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Brown Shoe Co Inc – ‘10-Q’ for 7/31/04

On:  Wednesday, 9/8/04, at 3:18pm ET   ·   For:  7/31/04   ·   Accession #:  14707-4-92   ·   File #:  1-02191

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  As Of                Filer                Filing    For·On·As Docs:Size

 9/08/04  Brown Shoe Co Inc                 10-Q        7/31/04    8:439K

Document/Exhibit                   Description                      Pages   Size 

 1: 10-Q        Quarterly Report                                    HTML    393K 
 2: EX-10.2     Form of Performance Share Award Agreement           HTML     18K 
 3: EX-10.3     Form of Non-Qualified Stock Option Plan Award Agmt  HTML     20K 
 4: EX-10.4     Form of Incentive Option Agreement                  HTML     20K 
 5: EX-10.5     Form of Restricted Stock Agreement                  HTML      9K 
 6: EX-31.1     Certification of the Chief Executive Officer -      HTML     10K 
                          Section 302                                            
 7: EX-31.2     Certification of the Chief Financial Officer -      HTML     10K 
                          Section 302                                            
 8: EX-32.1     Section 906 of the Sarbanes-Oxley Act of 2002       HTML      8K 

(Mark One)

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

As of August 28, 2004, 18,189,166 common shares were outstanding.
 
 

The accompanying condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and reflect all adjustments which management believes necessary (which include only normal recurring accruals) to present fairly the Company's financial position, results of operations, and cash flows. These statements, however, do not include all information and footnotes necessary for a complete presentation of the Company's financial position, results of operations and cash flows in conformity with accounting principles generally accepted in the United States.

Certain prior period amounts on the condensed consolidated balance sheets, statements of earnings and statements of cash flows have been reclassified to conform to the current period presentation. These reclassifications did not affect net earnings.

The Company's business is subject to seasonal influences, particularly the back-to-school selling season at Famous Footwear which falls in the Company's third quarter. Interim results may not necessarily be indicative of results which may be expected for any other interim period or for the year as a whole.

For further information, refer to the consolidated financial statements and footnotes included in the Company's Annual Report on Form 10-K for the year ended January 31, 2004.
 
 

The following table sets forth the computation of basic and diluted earnings per common share for the periods ended July 31, 2004 and August 2, 2003:
 

Options to purchase 231,167 and 15,000 shares of common stock for the thirteen week periods and 233,667 and 15,167 for the twenty-six week periods ended July 31, 2004 and August 2, 2003, respectively, were not included in the denominator for diluted earnings per common share because their effect would be antidilutive.
 
 

Comprehensive income includes changes in shareholders' equity related to foreign currency translation adjustments and unrealized gains or losses from derivatives used for hedging activities.

The following table sets forth the reconciliation from net earnings to comprehensive income for the periods ended July 31, 2004 and August 2, 2003:
 

Applicable business segment information is as follows for the periods ended July 31, 2004 and August 2, 2003:
 

The Other segment includes corporate administrative and other expenses, which are not allocated to the operating units, and the Company's investment in its majority-owned subsidiary, Shoes.com, Inc., a footwear e-commerce company.

Effective February 1, 2004, the Company began accounting for its Irish financing subsidiary, Brown Group Dublin Limited, which holds cash earned offshore other than in Canada, within the Other segment. Brown Group Dublin Limited had previously been accounted for within the Wholesale Operations segment. Prior year amounts have been reclassified to
 
 

conform to the current year presentation. This reclassification had no effect on operating earnings, but resulted in a transfer of assets of $62.4 million and $41.3 million at July 31, 2004 and August 2, 2003, respectively, to the Other segment.
 
 

Closure of Canadian Manufacturing Facility

In the fourth quarter of fiscal year 2003, the Company announced the closing of its last Canadian footwear manufacturing facility, located in Perth, Ontario, and recorded a pre-tax charge of $4.5 million, the components of which were as follows:

• Severance and benefit costs for approximately 300 factory employees - $2.3 million

• Inventory markdowns to liquidate factory inventory - $1.6 million

• Cost to buy out leases prior to their normal expiration date - $0.6 million

The Company anticipates that the restructuring activities associated with the closure of the Canadian manufacturing facility will be substantially completed by the end of fiscal 2004.
 
 

Goodwill and intangible assets were attributable to the Company's operating segments as follows:
 

The change between periods for the Naturalizer Retail segment reflects changes in the Canadian dollar exchange rate. The change in the Other segment from August 2, 2003 to July 31, 2004 of $1.1 million reflects the acquisition of additional shares of Shoes.com Inc. by the Company.
 
