Caleres - 10-Q quarterly report FY

(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  R    No£

As of December 1, 2007, 44,244,266 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 are necessary (which include only normal recurring accruals) to present fairly the financial position, results of operations, and cash flows of Brown Shoe Company, Inc. (the “Company”). These statements, however, do not include all information and footnotes necessary for a complete presentation of the Company's consolidated financial position, results of operations and cash flows in conformity with accounting principles generally accepted in the United States. The condensed consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany balances and transactions have been eliminated.

The Company's business is subject to seasonal influences, particularly the back-to-school selling season at Famous Footwear, which primarily 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.

Certain prior period amounts on the condensed consolidated financial statements have been reclassified to conform to the current period presentation. These reclassifications did not affect net earnings.

On March 7, 2007, the Company’s Board of Directors authorized a three-for-two split of its common stock, to be effected in the form of a dividend of one share of stock for every two shares outstanding. The dividend was paid on April 2, 2007 to shareholders of record on March 19, 2007. All share and per share data provided herein give effect to this stock split, applied retroactively.

Effective May 31, 2007, the par value of the Company’s common stock was reduced from $3.75 per share to $0.01 per share. All relevant share data provided herein give effect to this change, applied retroactively.

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 February 3, 2007.

In June 2007, the Company entered into a joint venture agreement with a subsidiary of Hongguo International Holdings Limited (Hongguo), a Singapore listed company, to market Naturalizer footwear in China in Fall 2007 and Via Spiga footwear in 2008. The Company is a 51% owner of the joint venture, B&H Footwear Limited (B&H Footwear), with Hongguo owning the other 49%. B&H Footwear will distribute the Naturalizer brand in department store shops and free-standing stores in several of China’s largest cities: Shanghai, Beijing, Guangzhou, and Shenzhen. B&H Footwear will also sell Naturalizer footwear to Hongguo on a wholesale basis, which Hongguo will sell in retail stores it plans to open throughout the rest of China. In addition to the equity interest, the Company will receive a royalty from B&H Footwear for its use of the Naturalizer brand name, which will be based on the sales of B&H Footwear through its retail operations and to Hongguo.

B&H Footwear began operations in the third quarter of 2007.  As of November 3, 2007, B&H Footwear operated three stores and shops, selling Naturalizer footwear in China, and Hongguo operated 15 stores and shops. The Company’s consolidated financial statements include the accounts of B&H Footwear.

In August, 2007, the Company invested $7.1 million in Edelman Shoe, Inc., acquiring 42.5% of the outstanding stock. Edelman Shoe, Inc. is a privately held company operated by Sam and Libby Edelman. The Edelmans maintain a majority equity interest in Edelman Shoe, Inc. and the Company has an option to buy the remaining interest in the future. This investment is

In June 2006, the FASB issued Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109.” FIN 48 establishes a single model to address accounting for uncertain tax positions. FIN 48 clarifies the accounting for income taxes by prescribing a minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on derecognition, measurement classification, interest and penalties, accounting in interim periods, disclosure and transition.

The Company adopted the provisions of FIN 48 on February 4, 2007. At February 4, 2007, the Company had $1.2 million of unrecognized tax benefits, relating to various state tax issues, which includes $0.2 million of estimated interest and penalties. A charge of $0.8 million, net of federal income tax benefits, was recorded against retained earnings as a cumulative effect adjustment at February 4, 2007. To the extent these unrecognized tax benefits are ultimately recognized, they will impact the effective tax rate in a future period. There have been no significant changes to these amounts during the quarter ended November 3, 2007.

Estimated interest and penalties related to the underpayment of income taxes are classified as a component of the income tax provision in the Condensed Consolidated Statements of Earnings and were insignificant for the quarter ended November 3, 2007. Accrued interest and penalties were $0.2 million as of February 4, 2007 and November 3, 2007.

