
Additionally, the growth of fashion-branded outlet malls has somewhat
constricted, and may further constrict, the supply of branded merchandise
formerly available to off-price retailers.

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In the Company's principal markets, San Antonio and New Orleans, larger
national and regional competitors have opened additional store locations and
more locations are planned. The Company hopes to overcome these disadvantages by
being more responsive to its customers' preferences in product mix and
presentation than its competitors and by expanding its store base into smaller
markets where it will face less direct competition. See "Management's Discussion
and Analysis."

EMPLOYEES

During fiscal year 1997, the Company's work force consisted of an
average of approximately 950 forty-hour equivalent employees, referred to by the
Company as "associates." This employee base consisted of approximately 475
full-time associates and an additional 475 part-time associates. Substantial
seasonality is associated with employment levels. The Company expects the
employee base in fiscal 1998 to be approximately the same as 1997 except for
increases directly associated with any increase in the number of stores.

Management believes that the Company's associates are paid
competitively with current local standards in the industry. The Company
contributes a portion of the cost of medical and life insurance coverage for
those associates who are eligible to participate in Company-sponsored plans. The
Solo Serve 401(k) Retirement Savings Plan and Trust is also available to
eligible associates. All associates also receive discounts on purchases of
Company merchandise in the stores. The Company considers its relationship with
its associates to be satisfactory.

CREDIT SALES

The Company offers customers several methods of payment, including
cash, personal checks and third-party credit cards (American Express, Discover,
MasterCard, and Visa). Solo Serve stores also offer a layaway deferred payment
plan. The Company does not have a private label credit card.

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ITEM 2. PROPERTIES

STORE LOCATIONS AND PROPERTIES

The table below shows the location and opening dates of each of the
Company's 27 stores in operation at the end of fiscal 1997:

<TABLE>
<CAPTION>
STORE MARKET STORE MARKET
LOCATION OPENING DATE LOCATION OPENING DATE
- --------------- ------------ --------------- ------------
<S> <C> <C> <C>
San Antonio, TX 1919 San Antonio, TX September 1988
San Antonio, TX May 1959 San Antonio, TX August 1989
San Antonio, TX May 1970 Corpus Christi, TX March 1990
San Antonio, TX February 1981 San Antonio, TX October 1990
San Antonio, TX July 1981 McAllen, TX September 1992
Austin, TX November 1981 Austin, TX October 1990
New Orleans, LA July 1983 Laredo, TX July 1991
New Orleans, LA September 1983 San Antonio, TX March 1992
New Orleans, LA October 1984 Brownsville, TX August 1992
Corpus Christi, TX March 1985 San Antonio, TX March 1994
New Orleans, LA September 1985 Austin, TX March 1994
New Orleans, LA November 1985 San Angelo, TX July 1997
San Antonio, TX November 1985 Brownwood, TX October 1997
San Antonio, TX April 1988
</TABLE>

In fiscal 1995 the Company closed its one store located in Montgomery,
Alabama. In fiscal 1996 the Company closed one of its Austin stores. In fiscal
1997 the Company closed its three stores in Mobile, Alabama, Baton Rouge,
Louisiana and Shreveport, Louisiana. The Company plans to reopen the Shreveport
store in mid-1998.

The Company owns the real estate and improvements on which three of its
Solo Serve stores in San Antonio, Texas are located and leases the remainder of
its stores. The leases have remaining terms ranging from 4 months to 14 years,
with renewal options at higher fixed rates in most cases. Most of the leases
provide for percentage rent over sales breakpoints. The Company presently leases
an office in New York for the use of its buyers when they make buying trips.

Subsequent to year end, on April 6, 1998, the Company sold and leased
back its 440,000 square foot distribution center and corporate office in San
Antonio, Texas. The buyer assumed the outstanding mortgage notes, and the
Company realized approximately $1 million in cash, net of selling costs, debt
assumption, and deposits. The Company has signed a 10 year lease for the
property, and will continue to occupy the facility.

The Company has entered into an agreement to sell and lease back the
three owned store locations. The buyer recently extended its option to purchase
the properties for 120 days and paid an additional $150,000 in nonrefundable
earnest money directly to the Company. Although the transaction is expected to
close by September 1, 1998, there can be no assurance that the agreement will be
consummated.

See "Management's Discussion and Analysis--Liquidity and Capital
Resources."

SERVICE MARKS

"Solo Serve" and "Solo" are service marks that have been registered by
the Company with the U.S. Patent and Trademark Office.

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<PAGE> 11

ITEM 3. LEGAL PROCEEDINGS

From time to time, the Company is involved in litigation relating to
claims arising out of its operations in the normal course of business. In the
opinion of management, the outcome of this litigation will not have a material
effect on the Company.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matter was submitted to a vote of security holders of the Company
during the fourth quarter of the fiscal year ended January 31, 1998.

ITEM 4A. EXECUTIVE OFFICERS OF THE COMPANY

Charles M. Siegel, age 59, became employed by the Company in August
1996 as President and Chief Executive Officer. He joined the Company as a
full-time consultant and Acting Chief Operating Officer in early July 1996.
Prior to joining the Company, Mr. Siegel was President, Chairman and Chief
Executive Officer of 50-Off Stores, Inc., which in 1988 became the successor
organization to Shoppers World stores, for which Mr. Siegel was a member of the
founding executive group in 1975.

Ross E. Bacon, age 53, became Chief Operating and Financial Officer and
Executive Vice President of the Company in September 1996. He had joined the
Company in July 1996 as Chief Financial Officer. From 1994 to 1996, Mr. Bacon
was a self-employed financial consultant, and from 1993 to 1994, he was Vice
President and Chief Financial Officer of Telecommunications Management, Inc.,
the parent company of Discount Cellular and Paging, a San Antonio-based cellular
telephone and paging company. Mr. Bacon was Vice President and Chief Financial
Officer of Flowers to Go, Inc. from 1992 until 1993.

Mark J. Blankenship, age 45, became Senior Vice President of Planning
and Allocation of the Company in June 1997. He had joined the Company in April
1994 as Vice President - Divisional Merchandise Manager. Prior to joining the
Company, Mr. Blankenship was Senior Vice President - General Merchandise Manager
of Stage Stores, Inc. in Houston, Texas.

Terry Lalosh, age 50, became Senior Vice President - General
Merchandise Manager of the Company in June 1997. He joined the Company in
August, 1995 as Divisional Merchandise Manager. From 1992 until July 1995, Mr.
Lalosh was Vice President - Divisional Merchandise Manager of Marshalls, a
national off-price retailer headquartered in Andover, Massachusetts.

11
<PAGE> 12

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Prior to February 9, 1996, Solo Serve Corporation common stock was
quoted on the NASDAQ National Market System under the symbol "SOLOQ." The
Company was notified by NASDAQ that the Company's common stock would no longer
be eligible for trading on the NASDAQ Stock Market effective February 9, 1996
because the Company's request for an exception from the quantitative maintenance
criteria required for inclusion in the NASDAQ National Market System had been
denied. Following delisting from NASDAQ/NMS, the Company's common stock began
trading on the over-the-counter market and the quotes are carried in the "pink
sheets." There are few trades in the Company's common stock. The following table
sets forth, for the periods indicated, the range of high and low closing bid
prices of the Common Stock of the Company in the over-the-counter market since
February 9, 1996, as reported by the National Quotation Bureau.

<TABLE>
<CAPTION>
High Low
---- ---
<S> <C> <C>
February 9, 1996 to May 4, 1996 $0.1250 $0.1250
Quarter ended August 3, 1996 .2500 .1250
Quarter ended November 2, 1996 .4375 .1875
Quarter ended February 1, 1997 .1875 .0938
Quarter ended May 3, 1997 .1563 .0938
Quarter ended August 2, 1997 .1875 .1563
Quarter ended November 1, 1997 .4375 .1563
Quarter ended January 31, 1998 .5625 .3750
</TABLE>

These price quotations reflect inter-dealer prices, without adjustments
for retail mark-ups, mark-downs or commissions and may not necessarily represent
actual transactions. On April 29, 1998, there were 3,565,812 shares of common
stock outstanding, held by 162 holders of record.

The Company has paid cash dividends on its common stock in prior years.
However, since the Company has been publicly held, the Company has never
declared or paid any cash dividends on the common stock. Furthermore, certain
covenants in various credit agreements of the Company restrict the payment of
dividends on the common stock.

12
<PAGE> 13

ITEM 6. SELECTED FINANCIAL DATA

The following data has been derived from the Company's audited
financial statements, including those found elsewhere in this Annual Report on
Form 10-K for the year ended January 31, 1998. The selected financial data below
should be read in conjunction with "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and with those audited financial
statements.

<TABLE>
<CAPTION>
Fiscal Year Ended
-------------------------------------------------------------------
Jan. 29, Jan. 28, Feb. 3, Feb. 1, Jan. 31,
1994 1995 1996 1997 1998
---------- --------- --------- --------- ----------
(in thousands, except operating and per share data)
<S> <C> <C> <C> <C> <C>
Number of Weeks in Fiscal Year 52 52 53 52 52
INCOME STATEMENT DATA:
Net revenues $ 169,053 $ 138,925 $ 109,823 $ 95,238 $ 82,046
Cost of goods sold (including buying and
distribution excluding depreciation shown below) 120,293 100,687 83,474 67,485 57,303
--------- --------- --------- --------- ---------
Gross profit 48,760 38,238 26,349 27,753 24,743
Selling, general and administrative expense 50,000 39,013 29,620 28,203 26,414
Depreciation and amortization 4,075 3,748 2,815 2,421 2,062
Store closure expense 1,500 -- -- -- 622
Write off of property and equipment -- -- -- 525 --
Non recurring item -- -- -- 464 --
--------- --------- --------- --------- ---------
Operating income (loss) (6,815) (4,523) (6,086) (3,860) (4,355)
Interest expense, net 1,237 1,090 1,129 1,624 1,934
--------- --------- --------- --------- ---------
Income (loss) before income taxes,
reorganization items, and extraordinary item (8,052) (5,613) (7,215) (5,484) (6,289)
Reorganization items -- 6,262 1,787 -- --
Provision for (benefit from) income taxes (3,070) 3,661 (1,418) -- --
--------- --------- --------- --------- ---------
Income (loss) before extraordinary item
(4,982) (15,536) (7,584) (5,484) (6,289)
Extraordinary item -- -- 2,753 -- (267)
--------- --------- --------- --------- ---------
Net income (loss) $ (4,982) $ (15,536) $ (4,831) $ (5,484) $ (6,556)
========= ========= ========= ========= =========
Income (loss) per common share before extraordinary item $ (1.70) $ (5.45) $ (2.10) $ (1.92) $ (2.20)
Net income (loss) per common share (basic and diluted)(1) $ (1.70) $ (5.45) $ (1.34) $ (1.92) $ (2.30)
Dividends declared per common share -- -- -- -- --
Weighted average shares outstanding 2,919 2,850 3,605 2,856 2,856
BALANCE SHEET DATA (AT PERIOD END):
Total assets $ 57,753 $ 54,692 $ 33,300 $ 26,387 $ 26,384
Long-term debt (including capital lease obligations) $ 17,998 $ 5 $ 15,136 $ 14,961 $ 13,341
Note payable to stockholder -- -- -- -- $ 500
Liabilities subject to compromise $ -- $ 33,385 $ 461 $ -- $ --
Total stockholders' equity (deficit) $ 27,572 $ 12,148 $ 9,817 $ 4,333 $ (2,223)
OPERATING DATA:
Number of stores in operation at end of period 46 30 29 28 27
Number of stores opened during period 8 2 -- -- 2
Number of stores closed during period 3 18 1 1 3
Comparable store net sales increase (decrease)(2) (5.9%) (11.2%) (5.6%) (10.6%) (11.4%)
Selling square footage in operation at end of period
(in thousands) 996 701 675 657 626
Sales per selling square foot $ 187 $ 169 $ 161 $ 143 $ 123
Average sales per store (in thousands) $ 4,244 $ 3,984 $ 3,758 $ 3,360 $ 2,860
</TABLE>