 

As of July 31, 2004, the Company had four share-based compensation plans, which are described more fully in Note 16 to the consolidated financial statements contained in the Company's Annual Report on Form 10-K for the year ended January 31, 2004. The Company accounts for those plans under the recognition and measurement principles of APB Opinion No. 25, "Accounting for Stock Issued to Employees" and related interpretations. Compensation expense is recognized in net earnings for stock appreciation units, stock performance plans and restricted stock grants. No share-based employee compensation cost is reflected in net earnings for stock options, as all option grants had an exercise price equal to the market value of the

underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share as if the Company had applied the fair value recognition provisions of SFAS No. 123, "Accounting for Stock-Based Compensation," to stock options outstanding:
 

The Company issued 55,387 and 150,347 shares of common stock for the thirteen week periods, and 112,577 and 266,153 shares of common stock for the twenty-six week periods, ended July 31, 2004 and August 2, 2003, respectively, for stock options exercised and restricted stock grants. The Company recognized $0.5 million of share-based compensation income during the thirteen weeks ended July 31, 2004 as a result of the decline in the Company's net earnings and stock price during that period.
 
 

The following table sets forth the components of net periodic benefit cost or income for the Company, including all domestic and Canadian plans:
 

The Company entered into an Amended and Restated Credit Agreement (the "Agreement") effective July 21, 2004, which amended and restated its existing $350 million revolving bank credit agreement. The Agreement provides for a maximum line of credit of $350 million, subject to the calculated borrowing base restrictions. In addition to extending the credit term, the Agreement also provides other benefits to the Company, including expanding the definition of eligible inventory in certain circumstances and reducing the interest rate spread paid on outstanding borrowings. Borrowing availability under the Agreement is based upon the sum of eligible accounts receivable and inventory, less outstanding borrowings, letters of credit and applicable reserves. The Agreement matures on July 21, 2009 and the Company's obligations are secured by the Company's accounts receivable and inventory. Borrowings under the Agreement bear interest at a variable rate determined based upon the level of availability under the Agreement. If availability falls below specified levels, the Company would then be subject to certain financial covenants. In addition, if availability falls below $25 million and the fixed charge coverage ratio is less than 1.0 to 1, the Company would be in default. The Agreement also contains certain other covenants and restrictions.

In connection with the Agreement, the Company incurred $1.1 million of issuance costs in the second quarter, which, together with remaining unamortized debt issuance costs of approximately $2.7 million associated with the existing bank credit agreement, will be amortized over the five-year term of the Agreement.
 
 

Environmental Remediation
The Company is involved in environmental remediation and ongoing compliance activities at several sites. The Company is remediating, under the oversight of Colorado authorities, the groundwater and indoor air at its owned facility in Colorado (also known as the Redfield site) and residential neighborhoods adjacent to and near the property that have been affected by solvents previously used at the facility. The anticipated future cost of remediation activities at July 31, 2004 is $7.1 million and is accrued within accrued expenses and other liabilities on the condensed consolidated balance sheet, but the ultimate cost may vary. The cumulative costs incurred through July 31, 2004 are $13.8 million.

The Company assesses future recoveries from insurance companies related to remediation costs by estimating a range of probable recoveries and recording the low end of the range. Recoveries from other responsible parties are recorded when a contractual agreement is reached. As of July 31, 2004, recorded recoveries totaled $3.8 million and are recorded in other noncurrent assets on the condensed consolidated balance sheet. $3.6 million of the recorded recoveries are expected from certain insurance companies as indemnification for amounts spent for remediation associated with the Redfield site. The insurance companies are contesting their indemnity obligations, and the Company has sued its insurers seeking recovery of defense costs, indemnity and other damages related to the former operations and the remediation at the site. The Company believes insurance coverage in place entitles it to reimbursement for more than the recovery recorded. The Company believes the recorded recovery is supported by the fact the limits of the insurance policies at issue exceed the amount of the recorded recovery, and certain insurers have offered to settle these claims. The Company is unable to estimate the ultimate recovery from the insurance carriers, but is pursuing resolution of its claims.
 
 

The Company has completed its remediation efforts at its closed New York tannery and two associated landfills. In 1995, state environmental authorities reclassified the status of these sites as being properly closed and requiring only continued maintenance and monitoring over the next 20 years. In addition, various federal and state authorities have identified the Company as a potentially responsible party for remediation at certain other landfills.

Based on information currently available, the Company had an accrued liability of $9.1 million as of July 31, 2004 to complete the cleanup, maintenance and monitoring at all sites. Of the $9.1 million liability, $6.8 million is included in accrued expenses and $2.3 million is included in other liabilities on the condensed consolidated balance sheet. The ultimate costs may vary, and it is possible costs may exceed the recorded amounts.