The following table sets forth the computation of basic and diluted earnings per common share for the periods ended November 3, 2007, and October 28, 2006:

Options to purchase 447,367 and 59,000 shares of common stock for the thirteen-week periods and 183,743 and 29,667 for the thirty-nine week periods ended November 3, 2007, and October 28, 2006, 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 November 3, 2007, and October 28, 2006:

During 2006, the Company initiated an Earnings Enhancement Plan designed to increase earnings through cost reductions, efficiency initiatives and the reallocation of resources. Key elements of the plan include: (i) restructuring administrative and support areas; (ii) redesigning logistics and distribution platforms; (iii) reorganizing to eliminate operational redundancies; (iv) realigning strategic priorities; and (v) refining the supply chain process and enhancing inventory utilization. The total costs to implement these plans are estimated to be approximately $36 million ($22 million on an after-tax basis). These estimates are preliminary and differences may arise between these estimates and actual costs to the Company. The Company incurred charges of $6.3 million ($3.9 million on an after-tax basis) in 2006. The Company incurred charges totaling $15.3 million ($9.8 million on an after-tax basis) during the thirty-nine weeks ended November 3, 2007.

The following is a summary of the activity in the reserve, by category of costs:

Of the $4.5 million in costs recorded during the thirteen weeks ended November 3, 2007, $2.8 million was recorded in the Specialty Retail segment, $1.3 million was recorded in the Other segment, and $0.4 million was recorded in the Wholesale Operations segment. The entire $4.5 million charge was reflected as a component of selling and administrative expenses. A tax benefit of $1.6 million was associated with this charge.

Applicable business segment information is as follows for the periods ended November 3, 2007, and October 28, 2006:

The Other segment includes unallocated corporate administrative and other costs and, in the thirteen and thirty-nine weeks ended October 28, 2006, includes net expenses of $3.7 million associated with an executive early retirement agreement. The Other segment also includes, during the thirty-nine weeks ended October 28, 2006, net recoveries of $7.3 million from insurance companies for remediation costs associated with our Redfield site in Denver, Colorado.

During the thirteen weeks and thirty-nine weeks ended November 3, 2007, operating earnings includes expenses of $1.3 million and $9.1 million, $0.4 million and $3.1 million, and $2.8 million and $3.1 million for the Other segment, the Wholesale Operations segment and the Specialty Retail segment, respectively, related to the Company’s Earnings Enhancement Plan.

During the thirteen weeks ended October 28, 2006, no charges were incurred related to the Company’s Earnings Enhancement Plan. During the thirty-nine weeks ended October 28, 2006, operating earnings includes expenses of $1.4 million, $0.4 million and $0.2 million, respectively, for the Other segment, the Wholesale Operations segment and the Specialty Retail segment, related to the Company’s Earnings Enhancement Plan.

During the thirteen and thirty-nine weeks ended October 28, 2006, the Wholesale Operations segment includes $2.3 million of costs associated with the exit of the Bass footwear license.

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

The change in goodwill and other intangible assets in the Famous Footwear segment is due to the acquisition of a trademark during the second quarter of 2007 for $2.8 million, which facilitates the Company's use of the Famous Footwear mark on its stores located in the metropolitan St. Louis area. These stores (approximately 25) were formerly named Supermarket of Shoes. This acquisition further solidifies our Famous Footwear name as a national brand.

During the third quarter of 2007, the Company granted 18,000 stock options to certain employees with a weighted-average exercise price and grant date fair value of $20.45 and $8.32, respectively.  These options vest in four equal increments, with 25% vesting over each of the next four years. These options have a term of ten years.  Compensation expense is recognized on a straight-line basis separately for each vesting portion of the stock option award. 

The Company granted no performance share awards during the third quarter of 2007. Vesting of performance-based awards is dependent upon the financial performance of the Company and the attainment of certain financial goals over the next three years. The performance share awards may pay out at a maximum of 200% of the target number of shares.  Compensation expense is being recognized based on the fair value of the award on the date of grant and the anticipated number of shares to be awarded on a straight-line basis over the three-year service period.

The Company also granted 9,500 restricted shares with a weighted average grant date fair value of $20.45 during the third quarter of 2007. The restricted shares vest in four years and compensation expense will be recognized on a straight-line basis over the four-year period.