(1) See Note 1 of Notes to Financial Statements.
(2) Comparable store sales are calculated by excluding the net sales of stores
for any week of one period if the store was not open during the same week of the
prior period. Net sales are not included for the first four weeks following a
store opening. In fiscal 1995, a 53 week year, the extra week was excluded from
comparable store sales.

13
<PAGE> 14

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

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

<TABLE>
<CAPTION>
NUMBER OF STORES
Fiscal 1995 Fiscal 1996 Fiscal 1997
----------- ----------- -----------
<S> <C> <C> <C>
Beginning of year 30 29 28
First Quarter Additions 0 0 0
First Quarter Dispositions 0 0 0
Second Quarter Additions 0 0 1
Second Quarter Dispositions (1) 0 (2)
Third Quarter Additions 0 0 1
Third Quarter Dispositions 0 (1) 0
Fourth Quarter Dispositions 0 0 (1)
-- -- --
END OF YEAR 29 28 27
-- -- --
</TABLE>

RESULTS OF OPERATIONS
As a percentage of sales

<TABLE>
<CAPTION>
Fiscal 1995 Fiscal 1996 Fiscal 1997
----------- ----------- -----------
<S> <C> <C> <C>
Net revenues 100.0% 100.0% 100.0%
Cost of goods sold, including buying and distribution
costs 76.0 70.9 69.8
----- ----- -----
Gross profit 24.0 29.1 30.2
Selling, general and administrative expense 27.0 29.6 32.2
Depreciation and amortization 2.6 2.5 2.5
Store closure expense -- -- 0.8
Write down of property and equipment -- 0.5 --
Non recurring item -- 0.5 --
----- ----- -----
Operating loss (5.6) (4.0) (5.3)
Interest expense 1.0 1.7 2.4
----- ----- -----
Loss before income taxes, reorganization and
extraordinary items (6.6) (5.7) (7.7)
----- ----- -----
Reorganization items (1.6) -- --
(Provision for) benefit from income taxes 1.3 -- --
----- ----- -----
Loss before extraordinary item (6.9) (5.7) (7.7)
Extraordinary item, net of tax 2.5 -- (0.3)
----- ----- -----
Net loss (4.4)% (5.7)% (8.0)%
===== ===== =====
</TABLE>

14
<PAGE> 15

PLAN OF REORGANIZATION

15
<PAGE> 16

FISCAL 1997 VERSUS FISCAL 1996

Net revenues for fiscal 1997 decreased 13.9% from the prior year to
$82.0 million from $95.2 million. Comparable stores net sales decreased 11.4%.
Management attributes the sales decline principally to increased competitive
pressures in its market areas, continuing unfavorable economic conditions in
some of the Company's principal markets and less promotional activities than in
prior years. Additionally the Company continues to experience an unstable credit
environment, principally with third party factors, which results in periodic and
occasionally significant constraints on the Company's ability to receive certain
merchandise at optimum times and in optimum quantities, and which management
believes negatively impacted sales.

Gross profit for fiscal 1997 decreased $3.1 million to $24.7 million
from $27.8 million in the prior year. Gross profit as a percentage of net
revenues increased to 30.1% from 29.1% in fiscal 1996. The increase in gross
profit percentage resulted principally from reduced shrinkage, reduced markdown
expense, and reduced buying and distribution costs from those experienced in
fiscal 1996. The Company has experienced declines in these costs as a percent of
sales over the past two years.

Selling, general and administrative ("SG&A") expenses for fiscal 1997
decreased $1.8 million, or 6.4%, to $26.4 million from $28.2 million for the
prior year. The decrease was primarily the result of reductions in payroll
costs, and the closing of three under-performing stores. Depreciation and
amortization expenses for fiscal 1997 decreased 12.5% to $2.1 million from $2.4
million primarily due to some assets becoming fully depreciated and the write
down of assets under FAS 121 in fiscal 1996.

The Company experienced an operating loss of $4.4 million in fiscal
1997 compared to an operating loss of $3.9 million in fiscal 1996. This was
primarily the result of decreased sales not being fully offset by increased
margins.

Net interest expense increased to $1.9 million in fiscal 1997 from $1.6
million in the prior year, primarily due to increased borrowings on the line of
credit.

During fiscal 1997, management has continued the business strategy
developed and implemented in fiscal 1996, which seeks to achieve higher gross
margins on lower comparable store sales than in prior years. The key elements of
this strategy are lower average store inventories, quick price reduction on
slower moving merchandise, constant flow of fresh merchandise, less promotional
pricing, and a significantly reduced expense structure. The Company has also
reduced SG&A expenses and buying and distribution costs. Although management
believes this business strategy is appropriate in light of business conditions
and recent sales trends, the Company's sales results have continued to be
disappointing. The gains during fiscal 1997 in gross profit percent and reduced
expenses have been offset by these sales declines during fiscal 1997 and the
Company has continued to experience operating losses. No assurance can be given
that the Company will be successful in its efforts to improve sales and
operations and reverse recent operating trends.

FISCAL 1996 VERSUS FISCAL 1995

Net revenues for fiscal 1996 decreased 13.3% from the prior year to
$95.2 million from $109.8 million. Comparable stores net sales decreased 10.6%.
Management attributed the sales decline principally to increased competitive
pressures in its market areas, continuing unfavorable economic conditions in
some of the Company's principal markets, less promotional activities than in
comparable periods of fiscal 1995, and the effect that the Company's bankruptcy
had on its core customers, whose purchasing decisions management believes to be
driven by the availability of certain branded products, which the Company had
difficulty obtaining immediately preceding and during the bankruptcy period. Net
revenues were favorably impacted $559 thousand by the reclassification of
certain revenue items which had been accounted for as a reduction in SG&A
expenses in prior years.

Gross profit for fiscal 1996 increased $1.5 million to $27.8 million
from $26.3 million in the prior year. Gross profit as a percentage of net sales
increased to 29.1% from 24.0% in fiscal 1995. The increase in gross profit
percentage resulted principally from reduced shrinkage, reduced promotional
activity, selectively higher initial markups, reduced buying and distribution
costs from those experienced in fiscal 1995, the above-referenced

16
<PAGE> 17

reclassification of certain revenue items which had been accounted for as a
reduction in SG&A expenses in prior years, and the reclassification of certain
expense items that had been accounted for as costs of goods sold in 1995.

Expenses attributable to SG&A for fiscal 1996 decreased $1.4 million,
or 4.7%, to $28.2 million from $29.6 million for the prior year. The decrease
was the result of cost cutting measures, the closing of one under-performing
store, termination of the Company's Post Retirement Benefit Plan, and
adjustments to various balance sheet balances offset by an increase in SG&A
expenses due to the above-referenced reclassification of certain revenue items
which had been accounted for as a reduction in SG&A expenses in prior years.
Depreciation and amortization expenses for fiscal 1996 decreased 14.3% to $2.4
million from $2.8 million primarily due to some assets becoming fully
depreciated.

At fiscal year end 1996, based on the revised cash flow estimates from
the planned closure of two store locations, the Company wrote down the
non-recoverable net book value ($525 thousand) of leasehold improvements and
fixtures and equipment associated with the locations in accordance with FAS 121.

The Company also recognized and recorded an unanticipated and
non-recurring charge of $464 thousand in January 1997 which related to fiscal
1996. In recent years, the Company self-insured workers' compensation and
medical insurance for its employees and purchased stop-loss coverage to limit
its maximum exposure. In late fiscal 1996, a dependent of one of the Company's
former employees who is covered by COBRA required expensive medical treatment
which was not covered by the stop-loss provider, and the majority of this
accrual relates to this claim, for less-than the accrued estimate previously
made. During fiscal 1997 the claim was resolved and the Company's liability
discharged. Effective January 1, 1997, the Company purchased fully insured
coverage for medical and workers' compensation insurance.

The Company experienced an operating loss, after the $525 thousand
write down of fixed assets and the $464 thousand reserve for the non-recurring
item, of $3.9 million in fiscal 1996 compared to an operating loss of $6.1
million in fiscal 1995.

Net interest expense increased to $1.6 million in fiscal 1996 from $1.1
million in the prior year. During the pendency of the Chapter 11 bankruptcy case
in fiscal 1995, the Company accrued interest on approximately $5.9 million in
indebtedness secured by a first mortgage on the Company's distribution center,
but did not accrue interest on any other pre-petition indebtedness. Interest
expense on all indebtedness was accrued following the confirmation of the Plan.
Had the Company accrued interest on all of its indebtedness for the full year,
the interest expense for fiscal 1995 would have been approximately $1.8 million
yielding a pro forma decrease in net interest expense of $200 thousand.