While the Company currently does not operate manufacturing facilities, prior operations included numerous manufacturing and other facilities for which the Company may have responsibility under various environmental laws for the remediation of conditions that may be identified in the future.

Litigation
In March 2000, a class action lawsuit was filed in Colorado State Court (District Court for the City and County of Denver) related to the Redfield site described above. Plaintiffs alleged claims for trespass, nuisance, strict liability, unjust enrichment, negligence and exemplary damages arising from the alleged release of solvents contaminating the groundwater and indoor air in the areas adjacent to and near the site. In December 2003, the jury hearing the claims returned a verdict finding one of the Company's subsidiaries negligent and awarded the class plaintiffs $1.0 million in damages. The Company has recorded this award along with pre-trial interest on the award and estimated costs related to sanctions imposed by the court related to a pre-trial discovery dispute between the parties. The total pre-tax charge recorded for these matters in the fourth quarter of fiscal 2003 was $3.1 million ($2.0 million after tax). The Company recorded an additional $0.6 million in expense in the first quarter of 2004, related to pre-trial interest, to reflect the trial court's ruling extending the time period for which pre-judgment interest applied. In April 2004, the plaintiffs filed a motion for a new trial; the court has denied that motion. Several other post-trial motions are still pending before the trial court. The plaintiffs have appealed the judgment to the Colorado Court of Appeals and have asked for a retrial. The Company has cross-appealed the trial court's ruling as to the amount of pre-judgment interest, and has conditionally appealed a number of the trial court's rulings in the event of a retrial. The ultimate outcome and cost to the Company may vary.

As described above in "Environmental Remediation," the Company has filed suit against its insurance carriers and is seeking recovery of certain defense costs, indemnity for the costs incurred for remediation related to the Redfield site and for the damages awarded in the class action, and other related damages.

The Company also is involved in legal proceedings and litigation arising in the ordinary course of business. In the opinion of management, the outcome of such ordinary course of business proceedings and litigation currently pending will not have a material adverse effect on the Company's results of operations or financial position.

Other
The Company is a guarantor of an Industrial Development Bond financing of $3.5 million for a manufacturing and warehouse facility in Bedford County, Pennsylvania. These facilities and the business that operated them were sold to another party in 1985, which assumed this obligation. This financing is scheduled to be paid annually beginning in 2004 through 2009.

The Company is contingently liable for lease commitments of approximately $10 million in the aggregate, which primarily relate to the Cloth World and Meis specialty retailing chains, which were sold in prior years.

In order for the Company to incur any liability related to these guarantees and lease commitments, the current owners would have to default. At this time, the Company does not believe this is reasonably likely to occur.

Overall, the second quarter was a difficult one for the Company as net earnings declined from the second quarter last year, despite a slight increase in net sales. Consolidated net sales rose 0.1% to $458.7 million for the second quarter of fiscal 2004, as compared to $458.4 million for the second quarter of the prior year. Net earnings were $7.8 million, or $0.41 per diluted share, for the second quarter compared to $0.62 per diluted share for the second quarter of last year. Each of our operating segments reported lower operating earnings than in last year's second quarter.

Following is a summary of the more significant factors affecting our results in the second quarter of fiscal 2004:

• Famous Footwear's net sales increased 0.3% to $269.8 million in the second quarter compared to $268.9 million last year. Same-store sales declined 2.5% due to lower traffic counts, a later start to the back-to-school selling season and a shift in tax-free days between the second and third quarters. Operating income declined to $12.6 million in the second quarter compared to $12.9 million in the second quarter of the prior year.

• Our Wholesale Operations segment's operating earnings declined in the second quarter to $9.0 million compared to $12.6 million in the second quarter last year. These results were negatively affected by weak sales in the children's and women's private label divisions, and a shortage of trucks in the Midwest and delays at the West Coast ports, which hindered our ability to ship products to our customers. In addition, we incurred approximately $1.5 million of transition and assimilation costs related to the Bass license, which was entered into at the beginning of fiscal 2004, and sales and earnings of the Bass business were below expectations.

• Our Naturalizer Retail operations experienced a 2.8% decline in net sales to $48.3 million in the second quarter, compared to $49.7 million in the second quarter of the prior year. Same-store sales were down 3.9% for the quarter. The sales decline is partially attributable to our emphasis on sandals and casual footwear, while the market was favoring dressy looks, leading to a poor performance in Canada and in our U.S. outlet stores. Operating earnings declined to a loss of $2.6 million in the second quarter compared to a loss of $1.0 million in the second quarter of the prior year.

• As a result of our financial performance in the second quarter and the decline in our stock price at the end of the period, net earnings were favorably impacted by reductions in compensation costs associated with stock-based and incentive compensation plans.