The Company recognized share-based compensation expense of $1.8 million and $2.3 million during the thirteen-week and $7.5 million and $7.3 million during the thirty-nine week periods ended November 3, 2007, and October 28, 2006, respectively.

The Company issued 12,893 and 968,542 shares of common stock during the thirteen and thirty-nine week periods ended November 3, 2007, respectively, for stock options exercised and restricted stock grants.

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

The Company has a Revolving Credit Agreement (the “Agreement”) that provides for a maximum line of credit of $350 million, subject to a calculated borrowing base, and is guaranteed by certain of its subsidiaries. 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 in 2009; and the Company’s obligations are secured by its 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. At November 3, 2007, the Company had no borrowings outstanding and $10.5 million in letters of credit outstanding under the Agreement. Total additional borrowing availability was $339 million at November 3, 2007.

On July 23, 2007, the Company and certain of its subsidiaries entered into the third amendment to the Agreement. This amendment amends the Agreement by, among other things:

The Company issued $150 million of 8.75% senior notes due 2012 (“Senior Notes”) in April 2005. The Senior Notes are guaranteed on a senior unsecured basis by each of the subsidiaries of Brown Shoe Company, Inc. that is an obligor under its secured Revolving Credit Agreement. Interest on the Senior Notes is payable on May 1 and November 1 of each year. The Senior Notes mature on May 1, 2012, but are callable any time on or after May 1, 2009, at specified redemption prices plus accrued and unpaid interest. The Senior Notes also contain certain restrictive covenants.

In 2007, the Company continued to use OgilvyOne LLC (“Ogilvy”) to provide certain marketing and consulting services. A member of the Company’s Board of Directors, Carla C. Hendra, is an officer of Ogilvy North America and OgilvyOne N.A., both of which are affiliates of Ogilvy. The Company incurred charges of $0.1 million and $1.0 million with Ogilvy during the thirteen–week and thirty-nine week period ended November 3, 2007, respectively.

The Company entered into a joint venture agreement with a subsidiary of Hongguo International Holdings Limited (Hongguo) to begin marketing Naturalizer footwear in China in Fall 2007 and Via Spiga footwear in 2008. The Company is a 51% owner of the joint venture, “B&H Footwear”, with Hongguo owning the other 49%. B&H Footwear began operations in the third quarter of 2007. B&H Footwear will distribute the Naturalizer brand in department store shops and free-standing stores in several of China’s largest cities. In addition, B&H Footwear sells Naturalizer footwear to Hongguo on a wholesale basis. Hongguo will then sell Naturalizer product through retail stores it is opening in China. During the third quarter of 2007, the Company, through its consolidated subsidiary, B&H Footwear, sold $1.8 million of Naturalizer footwear on a wholesale basis to Hongguo.

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. 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 (“the Redfield site” or, when referring to remediation activities at or under the facility, the “on-site remediation”) and residential neighborhoods adjacent to and near the property (the “off-site remediation”) that have been affected by solvents previously used at the facility. Based on the results of ongoing testing and the study of remediation alternatives by our environmental consultants, the Company, in 2006, submitted to the Colorado authorities a supplement to its former remediation plan, setting forth a long-term remediation plan and extending the time period the Company expects to perform certain remediation activities. Accordingly, a charge of $5.6 million was recorded in 2006, the majority of which represented the estimated discounted costs to complete the on-site remediation. The liability for the on-site remediation, $5.3 million, has been discounted at 4.8%. On an undiscounted basis, the on-site remediation liability would be $21.5 million. The Company expects to spend approximately $0.2 million in each of the next five succeeding years and $20.5 million thereafter related to the on-site remediation. During the thirteen and thirty-nine weeks ended November 3, 2007, the Company recorded no expense related to this remediation, other than the accretion of interest expense.

The cumulative expenditures for both on-site and off-site remediation through November 3, 2007 are $19.0 million. As discussed further below, the Company has recovered a portion of these expenditures from insurers and other third parties and continues to pursue recovery of additional remediation, defense costs and other damages from other insurers. The reserve for the anticipated future remediation activities at November 3, 2007, is $9.1 million, of which $1.0 million is accrued within accrued expenses and $8.1 million is accrued within other noncurrent liabilities. Of the total $9.1 million reserve, $5.3 million is for on-site remediation and $3.8 million is for off-site remediation.