17
<PAGE> 18
SEASONALITY AND QUARTERLY FLUCTUATIONS

The following tables sets forth certain unaudited quarterly information of the
Company and includes all adjustments (consisting of normal recurring
adjustments) that management considers necessary for a fair presentation of such
information for the interim periods. The operating results for any quarter are
not necessarily indicative of results for any future period.

<TABLE>
<CAPTION>
FISCAL 1996
-------------------------------------------------------------
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
----------- ----------- ----------- -----------
(in thousands, except per share data)
<S> <C> <C> <C> <C>
Net revenues $ 22,260 $ 28,070 $ 21,208 $ 23,700

Gross Profit 6,516 7,568 6,371 7,298

Net loss (973) (1,221) (1,472) (1,819)

Net loss per share of common stock (basic $ (.34) $ (.43) $ (.52) $ (.63)
and diluted)
</TABLE>

<TABLE>
<CAPTION>
FISCAL 1997
------------------------------------------------------------
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
----------- ----------- ----------- -----------
(in thousands, except per share data)
<S> <C> <C> <C> <C>
Net revenues $ 19,603 $ 21,365 $ 16,745 $ 24,333

Gross Profit 5,617 5,991 5,017 8,118

Net loss (2,633) ( 474) (2,179) (1,270)

Net loss per share of common stock (basic
and diluted) $ (.92) $ (.17) $ (.76) $ (.45)
</TABLE>

COMPARABLE STORE SALES

The following table sets forth for fiscal 1995, fiscal 1996, and fiscal
1997 certain information regarding the percentage decrease in total comparable
store sales adjusted so that all amounts relate to 52 weeks for the fiscal
years.

<TABLE>
<CAPTION>
Fiscal 1997
--------------------------------------------------------------------------------------------
Fiscal Fiscal First Second Third Fourth
1995 1996 Quarter Quarter Quarter Quarter Year
------ ------ ------- ------- ------- ------- ----
<S> <C> <C> <C> <C> <C> <C> <C>
Total (6%) (11%) (12%) (19%) (16%) (2%) (11%)
</TABLE>

Management attributes the comparable store net sales decrease
principally to increased competitive pressures in its market areas, continuing
unfavorable economic conditions in some of the Company's principal markets and
less promotional activities than in prior years. Additionally the Company
continues to experience an unstable credit environment, principally with third
party factors, which results in periodic and occasionally significant
constraints on the Company's ability to receive certain merchandise at optimum
times and in optimum quantities, and which management believes negatively
impacted sales.

Management believes that fiscal 1997 fourth quarter sales were
positively impacted by the Company's ability to receive appropriate quantities
of quality goods for the Christmas selling season. Trade credit support was
improved over that experienced in the comparable period of fiscal 1996, and the
Company was able to improve both sales and gross profit as a result.

18
<PAGE> 19
LIQUIDITY AND CAPITAL RESOURCES

Cash used by operating activities before reorganization items in fiscal
1997 was $2.5 million. The increased usage was primarily the result of the net
loss. Capital expenditures were approximately $758,000 and consisted primarily
of replenishment and refurbishment of existing equipment and facilities, a new
POS register system at three of the Company's stores, new copy equipment for the
advertising department, and upgrades in some computer equipment in the data
processing department.

The Company has a term note payable to Texas Commerce Bank ("TCB")
which carries an interest rate of prime plus one-half percent and is due in
equal monthly payments of principal and interest of $64,117 until January 1999,
when the remaining principal balance of $4.5 million is due. The TCB note is
secured by the Company's three owned store locations. These properties are
currently subject to a contract for sale and leaseback, which, if completed
is expected to result in the retirement of the TCB indebtedness.

The Company also has a note payable to MetLife Capital Corporation (the
"MetLife Note"), which is secured by various equipment and fixtures located at
the corporate office and certain stores. The MetLife Note carries an interest
rate of 8.0% and requires equal monthly payments, including principal and
interest, of $35,044 until September 1998. The Company also had two mortgage
notes payable, with identical terms (the "Mortgage Notes"), each of which was
secured by the Company's corporate office and distribution center in San
Antonio, Texas. The Mortgage Notes each carried an interest rate of 9.5% per
annum and required aggregate monthly payments of principal and interest of
$49,773 until December 2002, when the remaining aggregate principal balance of
$5.4 million was to become due. Subsequent to January 31, 1998, the Company
sold and leased back the distribution center and corporate office. The buyer,
in turn, assumed the outstanding Mortgage Notes, which released the Company
from any future liability on this indebtedness. (See Note 11.)

On October 2, 1997, the Company replaced its previous revolving credit
facility with a $12 million revolving credit facility with Sanwa Business Credit
Corporation ("Sanwa"). The loan matures October 2, 2000. Principal will be due
at maturity and interest only is due and payable in monthly installments.

Under the loan agreement, the advance rate under the Sanwa credit
facility is in an amount equal to 70% of the Company's eligible inventory during
the period May 1 through December 10 of each year and 65% of eligible inventory
at all other times. In addition to advances made based upon the percentage of
eligible inventory, Sanwa made available an additional $750,000 upon receipt of
a letter of credit in such amount from GAC, one of the Company's principal
stockholders. In consideration for GAC's providing the $750,000 standby letter
of credit to Sanwa, the Company granted GAC a second lien security interest
(subordinated to Sanwa) on the assets of the Company pledged to Sanwa. Covenants
under the loan agreement require the Company to maintain certain financial
ratios.

On March 17, 1998, the Company amended its loan agreement with Sanwa.
The amendment waives compliance with the financial covenants at January 31,
1998, eliminates the Company's minimum net worth covenant entirely, and revises
the interest coverage ratios for 1998. The amendment also increases the advance
rate on the Company's eligible inventory from 65% to 70% from the date of the
amendment through December 10, 1998 and provides an additional $600,000
available to borrow based upon a new $600,000 letter of credit in favor of
Sanwa provided by GAC. The new $600,000 letter of credit, which is anticipated
to terminate thirty days after consummation of the pending sale of the
Company's three owned store locations, is in addition to the previously
discussed $750,000 letter of credit provided by GAC, which is anticipated to
terminate December 31, 1998. The letters of credit are secured by a second lien
on substantially all of the assets of the Company other than real estate.

On October 2, 1997, Charles M. Siegel, President and Chief Executive
Officer of the Company, and a related family trust loaned the Company an
aggregate amount of $500,000 (the Siegel Loan). The loan bears interest at a
rate of prime plus 1%, and requires monthly payments of interest only for a
period of five years, at which time the principal becomes due (October 31,
2002). The Siegel Loan is subordinate to the Sanwa credit facility and to
repayment by the Company of any amounts advanced under the letter of credit
issued by GAC. The Company may not repay any principal due under the Siegel
Loan without Sanwa's prior consent and may make interest payments to Mr. Siegel
only if there is no existing default by the Company under the Sanwa credit
facility. In related transactions, Mr. Siegel purchased from GAC all of its
common stock in the Company, and his employment contract with the Company was
amended.

In addition to the Sanwa credit facility, the Company is dependent upon
short term trade credit as a source of inventory financing. Short term trade
credit arises from the willingness of the Company's vendors to grant payment
terms for inventory purchases and is either financed by the vendor or a third
party factoring institution. The Company's inventories were $900 thousand more
at fiscal year end 1997 than at fiscal year end 1996 and accounts payable
increased $3.3 million.

19
<PAGE> 20
During the first quarter of fiscal 1998 the Company's business has been
affected by a number of factors, including increased competition in its
principal markets, weakness in the apparel industry, unfavorable economic
conditions in certain markets and other factors, many of which are not within
the Company's control. Increased promotional activities by other retailers as
well as the opening of additional store locations in the Company's principal
markets have resulted in significant sales decreases. The Company has maintained
inventory at planned levels; however, the Company has experienced, and continues
to experience an unstable credit environment, principally with third party
factors, which has from time to time resulted in constraints on the Company's
ability to receive certain merchandise at optimum times and in optimum
quantities. Continuing unfavorable business conditions and financial performance
could heighten vendor and factor concern regarding the Company's
creditworthiness, which could adversely affect the Company's ability to receive
sufficient trade credit support to acquire adequate levels of inventory in the
future. No assurance can be given that the Company will be successful in its
efforts to improve sales and operations and reverse operating trends. Because of
these uncertainties, any investment in the Company's common stock should be
considered speculative.

If initiatives implemented in 1997 and early 1998 are not successful in
improving overall financial performance and meeting liquidity requirements, the
Company would consider other alternatives, including, without limitation,
implementation of additional measures designed to enhance capital and reduce
expenses and/or additional debt or equity financings.

Forward-looking Statements

Forward-looking statements in this Annual Report are made pursuant to
the safe harbor provisions of the Private Securities Litigation Reform Act of
1995. There are certain important factors that could cause results to differ
materially from those anticipated by some of the statements made above.
Investors are cautioned that all forward-looking statements involve risks and
uncertainty. In addition to the factors discussed above, among the other factors
that could cause actual results to differ materially are the following: general
economic conditions, consumer demand and preferences, and weather patterns in
the Company's markets; competitive factors, including continuing pressure from
pricing and promotional activities of competitors; impact of excess retail
capacity; the availability, selection and purchasing of attractive merchandise
on favorable terms; availability of financing; and relationships with vendors
and factors. Additional information concerning those and other factors are
contained in the Company's Securities and Exchange Commission filings, copies of
which are available from the Company without charge. 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.

ITEM 8. FINANCIAL STATEMENTS

For the financial statements and supplementary data required by this
Item 8, see the Index to Financial Statements and Schedules.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

On September 18, 1997, primarily as a result of the closing of its San
Antonio office, the Company dismissed Price Waterhouse LLP as its independent
accountants as previously reported in the Company's Current Report on Form 8-K
for that date. The dismissal was approved by the Audit Committee and the
Company's Board of Directors. Price Waterhouse LLP's reports on the financial
statements for the two most recent fiscal years did not contain an adverse
opinion, disclaimer of opinion, qualification or modification as to uncertainty,
audit scope or accounting principles, except that such reports included an
explanatory paragraph expressing substantial doubt as to the Company's ability
to continue as a going concern. Furthermore, during the two most recent fiscal
years and through September 18, 1997, there were no disagreements with Price
Waterhouse LLP on any matter of accounting principles or practices, financial
statement disclosure, or auditing scope or procedure, which disagreements, if
not resolved to the satisfaction of Price Waterhouse LLP, would have caused that
firm to make reference to the subject matter of such disagreements in its
reports on the financial statements for such years.