• We maintained our strong balance sheet position. Inventories at quarter-end are fresh and clean at $453.0 million, up from $417.7 million last year due to higher levels of new back-to-school merchandise, additional stores at Famous Footwear and the addition of Bass. Our current ratio, the relationship of current assets to current liabilities, decreased to 1.9 to 1 from 2.2 to 1 at year end but was flat compared to the second quarter of last year. Our debt-to-capital ratio, the ratio of our debt obligations to the sum of our debt obligations and shareholders' equity, at the end of the quarter improved to 25.5% from 29.2% at the end of the year-ago quarter. We entered into an Amended and Restated Credit Agreement effective July 21, 2004, which amended and restated our existing $350 million revolving bank credit agreement. In addition to extending the credit term, the Amended and Restated Credit Agreement also provides other benefits to us, including expanding the definition of eligible inventory in certain circumstances and reducing the interest rate spread paid on outstanding borrowings.

Net Sales
Net sales increased $0.3 million, or 0.1%, to $458.7 million in the second quarter of 2004 as compared to $458.4 million in the second quarter of the prior year. This increase is primarily attributable to the acquisition of the Bass footwear license at the beginning of fiscal 2004, which contributed $9.1 million of net sales during the second quarter. Offsetting the impact of the Bass sales increase was weakness in both the children's and women's private label wholesale divisions as well as a decline in sales at the Naturalizer Retail stores.

Net sales increased $45.7 million, or 5.0%, to $950.5 million in the first half of 2004 as compared to $904.8 million in the first half of the prior year. The increase is primarily attributable to the acquisition of the Bass footwear license at the beginning of 2004, which contributed $24.4 million in net sales during the first half of 2004. In addition, the net sales improvement was driven by first quarter sales gains within our private label, Dr. Scholl's and LifeStride lines, and from new Famous Footwear stores.

Gross Profit
Gross profit increased $1.4 million, or 0.7%, to $189.3 million for the second quarter of 2004 as compared to $187.9 million in the second quarter of the prior year. As a percent of net sales, our gross margin percentage increased to 41.3% in the second quarter from 41.0% in the second quarter of the prior year as a result of higher gross profit rates at Famous Footwear due to the fresher product mix and lower markdowns.

Gross profit increased $15.6 million, or 4.2%, to $388.6 million in the first half of 2004 as compared to $373.0 million in the first half of the prior year. The overall increase in gross profit is primarily driven by the $45.7 million increase in net sales. As a percent of net sales, our gross profit rate decreased to 40.9% in the first half of 2004 as compared to 41.2% in the first half of the prior year. The decline in the gross profit rate reflects a greater mix of wholesale sales, which carry a lower gross margin rate than our overall retail sales, and a lower gross profit rate in our Wholesale Operations segment.

Selling and Administrative Expenses
Selling and administrative expenses increased $6.7 million, or 4.0%, to $176.0 million for the second quarter as compared to $169.3 million in the second quarter of the prior year. This increase is attributable to both transition and assimilation costs related to the Bass footwear line of approximately $1.5 million and to our ongoing investments in talent, systems, and infrastructure intended to position the Company for future growth. Offsetting these factors were benefits from reduced compensation costs associated with stock-based and incentive compensation plans of $2.4 million compared to last year.

Selling and administrative expenses increased $21.4 million, or 6.3%, to $360.4 million in the first half of 2004 as compared to $339.0 million in the first half of the prior year. This increase is due to both transition and assimilation costs related to the Bass footwear line of approximately $4.8 million and our ongoing investments in talent, systems and infrastructure intended to position the Company for future growth.

Interest Expense
Interest expense decreased $0.3 million, or 14.9%, to $2.2 million in the second quarter as compared to $2.5 million in the second quarter of the prior year. The decrease in interest expense is due to a decline in the average daily borrowings. In addition, on July 21, 2004, the Company amended and restated its credit agreement, which resulted in more favorable interest rates near the end of the second quarter.

Interest expense decreased $0.9 million, or 14.8%, to $4.6 million in the first half of 2004 as compared to $5.5 million in the first half of the prior year due to a decline in the average daily borrowings.

Income Tax Provision
Our consolidated effective tax rate was 30.9% in the second quarter of 2004 as compared to 28.7% in the second quarter of the prior year, reflecting a greater projected annual mix of domestic income. We do not provide deferred taxes on unremitted foreign earnings, as it is our intention to reinvest those earnings indefinitely or to repatriate the earnings only when it is tax-advantageous to do so.

For the first half of 2004, our consolidated effective income tax rate was 31.4% as compared to 28.4% for the first half of the prior year, reflecting a greater projected annual mix of domestic income.