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 17 years. The Company has an accrued liability of $2.0 million at November 3, 2007, related to these sites, which has been discounted at 6.4%. On an undiscounted basis, this liability would be $3.1 million. The Company expects to spend approximately $0.2 million in each of the next five succeeding years and $2.1 million thereafter related to these sites. In addition, various federal and state authorities have identified the Company as a potentially responsible party for remediation at certain other landfills. However, the Company does not currently believe that its liability for such sites, if any, would be material.

Based on information currently available, the Company had an accrued liability of $11.2 million as of November 3, 2007, to complete the cleanup, maintenance and monitoring at all sites. Of the $11.2 million liability, $1.0 million is included in accrued expenses, and $10.2 million is included in other noncurrent liabilities in the condensed consolidated balance sheet. The Company continues to evaluate its estimated costs in conjunction with its environmental consultants and records its best estimate of such liabilities. However, future actions and the associated costs are subject to oversight and approval of various governmental authorities. Accordingly, the ultimate costs may vary, and it is possible costs may exceed the recorded amounts.

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 the Company’s subsidiary negligent and awarded the class plaintiffs $1.0 million in damages. The Company recorded this award along with estimated pretrial interest on the award and estimated costs related to sanctions imposed by the court related to a pretrial discovery dispute between the parties. The total pretax charge recorded for these matters in 2003 was $3.1 million. The Company recorded an additional $0.6 million in expense in 2004, related to pretrial interest, to reflect the trial court’s ruling extending the time period for which prejudgment interest applied. The plaintiffs filed an appeal of the December 2003 jury verdict and in August 2007, the Colorado Court of Appeals issued its decision of the appeal.  The Court rejected plaintiffs’ attempt to obtain a new trial by affirming the trial court judgment.  The Court also denied a cross-appeal by the Company seeking a reversal of a portion of the pretrial interest awarded to plaintiffs.  The Court also reversed the trial court’s award of costs to the Company, and remanded the case to the trial court for a determination of whether plaintiffs are entitled to recover their costs related to the trial. The plaintiffs have filed a petition with the Supreme Court of Colorado seeking review of the Court of Appeal’s decision denying them a new trial. The ultimate outcome and cost of further proceedings in this matter may vary.

In connection with the Redfield environmental remediation and class action litigation discussed above, the Company sued a number of its insurers seeking recovery of defense costs, indemnity and other damages related to the former operations and the remediation at the site. During 2006, the Company reached agreements with certain of those insurers to resolve the coverage claims arising out of the Redfield site and recorded income related to these recoveries of $7.3 million, net of related legal fees, as a reduction of selling and administrative expenses. The Company continues to pursue recovery of additional remediation, defense costs and other damages from other insurers, but is unable to estimate the ultimate recovery from those insurers. In addition, the Company has filed a contribution action in Colorado State Court against the Colorado Department of Transportation, which owns and operates a facility adjacent to the Redfield site.

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. All legal costs associated with litigation are expensed as incurred.

During 2004, the Company recorded charges of $2.4 million relating to the insolvency of an insurance company that insured the Company for workers’ compensation and casualty losses from 1973 to 1989. That company is now in liquidation. Certain claims from that time period are still outstanding. While management has recorded its best estimate of loss, the ultimate outcome and cost to the Company may vary.

The Company is contingently liable for lease commitments of approximately $2.4 million in the aggregate, which relate to the Cloth World and Meis specialty retailing chains and a manufacturing facility, which were sold in prior years. In order for the Company to incur any liability related to these lease commitments, the current owners would have to default. As of November 3, 2007, the Company does not believe this is reasonably likely to occur.

In 2005, Brown Shoe Company, Inc. issued senior notes which are fully and unconditionally and jointly and severally guaranteed by all of its existing and future subsidiaries that are guarantors under its existing Revolving Credit Agreement. The following table presents the condensed consolidating financial information for each of Brown Shoe Company, Inc. (Parent), the Guarantors and subsidiaries of the Parent that are not Guarantors (the Non-Guarantors), together with consolidating eliminations, as of and for the periods indicated.