On September 18, 1997, the Company appointed Ernst & Young LLP as its
independent accountants. During the two most recent fiscal years and through
September 18, 1997, the Company had not consulted with Ernst & Young LLP
regarding the application of accounting principles to a specific transaction,
either completed or proposed, or the type of audit opinion that might be
rendered on the Company's financial statements.

20
<PAGE> 21

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS

Incorporated by reference to the Proxy Statement expected to be filed by the
Company no later than May 30, 1998.

ITEM 11. EXECUTIVE COMPENSATION

Incorporated by reference to the Proxy Statement expected to be filed by the
Company no later than May 30, 1998.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

Incorporated by reference to the Proxy Statement expected to be filed by the
Company no later than May 30, 1998.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Incorporated by reference to the Proxy Statement expected to be filed by the
Company no later than May 30, 1998.

21
<PAGE> 22

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

(a)1. Financial Statements

The following financial statements of the Company are included following
the Index to Financial Statements and Schedule on page F-1 of this Report.

Reports of Independent Accountants

Balance Sheets

Statements of Operations

Statements of Changes in Stockholders' Equity (Deficit)

Statements of Cash Flows

Notes to Financial Statements

(a)2. Financial Statement Schedule

The following financial statement schedule is included following the Index
to Financial Statements and Schedule on page F-1 of this Report.

Report of Independent Accountants on Financial Statement Schedule

X. Supplementary Statements of Operations Information

All other schedules have been omitted because they are not applicable, not
required under the instructions or the information requested is set forth in the
financial statements or related notes thereto.

22
<PAGE> 23
(a)3. Exhibits

The following Exhibits are incorporated by reference to the filing
indicated or are included following the Index to Exhibits:

Exhibit
Number Description of Exhibit
- ------ ----------------------

3.1 Restated Certificate of Incorporation of the Company (7)

3.2 Certificate of Designation of Rights and Preferences of Preferred Stock
(7)

3.3 Bylaws of the Company, as amended and restated (14)

4.1 Specimen Certificate for Common Stock of the Registrant (representing
shares of common stock of the Company after giving effect to the
previously reported 1-for-2 reverse split effected July 18, 1995) (9)

10.1 Registration Rights Agreement among General Atlantic Corporation,
Robert J. Grimm and the Company (1)

10.2 Agreement Regarding Tax Consequences of Deconsolidation between the
Company and General Atlantic Corporation (1)

10.3 Tax Allocation Agreement between the Company and General Atlantic
Corporation (1)

10.4 Form of Indemnity Agreement between Directors, Executive Officers and
the Company (1)

10.5 Associate Stock Purchase Plan of the Company (2)

10.6 Retirement Savings Plan and Trust of the Company (2)

10.7 Mortgage Note A, dated November 20, 1992, in principal amount of
$4,940,000, with the Company as Maker and Nationwide Life Insurance
Company as Holder (2)

10.8 Mortgage Note B, dated November 20, 1992, in principal amount of
$1,000,000, with the Company as Maker and Employers Life Insurance
Company of Wausau as Holder (2)

10.9 Subscription Agreement between the Company and General Atlantic
Corporation (7)

10.10 Solo Serve Corporation 1995 Stock Incentive Plan (8) +

10.11 Solo Serve Corporation Director Stock Option Plan (8) +

10.12 First Amendment to Solo Serve Corporation Director Stock Option
Plan *+

10.13 Loan and Security Agreement, dated as of June 20, 1995, by and between
Solo Serve Corporation and Congress Financial Corporation (Southwest)
(7)

10.14 Amended Loan and Security Agreement, dated July 18, 1995, by and
between Solo Serve Corporation and MetLife Capital Corporation (8)

10.15 Loan Modification Agreement, dated July 18, 1995, by and among Solo
Serve Corporation, Nationwide Life Insurance Company, and Employers
Life Insurance Company (8)

10.16 Promissory Note, dated July 31, 1995, in principal amount of
$5,565,000, with the Company as Maker, and Texas Commerce Bank National
Association as Holder (8)

10.17 Loan Modification Agreement, dated October 27, 1995, by and between
Solo Serve Corporation and Congress Financial Corporation (Southwest)
(9)

10.18 Consulting Services Agreement between the Company and Robert J. Grimm
(10) +

10.19 Second Amendment to Loan and Security Agreement, dated January 31,
1996, by and between Solo Serve Corporation and Congress Financial
Corporation (Southwest) (11)

10.20 Letter Agreement dated January 23, 1996 by and between the Company and
MetLife Capital Corporation modifying the Loan and Security Agreement
between the Company and MetLife Capital Corporation, as amended on July
18, 1995 (11)

10.21 Amendment No. 3 to Loan and Security Agreement by and between Solo
Serve Corporation and Congress Financial Corporation (Southwest) dated
June 26, 1996 (12)

10.22 Letter of Credit and Security Agreement between Solo Serve Corporation
and General Atlantic Corporation dated as of June 26, 1996 (12)

10.23 Intercreditor and Subordination Agreement between Congress Financial
Corporation (Southwest) and General Atlantic Corporation dated as of
June 26, 1996, as acknowledged and agreed to by Solo Serve Corporation
(12)

10.24 Consulting Agreement between the Company and Charles Siegel (13) +

23
<PAGE> 24

10.25 Employment Agreement between the Company and Charles Siegel (13) +

10.26 Amendment No. 4 to Loan and Security Agreement by and between Solo
Serve Corporation and Congress Financial Corporation (Southwest) dated
as of September 1, 1996 (13)

10.27 Amendment No. 5 to Loan and Security Agreement by and between Solo
Serve Corporation and Congress Financial Corporation (Southwest) dated
as of March 31, 1997 (14)

10.28 Letter Agreement dated March 28, 1997 by and between the Company and
MetLife Capital Corporation modifying the Loan and Security Agreement
between the Company and MetLife Capital Corporation, as amended on July
18, 1995 (14)

10.29 Letter Agreement dated July 8, 1996 by and between the Company and Ross
E. Bacon (14)+

10.30 Amendment No. 6 to Loan and Security Agreement by and between Solo
Serve Corporation and Congress Financial Corporation (Southwest) dated
as of May 19, 1997 (14)

10.31 Agency Agreement by and between Solo Serve Corporation and Hilco/Great
American Group dated May 7, 1997, as amended together with related
agreements (15)

10.32 Amendment No. 7 to Loan and Security Agreement by and between Solo
Serve Corporation and Congress Financial Corporation (Southwest) dated
June 16, 1997 (15)

10.33 Standby Guarantee and Indemnification Agreement by and between Solo
Serve Corporation and Congress Financial Corporation (Southwest) dated
June 16, 1997 (15)

10.34 Commitment Letter of Sanwa Business Credit Corporation dated September
8, 1997 (16)

10.35 Letter of Price Waterhouse LLP dated September 18, 1997 (17)

10.36 Loan and Security Agreement by and between the Company and Sanwa
Business Credit Corporation (18)

10.37 Employment Agreement by and between the Company and Charles M. Siegel
(18)+

10.38 Subordinated Promissory Note of the Company to Charles Siegel in
Principal Amount of $400,000 (18)

10.39 Subordinated Promissory Note of the Company to The Siegel Family Trust
in Principal Amount of $100,000 (18)

10.40 Letter of Credit and Security Agreement by and between the Company and
General Atlantic Corporation (18)

10.41 Subordination and Intercreditor Agreement by and among the Company,
Sanwa Business Credit Corporation, and General Atlantic Corporation
(18)

10.42 Subordination and Intercreditor Agreement by and among the Company,
Sanwa Business Credit Corporation, Charles M. Siegel, and The Siegel
Family Trust (18)

10.43 First Amendment to Loan and Security Agreement by and between the
Company and Sanwa Business Credit Corporation (19)

10.44 Amended and Restated Letter of Credit and Security Agreement by and
between the Company and General Atlantic Corporation (19)

10.45 Stockholder Agreement (19)

10.46 Employment Agreement between the Company and Ross Bacon (19)+

10.47 Employment Agreement between the Company and Mark Blankenship (19)+

10.48 Employment Agreement between the Company and Terry Lalosh (19)+

10.49 Lease Agreement between the Company and Koontz/McCombs 1, Ltd.*

10.50 Earnest Money Contract between the Company and Koontz/McCombs, LLC*

10.51 Escrow and Security Agreement by and among the Company, Nationwide Life
Insurance Company, Employers Life Insurance Company of Wasuau,
Koontz/McCombs 1, Ltd. and Holliday Fenoglio Fowler, L.P.*

10.52 Assumption Agreement by and among the Company, Nationwide Life
Insurance Company, Employers Life Insurance Company of Wasuau,
Koontz/McCombs 1, Ltd., Koontz/McCombs, LLC and Bart C. Koontz*

21.1 Subsidiaries of the Registrant (14)

23.1 Consent of Independent Accountants *

23.2 Consent of Independent Accountants *

27 Financial Data Schedule *

--------------

* Filed herewith.
+ Management Compensatory Plan or Arrangement

24
<PAGE> 25

(1) Incorporated by reference to the Exhibits to the Company's Registration
Statement on Form S-1 (No. 33-46324), as filed on March 11, 1992, and
amended by Amendment No. 1, filed on March 26, 1992, Amendment No. 2,
filed on April 20, 1992, and Amendment No. 3, filed on April 24, 1992.

(2) Incorporated by reference to the Exhibits to the Company's Annual
Report on Form 10-K for the Fiscal year ended January 30, 1993.

(3) Incorporated by reference to the Exhibits filed to the Company's
Quarterly Report on Form 10-Q for the Quarter ended July 30, 1994.

(4) Incorporated by reference to the Exhibits filed to the Company's Annual
Report on Form 10-K for the Fiscal Year ended January 28, 1995.

(5) Incorporated by reference to the Exhibits filed to the Company's
Quarterly Report on Form 10-Q for the Quarter ended April 29, 1995.

(6) Incorporated by reference to the Exhibits filed to the Company's
Current Report on Form 8-K for July 6, 1995.

(7) Incorporated by reference to the Exhibits filed to the Company's
Current Report on Form 8-K for July 18, 1995.

(8) Incorporated by reference to the Exhibits filed to the Company's
Quarterly Report on Form 10-Q for the Quarter ended July 29, 1995.

(9) Incorporated by reference to the Exhibits filed to the Company's
Quarterly Report on Form 10-Q for the Quarter ended October 28, 1995.

(10) Incorporated by reference to the Exhibits filed to the Company's Annual
Report on Form 10-K for the Fiscal Year ended February 3, 1996.

(11) Incorporated by reference to the Exhibits filed to the Company's
Current Report on Form 8-K for February 8, 1996.

(12) Incorporated by reference to the Exhibits filed to the Company's
Current Report on Form 8-K for July 2, 1996.

(13) Incorporated by reference to the Exhibits filed to the Company's
Quarterly Report on Form 10-Q for the Quarter ended August 3, 1996.

(14) Incorporated by reference to the Exhibits filed to the Company's Annual
Report on Form 10-K for the Fiscal Year ended February 1, 1997.

(15) Incorporated by reference to the Exhibits filed to the Company's
Quarterly Report on Form 10-Q for the Quarter ended May 3, 1997.

(16) Incorporated by reference to the Exhibits filed to the Company's
Quarterly Report on Form 10-Q for the Quarter ended August 2, 1997.

(17) Incorporated by reference to the Exhibits filed on the Company's
Current Report on Form 8-K for September 18, 1997.

(18) Incorporated by reference to the Exhibits filed to the Company's
Current Report on Form 8-K for October 2, 1997.

(19) Incorporated by reference to the Exhibits filed to the Company's
Current Report on Form 8-K for March 17, 1998.

(b) Reports on Form 8-K. No reports on Form 8-K were filed during the
last quarter of the period covered by this report:

25
<PAGE> 26

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.

SOLO SERVE CORPORATION

By: /s/ Charles M. Siegel
------------------------------------------------
Charles M. Siegel
President and Chief Executive Officer

By: /s/ Ross E. Bacon
------------------------------------------------
Ross E. Bacon,
Executive Vice President and Chief Operating
and Financial Officer, Treasurer and Secretary
(Principal Financial and Accounting Officer)

DATED: May 1, 1998

Pursuant to the requirements of the Securities and Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the date indicated.

<TABLE>
<CAPTION>
Signature Name and Title Date
--------- -------------- ----
<S> <C> <C>
/s/ Charles M. Siegel President and Chief Executive May 1, 1998
- ----------------------------- Officer, Director
Charles M. Siegel

/s/ Ross E. Bacon Executive Vice President and May 1, 1998
- ----------------------------- Chief Operating and Financial
Ross E. Bacon Officer, Treasurer and Secretary
(Principal Financial and
Accounting Officer)

/s/ Robert J. Grimm Chairman of the Board May 1, 1998
- -----------------------------
Robert J. Grimm

/s/ Stephen P. Reynolds Director May 1, 1998
- -----------------------------
Stephen P. Reynolds

/s/ John C. Seiler Director May 1, 1998
- -----------------------------
John C. Seiler

/s/ Walter H. Teninga Director May 1, 1998
- -----------------------------
Walter H. Teninga
</TABLE>

26
<PAGE> 27

SOLO SERVE CORPORATION
INDEX TO FINANCIAL STATEMENTS AND SCHEDULES

As of January 31, 1998 and for the 3 years ended February 3, 1996,
February 1, 1997 and January 31, 1998

<TABLE>
<S> <C>
Reports of Independent Auditors.............................................................. F-2

Balance Sheets............................................................................... F-3

Statements of Operations..................................................................... F-4

Statements of Changes in Stockholders' Equity (Deficit)...................................... F-5

Statements of Cash Flows..................................................................... F-6

Notes to Financial Statements................................................................ F-7

Financial Statement Schedule

Reports of Independent Auditors on Financial Statement Schedule.............................. S-1

Schedule X - Supplementary Statements of Operations Information.............................. S-3
</TABLE>

Schedules not included above have been omitted because they are not applicable
or the required information is shown in the financial statements or related
notes.

F-1
<PAGE> 28

Report of Independent Auditors

Board of Directors and Stockholders
Solo Serve Corporation

We have audited the accompanying balance sheet of Solo Serve Corporation as of
January 31, 1998, and the related statements of operations, changes in
stockholders' equity (deficit), and cash flows for the year then ended. These
financial statements are the responsibility of the Corporation's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.

We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Solo Serve Corporation at
January 31, 1998, and the results of its operations and its cash flows for the
year then ended, in conformity with generally accepted accounting principles.

The accompanying financial statements have been prepared assuming that the
Corporation will continue as a going concern. As more fully described in Note 1,
the Corporation's Plan of Reorganization was approved by creditors and
shareholders and confirmed by the United States Bankruptcy Court on July 6, 1995
and became effective on July 18, 1995. The Corporation's recurring operating
losses since the effective date of the Plan of Reorganization raise substantial
doubt about its ability to continue as a going concern. Management's plans in
regard to future operations are also described in Note 1. The financial
statements do not include any adjustments to reflect the possible future effects
on the recoverability and classification of assets or the amounts and
classification of liabilities that may result from the outcome of this
uncertainty.

Ernst & Young LLP

April 10, 1998

F-2
<PAGE> 29

REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Stockholders of Solo Serve Corporation

In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of operations, of changes in stockholders' equity and of
cash flows present fairly, in all material respect, the financial position of
Solo Serve Corporation and its subsidiary (the Company) at February 1, 1997, and
the results of their operations and their cash flows for each of the two years
in the period ended February 1, 1997, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.

The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As described in Note 1, the Company's
Plan of Reorganization was approved by creditors and shareholders and confirmed
by the United States Bankruptcy Court on July 6, 1995 and became effective on
July 18, 1995. The Company's recurring operating losses raise substantial doubt
about its ability to continue as a going concern. Management's plans in regard
to future operations are also described in Note 1. The consolidated financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.

PRICE WATERHOUSE LLP

San Antonio, Texas
May 14, 1997

F-2A
<PAGE> 30

SOLO SERVE CORPORATION
BALANCE SHEETS

ITEM 1. Financial Statements

<TABLE>
<CAPTION>
ASSETS FEBRUARY 1, 1997 JANUARY 31, 1998
---------------- -----------------
<S> <C> <C>
CURRENT ASSETS:
Cash $ 1,065,564 $ 1,042,357
Inventory 11,107,938 12,030,628
Other current assets 988,469 1,412,914
------------ ------------
Total current assets 13,161,971 14,485,899
Property and equipment, net 12,935,322 11,897,807
Goodwill, net 290,000 --
------------ ------------
TOTAL ASSETS $ 26,387,293 $ 26,383,706
============ ============

LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)

CURRENT LIABILITIES:
Accounts payable $ 3,983,898 $ 7,295,493
Accrued expenses 2,339,615 2,329,506
Current portion of long-term debt 770,602 5,140,895
------------ ------------
Total current liabilities 7,094,115 14,765,894

Long-term debt 14,960,600 13,340,959
Note payable to stockholder -- 500,000
Commitments and contingencies -- --
------------ ------------

TOTAL LIABILITIES 22,054,715 28,606,853
------------ ------------

STOCKHOLDERS' EQUITY (DEFICIT):
Preferred stock, $.01 par value, 2,000,000 shares authorized, 1,388,869
shares issued and outstanding at February 1, 1997 and January 31, 1998 13,889 13,889
Common stock, $.01 par value; 8,000,000 shares authorized, 2,856,126
shares issued and outstanding at February 1, 1997 and January 31, 1998 28,562 28,562
Capital in excess of par value 24,410,290 24,410,290

Retained earnings (deficit) (20,120,163) (26,675,888)
------------ ------------

TOTAL STOCKHOLDERS' EQUITY (DEFICIT) 4,332,578 (2,223,147)
------------ ------------

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) $ 26,387,293 $ 26,383,706
============ ============

</TABLE>

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

F-3
<PAGE> 31

SOLO SERVE CORPORATION
STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
FOR THE FISCAL YEAR ENDED
FEBRUARY 3, 1996 FEBRUARY 1, 1997 JANUARY 31, 1998
---------------- ---------------- ----------------
Number of weeks in fiscal year 53 52 52
---------------- ---------------- ----------------
<S> <C> <C> <C>
Net revenues $ 109,823,364 $ 95,237,689 $ 82,045,778

Cost of goods sold (including buying and distribution,
excluding depreciation shown below) 83,474,450 67,484,703 57,302,606
------------- ------------- -------------

Gross profit 26,348,914 27,752,986 24,743,172

Selling, general, and administrative expense 29,620,266 28,203,345 26,414,436

Depreciation and amortization expense 2,815,024 2,420,868 2,062,041

Store closure expense -- -- 622,224

Write down of property and equipment -- 525,000 --

Non-recurring charge -- 464,000 --

------------- ------------- -------------

Operating loss (6,086,376) (3,860,227) (4,355,529)

Interest expense, (contractual interest of $1,791,412 for the
53 weeks ended February 3, 1996) 1,129,346 1,624,320 1,933,853
------------- ------------- -------------

Loss before reorganization items, income taxes and
extraordinary items (7,215,722) (5,484,547) (6,289,382)
------------- ------------- -------------

Reorganization Items:

Loss on disposal of stores 553,222 -- --
Provision for other reorganization expenses 1,421,754 -- --
Interest earned on accumulated cash resulting from
Chapter 11 proceedings (188,283) -- --
------------- ------------- -------------
1,786,693 -- --
------------- ------------- -------------
Loss before income taxes and extraordinary items (9,002,415) (5,484,547) (6,289,382)
------------- ------------- -------------

Provision for (benefit from) income taxes:
Deferred (1,418,200) -- --
------------- ------------- -------------
(1,418,200) -- --
------------- ------------- -------------
Loss before extraordinary items (7,584,215) (5,484,547) (6,289,382)

Extraordinary items:
Gain on discharge of debt (net of tax effect of ($1,418,200) 2,752,975 -- --
-- -- (266,343)
Loss on early retirement of debt (net of tax effect)
------------- ------------- -------------

Net loss $ (4,831,240) $ (5,484,547) $ (6,555,725)
============= ============= =============

Loss per common share before extraordinary item $ (2.10) $ (1.92) $ (2.20)
============= ============= =============

Extraordinary gain (loss) per common share $ 0.76 -- $ (0.10)
============= ============= =============

Net loss per common share (basic and diluted) $ (1.34) $ (1.92) $ (2.30)
============= ============= =============

Weighted average common shares outstanding 3,604,853 2,856,126 2,856,126
============= ============= =============

</TABLE>

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

F-4
<PAGE> 32

SOLO SERVE CORPORATION
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)