The condensed consolidating financial statements have been prepared using the equity method of accounting in accordance with the requirements for presentation of such information. Management believes that the information, presented in lieu of complete financial statements for each of the Guarantors, provides meaningful information to allow investors to determine the nature of the assets held by, and operation and cash flow of, each of the consolidating groups.

Overall, the business environment continued to be difficult in both our retail and wholesale businesses during the third quarter, resulting in lower net sales compared to the third quarter of last year. However, our net earnings were slightly greater than the third quarter of last year, while our diluted earnings per share were lower reflecting additional shares outstanding.

We also continued to make progress during the third quarter on a number of key initiatives, including our Earnings Enhancement Plan, international expansion and other business investments. These initiatives are described further in the Recent Developments section below.

The following is a summary of the financial highlights for the third quarter:

There were several items that impacted our third quarter results in 2007 and 2006. These items include:

Following is a summary of our operating results in the third quarter of 2007 and the status of our balance sheet:

We continue to make progress on our Earnings Enhancement Plan introduced in 2006, which was designed to increase earnings through cost reductions, efficiency initiatives and the reallocation of resources. Key elements of the plan include: (i) restructuring administrative and support areas; (ii) redesigning logistics and distribution platforms; (iii) reorganizing to eliminate operational redundancies; (iv) realigning strategic priorities; and (v) refining the supply chain process and enhancing inventory utilization. Annual after-tax savings expected to be achieved upon the anticipated completion of the initiatives in late 2008 continue to be estimated at $17–$20 million.

We have made substantial progress in implementing a number of initiatives under this plan, including:

While much has been accomplished, we are still developing certain of the initiatives, and we expect to update our costs and savings estimates as they are further refined. However, our current estimates are as follows:

In June 2007, we entered into a joint venture agreement with a subsidiary of Hongguo International Holdings Limited (Hongguo) to market Naturalizer footwear in China in Fall 2007 and Via Spiga footwear in 2008. We own 51% of the equity of the joint venture, B&H Footwear Limited (B&H Footwear), with Hongguo owning the other 49%. In addition to the equity interest, we will receive a royalty from B&H Footwear for its use of the Naturalizer brand name. B&H Footwear operates from our Dongguan, China offices, where we currently maintain our sourcing operation of nearly 600 employees. B&H Footwear combines our strength in brand-building and marketing with Hongguo’s established network of approximately 700 retail locations and operational expertise in the retail industry in China.

B&H Footwear will distribute the Naturalizer brand in department store shops and free-standing stores in several of China’s largest cities: Shanghai, Beijing, Guangzhou, and Shenzhen. B&H Footwear will also sell Naturalizer footwear to Hongguo on a wholesale basis, which Hongguo will sell in retail stores it plans to open throughout the rest of China. Over the next five years, B&H Footwear plans to open approximately 75 stores and shops carrying the Naturalizer brand, and Hongguo plans to open approximately 350 locations. During this same time period, 100 Via Spiga points of distribution are expected to be opened, approximately 30 by B&H Footwear and approximately 70 by Hongguo.

B&H Footwear began operations in the third quarter of 2007. As of November 3, 2007, B&H Footwear operated three Naturalizer stores and shops and Hongguo operated 15 stores and shops. In 2007, we expect that the sales of B&H Footwear will be immaterial and the start-up costs and operating losses will total approximately $1.5 million to $2.0 million (or $0.03 to $0.04 per diluted share).

In August 2007, we invested $7.1 million in Edelman Shoe, Inc., acquiring 42.5% of the outstanding stock. Edelman Shoe, Inc. is a privately held company operated by Sam and Libby Edelman. The Edelmans maintain a majority equity interest in Edelman Shoe, Inc. and we have an option to buy the remaining interest in the future. This investment is expected to allow Edelman Shoe, Inc. to accelerate the development and expansion of the Sam Edelman brand, which was launched in 2004 and is sold in better department stores and independent and specialty stores across the country.