<TABLE>
<CAPTION>
Preferred
Stock Common Stock
Preferred Common Stock Preferred Common Capital in Capital in
Stock Shares Shares Stock $.01 Stock $.01 Excess of Excess of
Outstanding Outstanding par value par value par value par value
------------ ------------- ---------- ---------- ---------- ------------
<S> <C> <C> <C> <C> <C> <C>
Balance at January 28, 1995 5,712,252 57,123 21,895,618
--------- --------- ------- ------ ---------- ----------

Proceeds from issuance of preferred stock 1,388,889 $13,889 $2,486,111

Common stock one-for-two reverse split (2,856,126) (28,561) 28,561

Net Loss
--------- --------- ------- ------ ---------- ----------
Balance at February 3, 1996 1,388,889 2,856,126 13,889 28,562 2,486,111 21,924,179
--------- --------- ------- ------ ---------- ----------

Net Loss
--------- --------- ------- ------- ---------- ------------
Balance at February 1, 1997 1,388,889 2,856,126 $13,889 $28,562 $2,486,111 $ 21,924,179
--------- --------- ------- ------- ---------- ------------

Net Loss
========= ========= ======= ======= ========== ============
Balance at January 31, 1998 1,388,889 2,856,126 $13,889 $28,562 $2,486,111 $ 21,924,179
========= ========= ======= ======= ========== ============
</TABLE>

<TABLE>
<CAPTION>
Retained
Earnings
(Deficit) Total
---------- -----------
<S> <C> <C>
Balance at January 28, 1995 (9,804,376) 12,148,365
---------- ----------

Proceeds from issuance of preferred stock 2,500,000

Common stock one-for-two reverse split -

Net Loss (4,831,240) (4,831,240)
------------ ----------
Balance at February 3, 1996 (14,635,616) 9,817,125
------------ ----------

Net Loss (5,484,547) (5,484,547)
------------ ----------
Balance at February 1, 1997 $(20,120,163) $4,332,578
------------ ----------

Net Loss (6,555,725) (6,555,725)
============ ===========
Balance at January 31, 1998 $(26,675,888) $(2,223,147)
============ ===========
</TABLE>

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

F-5
<PAGE> 33

SOLO SERVE CORPORATION
STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
FOR THE FISCAL YEAR ENDED
FEBRUARY 3, 1996 FEBRUARY 1, 1997 JANUARY 31, 1998
---------------- ---------------- -----------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) before extraordinary items $ (4,831,239) $ (5,484,547) $ (6,289,382)
Extraordinary Items 2,752,975 -- (266,343)
------------- ------------- -------------
Net loss (7,584,214) (5,484,547) (6,555,725)

ADJUSTMENTS TO RECONCILE NET INCOME (LOSS) TO CASH
Depreciation 2,694,492 2,300,868 1,772,041
Amortization of intangibles 120,532 120,000 290,000
Loss on retirement and write down of leasehold improvements 208,070 652,573 23,770
and property and equipment
Changes in assets and liabilities
(Increase) decrease in inventories 738,648 3,102,242 (922,690)
(Increase) decrease in other current assets 181,519 1,285,161 (424,445)
(Increase) decrease in non-current receivables 1,662,935 -- --
Decrease (increase) in long-term deferred income taxes (1,418,200) -- --
Increase (decrease) in accounts payable (1,652,125) 557,077 3,311,595
(Decrease) increase in accrued expenses (606,607) (870,395) (10,109)
(Decrease) increase in long-term postretirement benefit 63,900 (565,200) --
obligation
------------- ------------- -------------
Total adjustments 1,993,164 6,582,326 4,040,162
------------- ------------- -------------
Net cash provided by (used in) operating activities
before reorganization items (5,591,050) 1,097,779 (2,515,563)

OPERATING CASH FLOWS FROM REORGANIZATION ITEMS:
Payments made on reorganization costs (1,185,823) -- --
Non cash items from reorganization (1,132,424) (460,612) --
Loss on disposal of stores 553,222 -- --
Provision for other reorganization expenses 257,139 -- --
------------- ------------- -------------
Net cash provided by (used in) operating activities (7,098,936) 637,167 (2,515,563)
------------- ------------- -------------

CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (877,402) (254,494) (758,296)
------------- ------------- -------------
Net cash provided by (used in) investing activities (877,402) (254,494) (758,296)

CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings under long-term debt 25,067,240 103,367,509 90,527,193
Payments under long-term debt (21,969,755) (103,456,145) (87,776,541)
Borrowings from stockholder -- -- 500,000
------------- ------------- -------------
Net cash provided by (used in) finance activities before 3,097,485 (88,636) 3,250,652
reorganization items

FINANCING CASH FLOWS FROM REORGANIZATION ITEMS:
Distributions to claimants under plan of reorganization (13,933,177) -- --
Sale of preferred stock 2,500,000 -- --
------------- ------------- -------------
Net cash provided by (used in) financing activities (8,335,692) (88,636) 3,250,652
------------- ------------- -------------

Net increase (decrease) in cash (16,312,030) 294,037 (23,207)

Cash at beginning of year 17,083,557 771,527 1,065,564
------------- ------------- -------------
Cash at end of year $ 771,527 $ 1,065,564 $ 1,042,357
============= ============= =============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest $ 1,116,300 $ 1,579,691 $ 1,826,707
</TABLE>

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

F-6
<PAGE> 34

SOLO SERVE CORPORATION
NOTES TO FINANCIAL STATEMENTS

NOTE 1 - NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES:

BUSINESS

Solo Serve Corporation (the "Company") was incorporated in the State of
Texas on June 1, 1979 and was a majority-owned subsidiary of General Atlantic
Corporation ("GAC") until its initial public offering of shares of common stock
on April 29, 1992. The Company was reincorporated in Delaware in December 1991.
The Company is engaged in the operation of off-price retail department stores
located in Texas and Louisiana. The Company has a 52/53 week fiscal year ending
on the Saturday closest to January 31.

ESTIMATES

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.

INVENTORY

Inventory is stated at the lower of cost or market. Cost is determined
by the specific identification method. The cost effects of permanent retail
reductions for slow moving items are charged to cost of goods sold in the period
such reductions are incurred.

DEPRECIATION AND AMORTIZATION

Depreciation of property and equipment is computed using the
straight-line method over estimated useful lives of the related assets.
Maintenance and repairs are expensed as incurred.

INCOME TAXES

Deferred income taxes are provided to reflect temporary differences
between the tax and book bases of assets and liabilities. The Company provides
valuation allowances for its deferred tax assets pursuant to the provisions of
Statement of Financial Accounting Standards No. 109.

PRE-OPENING EXPENSES

Pre-opening expenses are charged to expense over the first twelve
months of operations.

REVENUE RECOGNITION

The Company recognizes revenue as merchandise is sold.

LAYAWAY SALES

Layaway sales are recognized in full when the layaway deposit is
received, and the unpaid balance is recorded as accounts receivable.
Cancellations result in a decrease in recorded sales and cost of sales.
Cancellation fees and service fees required to place a purchase in layaway are
recognized as revenue.

RENTAL EXPENSE

Rental expense for leases with escalation clauses is recorded on a
straight-line basis.

ADVERTISING COSTS

The Company expenses advertising costs as incurred. Advertising expense
for the fiscal years 1995, 1996 and 1997 was $3,742,000, $2,978,000 and
$2,652,000, respectively.

F-7
<PAGE> 35

SOLO SERVE CORPORATION
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)

NOTE 1 - NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)

EARNINGS PER SHARE

The computation of basic and diluted earnings per share is based on the
weighted average number of common shares outstanding and dilutive common stock
equivalents (stock options and voting, convertible preferred stock) outstanding
during each period (Note 7).

REORGANIZATION AND MANAGEMENT'S PLANS

On July 21, 1994, the Company filed a petition under Chapter 11 of the
Bankruptcy Code ("Chapter 11") in the United States Bankruptcy Court for the
Western District of Texas (the "Bankruptcy Court"). On July 6, 1995, the
Bankruptcy Court approved a Proposed Plan of Reorganization (the "Plan") jointly
sponsored by the Official Committee of Unsecured Creditors and Texas Commerce
Bank San Antonio, N.A. ("TCB"), which became effective on July 18, 1995. On the
effective date of the Plan, the Company issued 1,388,889 shares of convertible
Preferred Stock for an aggregate consideration of $2.5 million. All of the
shares of Preferred Stock was purchased by General Atlantic Corporation ("GAC"),
the Company's largest stockholder. On April 17, 1996, the Bankruptcy Court
entered the Final Decree, which administratively closed Solo Serve's Chapter 11
bankruptcy case.

Pursuant to the Plan, the Company's existing common stock was subject
to a one-for-two reverse split. The shares of Preferred Stock issued in
connection with the Plan have a liquidation value of $1.80 per share, are
convertible to an equal number of shares of Common Stock, have voting rights on
an as converted basis, and are entitled to no preferential dividends. With the
issuance of shares of Preferred Stock mentioned above, GAC increased its
percentage ownership of the voting shares of the Company to approximately 62%
from its pre-reorganization interest of approximately 44%. In October 1997 and
March 1998 certain members of Company management (the "Management Holders")
acquired a total of 1,964,686 shares of the Company's Common Stock from GAC.
This represented all of GAC's shares of Common Stock and 709,686 of its shares
of Preferred Stock which were converted to shares of Common Stock. GAC continues
to own 679,203 shares of the Company's Preferred Stock, which represents
approximately 16% of the aggregate voting stock of Solo Serve and all of the
Company's issued and outstanding shares of Preferred Stock.

F-8
<PAGE> 36

regarding the Company's creditworthiness, which could adversely affect the
Company's ability to receive sufficient trade credit support to acquire adequate
levels of inventory in the future.

In response to these conditions, management restructured its lending
arrangements, opened stores in markets smaller than it has traditionally served,
and entered into contracts to sell and leaseback all of its owned properties. If
current plans to improve overall financial performance and meet liquidity
requirements are not successful, the Company would consider other alternatives
designed to enhance liquidity, including additional debt or equity financings,
or other strategic alternatives

NOTE 2 - PROPERTY AND EQUIPMENT:

Property and equipment stated at cost is comprised of:

<TABLE>
<CAPTION>
ESTIMATED USEFUL LIFE FEBRUARY 1, 1997 JANUARY 31, 1998
------------------------ ---------------- ----------------
<S> <C> <C> <C>
Land $ 2,006,031 $ 2,006,031
Furniture, fixtures and equipment 3-10 17,306,704 17,662,200
Leasehold improvements 10-15 4,541,925 4,831,406
Buildings 20-40 8,683,897 8,683,897
------------- ---------------
32,538,557 33,183,534
Less accumulated depreciation 19,603,235 21,285,727
============= ===============
$ 12,935,322 $ 11,897,807
============= ===============
</TABLE>

During the second quarter of 1995, the Company closed its store in
Montgomery, Alabama and recorded a loss on the disposal of approximately
$553,000, which is included in reorganization items.

During the second quarter of fiscal 1997, the Company closed two stores
and during the fourth quarter closed a third, all in Louisiana. This resulted in
a charge of approximately $622,000 to store closure expense for inventory
adjustments, and lease terminations related to these stores. In fiscal 1996,
based on the revised cash flow estimates from these three locations, the Company
recorded a $525,000 write-down of the net book value of leasehold improvements
and fixtures and equipment associated with these locations.

F-9
<PAGE> 37

SOLO SERVE CORPORATION
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)

NOTE 3 - ACCRUED EXPENSES:

Accrued expenses are comprised of:

<TABLE>
<CAPTION>
FEBRUARY 1, 1997 JANUARY 31, 1998
---------------- -----------------
<S> <C> <C>
Accrued rent $ 756,471 $ 703,224
Accrued sales and property taxes 534,612 526,311
Voluntary benefits 217,078 105,500
Employee benefits 372,213 --
Incentive compensation 20,390 52,561
Layaway escrow 21,621 36,532
Reserve for store closing -- 290,097
Other 417,230 615,281
========== ==========
$2,339,615 $2,329,506
========== ==========
</TABLE>

NOTE 4 - LONG-TERM DEBT:

Long-term debt consists of the following:

<TABLE>
<CAPTION>
FEBRUARY 1, 1997 JANUARY 31, 1998
---------------- ----------------
<S> <C> <C>
Notes payable to bank, interest at prime plus 1/2% (9.0% at January 31,
1998) secured by properties $ 5,131,406 $ 4,808,716

Note payable to insurance company, interest at 8.0%; secured by
equipment and properties 654,132 272,127

Mortgage notes payable to insurance companies, interest at 9.5%;
secured by the distribution center 5,760,664 5,706,011

Revolving credit facility, interest at prime plus 1% (9.5% at January 31,
1998); secured primarily by inventory 4,185,000 7,695,000
----------- -----------
15,731,202 18,481,854
Less current portion 770,602 5,140,895
----------- -----------

Long-term portion $14,960,600 $13,340,959
=========== ===========
</TABLE>

The Company has a term note payable to Texas Commerce Bank ("TCB") due
in equal monthly payments of principal and interest of $64,117 until January
1999, when the remaining principal balance of $4.5 million is due. The TCB note
is secured by the Company's three owned store locations. These properties are
currently subject to a contract for sale and leaseback, which, if completed is
expected to result in the retirement of the TCB indebtedness.

The Company also has a note payable to MetLife Capital Corporation (the
"MetLife Note"), which is secured by various equipment and fixtures located at
the corporate office and certain stores. The MetLife Note requires equal monthly
payments, including principal and interest, of $35,044 until September 1998. The
Company also has two mortgage notes payable, with identical terms (the "Mortgage
Notes"), each of which is secured by the Company's corporate office and
distribution center in San Antonio, Texas. The Mortgage Notes require aggregate
monthly payments of principal and interest of $49,773 until December 2002, when
the remaining aggregate principal balance of $5.4 million is due. Subsequent to
January 31, 1998, the Company sold and leased back the distribution center and
corporate office. The buyer, in turn, assumed the outstanding Mortgage Notes,
which released the Company from any future liability on this indebtedness. (See
Note 11.)

F-10
<PAGE> 38

On March 17, 1998, the Company amended its loan agreement with Sanwa.
The amendment waives compliance with the financial covenants at January 31,
1998, eliminates the Company's minimum net worth covenant entirely, and revises
the interest coverage ratios for 1998. If the Company fails to meet the revised
interest coverage ratio, the entire balance due under the loan agreement would
be reclassified as a current liability. The amendment also increases the advance
rate on the Company's eligible inventory from 65% to 70% from the date of the
amendment through December 10, 1998 and provides an additional $600,000
available to borrow based upon a new $600,000 letter of credit in favor of Sanwa
provided by GAC. The new $600,000 letter of credit, which is anticipated to
terminate thirty days after consummation of the pending sale of the Company's
three owned store locations, is in addition to the previously discussed $750,000
letter of credit provided by GAC, which is anticipated to terminate December 31,
1998. The letters of credit are secured by a second lien on substantially all of
the assets of the Company other than real estate.

On October 2, 1997, Charles M. Siegel, President and Chief Executive
Officer of the Company, and a related family trust loaned the Company an
aggregate amount of $500,000 (the Siegel Loan). The loan bears interest at a
rate of prime plus 1%, and requires monthly payments of interest only for a
period of five years, at which time the principal becomes due (October 31,
2002). The Siegel Loan is subordinate to the Sanwa credit facility and to
repayment by the Company of any amounts advanced under the letter of credit
issued by GAC. The Company may not repay any principal due under the Siegel Loan
without Sanwa's prior consent and may make interest payments to Mr. Siegel only
if there is no existing default by the Company under the Sanwa credit facility.
In related transactions, Mr. Siegel purchased from GAC all of its common stock
in the Company, and his employment contract with the Company was amended.

The Company has issued an unused $75,000 Letter of Credit in favor of
Liberty Mutual Insurance Company.

Future maturities of long-term debt by fiscal year are as follows:

<TABLE>
<CAPTION>
Fiscal
------
<S> <C>
1998 5,140,895
1999 65,986
2000 7,767,507
2001 79,671
2002 5,427,795
-----------
$18,481,854
===========
</TABLE>

Based on borrowing rates currently available to the Company for bank
loans with similar terms and maturities, the fair value of long-term debt is
estimated to be $18.5 million at January 31, 1998, including amounts payable
within one year.

F-11
<PAGE> 39

SOLO SERVE CORPORATION
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)

NOTE 5 - NON-RECURRING CHARGE:

The Company recognized and recorded an unanticipated and non-recurring
charge of $464,000 in fiscal 1996. In recent years, the Company self-insured
workers' compensation and medical insurance for its employees and purchased
stop-loss coverage to limit its maximum exposure. In late fiscal 1996, a
dependent of one of the Company's former employees who is covered by COBRA
required expensive medical treatment which was not covered by the stop-loss
provider, and the majority of this accrual relates to this claim. During fiscal
1997 the claim was resolved and the Company's liability discharged. Effective
January 1, 1997, the Company purchased fully insured coverage for medical and
workers' compensation insurance.

NOTE 6 - INCOME TAXES:

The principal reasons for the difference between the statutory federal
income tax rate and the Company's provision for income taxes were:

<TABLE>
<CAPTION>
FISCAL 1995 FISCAL 1996 FISCAL 1997
----------- ----------- ------------
<S> <C> <C> <C>
Tax benefit at statutory federal rate $(1,642,307) $(1,864,746) $(2,138,390)
Other 573,952 47,175 74,215
Increase in state net operating loss carryovers (241,099) (64,263) (197,443)
Valuation allowance for net deferred asset 1,309,454 1,881,834 2,261,618
=========== =========== ===========
$ 0 $ 0 $ 0
=========== =========== ===========
</TABLE>

The approximate tax effect of temporary differences that give rise to
deferred tax assets (liabilities) is as follows:

<TABLE>
<CAPTION>
FEBRUARY 1, 1997 JANUARY 31, 1998
---------------- -----------------
<S> <C> <C>
Markdowns $ 276,239 $ 260,554
Uniform inventory capitalization 343,710 309,710
Voluntary benefits accrual 73,807 35,870
Medical benefits accrual 126,552 --
Accrued rent 257,199 239,095
Layaway sales (22,782) (22,472)
Difference in book and tax basis of property
and equipment 611,690 873,628
Difference in book and tax basis of building 1,168,482 1,168,482
Store closing reserve -- 98,633
Net operating loss carryover 8,015,698 9,949,889
General business credit carryover (expiring
during the years 1996-2000) 356,638 356,638
Alternative minimum tax carryover 100,131 97,860
State net operating loss carryover 797,626 995,069
Other, net (82,117) (78,465)
------------ ------------

Total net tax assets 12,022,873 14,284,491
Valuation allowance (12,022,873) (14,284,491)
============ ============
Deferred tax asset $ 0 $ 0
============ ============
</TABLE>

Due to the increased operating loss carryforwards generated from the
Company's continuing operations and reorganization, management believes that
uncertainties exist such that it is unlikely that the Company's deferred tax
assets will be realized in the future and therefore have recorded a valuation
allowance equal to 100% of its existing net deferred tax asset. In fiscal 1995,
1996 and 1997, the Company recorded an additional valuation allowance of
$1,309,454, $1,881,834 and $2,261,618, respectively for deferred tax assets
generated in those years. The Company's net operating loss carryforward of
approximately $29.5 million expires in the years 2008-2012.

F-12
<PAGE> 40

SOLO SERVE CORPORATION
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)

NOTE 7 - STOCK OPTION PLAN:

The Company has a stock option plan for certain key employees. The
following table summarizes option activity for fiscal years 1995, 1996 and 1997:

<TABLE>
<CAPTION>
Weighted
Average
Exercise
Stock Options Shares Price
- ------------- ------ --------
<S> <C> <C>
Outstanding January 28, 1995 458,780 3.50

Granted 460,000 1.61
Canceled (468,780) 3.46
Exercised -- --
-------- -----

Outstanding February 3, 1996 450,000 1.61

Granted 281,000 .28
Canceled (370,000) 1.50
Exercised --
-------- -----

Outstanding January 31, 1997 361,000 $0.69

Granted -- --
Canceled (21,000) .25
Exercised --
-------- -----

Outstanding January 31, 1998 260,000 $0.69
======== =====
</TABLE>

At February 3, 1996, February 1, 1997, and January 31, 1998 exercisable stock
options totaled 56,799; 176,500; and 300,334 shares and had weighted average
exercise prices of $1.61, $0.69, and $0.69, respectively.

The weighted average fair value of options granted during the two years ended
February 3, 1996 and February 1, 1997 was $1.61 and $0.28, respectively. No new
options were granted during fiscal 1997.

On the effective date of the Plan, all existing stock options were canceled. A
new Stock Incentive Plan was implemented on the Effective Date. The new plan
provides for 500,000 shares to be available for grant after taking into effect
the one-for-two reverse split. The 370,000 shares granted on August 8, 1995 were
canceled during 1996, and were replaced by options to purchase 10,000, 25,000,
20,000, 75,000 and 151,000 shares at exercise prices of $.375, $.375, $.4375,
$.25 and $.25, respectively. The outstanding options are exercisable as follows:
141,000 in 1996; 95,334 in 1997; 20,333 in 1998 and 3,333 in 1999. On September
1, 1995 options to purchase 80,000 shares at an exercisable price of $2.125 per
share were granted to Directors. On June 17, 1997 the Directors' options were
repriced at $.1875. The Directors' options are exercisable as follows: 48,000 in
1996; 16,000 in 1997 and 16,000 in 1998. All options are exercisable for 10
years from the date of issuance, with the exception of options for 25,000
shares, which are exercisable for five years. The average remaining contractual
life of these options is eight years.

The Company applies APB Opinion No. 25, "Accounting for Stock Issued to
Employees" and related interpretations in accounting for its stock option plans
as allowed under FAS Statement No. 123, "Accounting for Stock-Based
Compensation." Accordingly, the Company has not recognized compensation expense
for its stock options. Had compensation expense for the Company's stock options
granted in fiscal 1996 and fiscal 1995 been determined based on the fair value
at the grant dates consistent with the methodology of FAS No. 123, such
compensation expense would have been $85,106, $151,045 and $35,071 in fiscal
1995, 1996 and 1997, respectively, and pro forma net loss and loss per share
would have been as follows:

F-13
<PAGE> 41

SOLO SERVE CORPORATION
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)

NOTE 7 - STOCK OPTION PLAN: (CONTINUED)

<TABLE>
<CAPTION>
FISCAL

1995 1996 1997
---- ---- ----
<S> <C> <C> <C>
Pro forma net loss $(4,916,346) $(5,635,592) $(6,590,796)
Pro forma net loss per share,
basic and diluted $(1.36) $(1.97) $(2.31)

</TABLE>

For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting period. The fair value for
these options was estimated at the date of grant using the Black-Scholes option
pricing model with the following weighted-average assumptions:

<TABLE>
<CAPTION>
YEAR ENDED
------------------------------------------------
FEBRUARY 3, FEBRUARY 1, JANUARY 31,
1996 1997 1998
----------- ----------- -----------
<S> <C> <C> <C>
Assumptions used in determining the
fair value of options granted:
Expected volatility 2.63 2.63 1.72
Expected dividend yield - - -
Expected life (term) 6 years 6 years 6 years
Risk-free interest rate 5.29% 5.40% 6.50%
</TABLE>

The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options which have no vesting restrictions and are fully
transferable. In addition, options valuation models require the input of highly
subjective assumptions including expected stock price volatility. Because the
Company's employee stock options have characteristics significantly different
from those of traded options, and because changes in the subjective input
assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable measure of
the fair value of its employees' stock options.

NOTE 8 - RETIREMENT SAVINGS PLAN AND TRUST:

The Company adopted the Solo Serve 401(k) Retirement Savings Plan and
Trust effective January 1, 1993. Participation in the Retirement Savings Plan is
offered to eligible employees of the Company. Generally, all employees of the
Company who are 21 years of age and who have six months of service are eligible
for participation in the plan.

The Retirement Savings Plan is a defined contribution plan which
provides that participants generally may make voluntary salary deferral
contributions, on a pre-tax basis, from 1% to 15% of their compensation in the
form of voluntary payroll deductions. The Company may make discretionary
contributions from its annual profits. During fiscal year 1995, the Company's
contributions totaled $45,775. No contribution was made during fiscal 1996 or
fiscal 1997.

F-14
<PAGE> 42

SOLO SERVE CORPORATION
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)

NOTE 9 - COMMITMENTS AND CONTINGENCIES:

The Company has operating leases for most of its retail store facilities.
Rental expense for the years ended February 3, 1996, February 1, 1997 and
January 31, 1998 amounted to $4,169,183, $4,080,767 and $4,128,871 respectively.
The Company has granted a license to an independent vendor to occupy 200 square
feet of selling space and operate a fine jewelry department in six of the
Company's stores. The following table summarizes payment under these leases:

<TABLE>
<CAPTION>
NET FUTURE
FUTURE MINIMUM SUBLEASE MINIMUM
FISCAL LEASE PAYMENTS INCOME LEASE PAYMENT
-------------- ----------- -----------
<S> <C> <C> <C>
1998 4,338,164 108,000 4,230,164
1999 3,833,611 63,000 3,770,611
2000 3,326,718 -- 3,326,718
2001 2,514,975 -- 2,514,975
2002 2,192,399 -- 2,192,399
AFTER 5,497,877 -- 5,497,877
=========== =========== ===========
$21,703,744 $ 171,000 $21,532,744
=========== =========== ===========
</TABLE>

Some of the Company's operating leases have additional rentals
contingent on individual store sales. The Company may be required to pay
additional rentals if certain sales levels are achieved. For the years ended
February 3, 1996, February 1, 1997, and January 31, 1998 the Company paid
nothing under additional rental agreements.

The Company has an employment contract with its chief executive officer
and president that provides for compensation arrangements. Subsequent to January
31, 1998, the Company entered into employment agreements with each of Messrs.
Bacon, Lalosh and Blankenship which also provide for compensation arrangements.

The Company is involved in litigation arising in the normal course of
business. In the opinion of management, the outcome of this litigation will not
have a material effect on the financial statements of the Company.

F-15
<PAGE> 43

SOLO SERVE CORPORATION
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)

NOTE 10 - CALCULATION OF BASIC AND DILUTED EARNINGS PER SHARE:

The following table sets forth the computation of basic and diluted
earnings per share:

<TABLE>
<CAPTION>
FOR THE FISCAL YEAR ENDED
-------------------------------------------------
FEBRUARY 3, FEBRUARY 1, JANUARY 31,
1996 1997 1998
------------- ----------- -------------
<S> <C> <C> <C>
NUMERATOR
Income (loss) before extraordinary item $ (7,584,215) $(5,484,547) $ (6,289,382)
Extraordinary item 2,752,975 -- 266,343
------------- ----------- -------------

Numerator for basic earnings (loss)per share-
income available to common stock holders (4,831,240) (5,484,547) (6,555,725)

Effect of dilutive securities -- -- --
------------- ----------- -------------

Numerator for diluted earnings (loss) per share-
income available to common stockholders
after assumed conversions (4,831,240) (5,484,547) (6,555,725)
============= =========== =============

DENOMINATOR:

Denominator for basic earnings (loss) per share
weighted-average shares 3,604,853 2,856,126 2,856,126

Effect of dilutive securities
Employee stock options -- -- --
------------- ----------- -------------

Denominator for diluted earnings (loss) per share-
adjusted weighted-average shares,
no assumed dilutions due to losses 3,604,853 2,856,126 2,856,126
============= =========== =============

Basic earnings (loss) per common share:
Loss before extraordinary item $ (2.10) $ (1.92) $ (2.20)
Extraordinary item $ 0.76 -- $ (0.10)
Net loss $ (1.34) $ (1.92) $ (2.30)

Diluted earnings (loss) per common share:
Loss before extraordinary item $ (2.10) $ (1.92) $ (2.20)
Extraordinary item $ 0.76 -- $ (0.10)
Net loss $ (1.34) $ (1.92) $ (2.30)
</TABLE>

NOTE 11 - EVENTS SUBSEQUENT TO YEAR END:

On April 6, 1998, the Company sold and leased back its 440,000 square
foot distribution center and corporate office in San Antonio, Texas. The buyer
assumed the outstanding mortgage notes, and the Company realized approximately
$1 million in cash, net of selling costs, debt assumption; and deposits. The
Company has signed a 10 year lease for the property, and will continue to
occupy the facility.

In addition, each of three members of senior management acquired
236,562 shares of the Company's common stock from GAC, which shares GAC received
upon conversion of an equal number of shares of the Company's preferred stock.
Also, the Company's chief executive officer transferred to each of these three
members of senior management, 80,000 shares of common stock.

F-16
<PAGE> 44

Report of Independent Auditors

Board of Directors
Solo Serve Corporation

We have audited the financial statements of Solo Serve Corporation as of January
31, 1998, and for the year then ended, and have issued our report thereon dated
April 10, 1998. Our audit also included the financial statement schedule listed
in the Index at Item 14(a). This schedule is the responsibility of the Company's
management. Our responsibility is to express an opinion based on our audit.

In our opinion, the financial statement schedule referred to above, when
considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.

Ernst & Young LLP

San Antonio, Texas
April 10, 1998

S-1
<PAGE> 45

REPORT OF INDEPENDENT ACCOUNTANTS ON
FINANCIAL STATEMENT SCHEDULE

To the Board of Directors of Solo Serve Corporation

Our audits of the consolidated financial statements referred to in our report
dated May 14, 1997 appearing on page F-2A of this Annual Report on Form 10-K
also included an audit of the Financial Statement Schedule listed in Item
14(a)(2) of the Form 10-K (and appearing on the following page S-3). In our
opinion, this Financial Statement Schedule presents fairly, in all material
respects, for each of the two years in the period ended February 1, 1997, the
information set forth therein when read in conjunction with the related
consolidated financial statements.

PRICE WATERHOUSE LLP

San Antonio, Texas
May 14, 1997

S-2
<PAGE> 46

SCHEDULE X

SOLO SERVE CORPORATION
SUPPLEMENTARY STATEMENTS OF OPERATIONS INFORMATION

<TABLE>
<CAPTION>
FISCAL 1995 FISCAL 1996 FISCAL 1997
----------- ----------- -----------
<S> <C> <C> <C>
Maintenance and repairs $1,184,744 $1,155,092 $1,017,652
========== ========== ==========

Depreciation of owned assets 2,141,933 1,841,329 1,372,824

Amortization of leasehold improvements 552,559 459,539 399,217

Amortization of intangibles 120,532 120,000 290,000
---------- ---------- ----------

Total $2,815,024 $2,420,868 $2,062,041
========== ========== ==========

Advertising Costs $3,742,498 $2,978,114 $2,651,516
========== ========== ==========
</TABLE>

S-3

<PAGE> 47
EXHIBIT INDEX

<TABLE>
<CAPTION>
Exhibit
Number Description of Exhibit
- ------ ----------------------
<S> <C>
3.1 Restated Certificate of Incorporation of the Company (7)