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 June 2, 2007, 44,164,274 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 gives effect to this stock split, 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.

On May 24, 2007, the Company’s shareholders approved a change in the par value of its common stock from $3.75 per share to $0.01 per share. The change in par value became effective upon the filing of the Company’s Restated Certificate of Incorporation with the State of New York on May 31, 2007. All relevant share data provided herein gives effect to this change, applied retroactively.

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 May 5, 2007.

Estimated interest and penalties related to the underpayment of income taxes are classified as a component of income tax provision in the Condensed Consolidated Statements of Earnings and were insignificant for the quarter ended May 5, 2007. Accrued interest and penalties were $0.2 million as of February 4, 2007 and May 5, 2007.

The following table sets forth the computation of basic and diluted earnings per common share for the periods ended May 5, 2007, and April 29, 2006:

Options to purchase 179,243 and 30,000 shares of common stock for the thirteen-week periods ended May 5, 2007, and April 29, 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 May 5, 2007, and April 29, 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 in the range of $34-$38 million ($21-$23 million on 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 $5.1 million ($3.3 million on an after-tax basis) during the thirteen weeks ended May 5, 2007.

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

Of the $5.1 million in costs recorded during the thirteen weeks ended May 5, 2007, $2.7 million was recorded in the Other segment, $2.1 million was recorded in the Wholesale Operations segment, and $0.3 million was recorded in the Specialty Retail segment. The entire $5.1 million charge was reflected as a component of selling and administrative expenses. A tax benefit of $1.8 million was associated with this charge.

Inventory markdowns and the write-off of assets are noncash items.

Applicable business segment information is as follows for the periods ended May 5, 2007, and April 29, 2006:

The Other segment includes unallocated corporate administrative and other costs.

During the thirteen weeks ended May 5, 2007, operating earnings includes expenses of $2.7 million, $2.1 million and $0.3 million for the Other segment, the Wholesale Operations segment and the Specialty Retail segment, respectively, related to the Company’s Earnings Enhancement Plan.

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

The change in goodwill and other intangible assets between April 29, 2006 and May 5, 2007 in the Wholesale Operations segment is primarily due to the amortization of our licensed and owned trademarks. The change between periods for the Specialty Retail segment reflects changes in the Canadian dollar exchange rate. The change in the Other segment from April 29, 2006, to May 5, 2007, of $0.5 million, reflects the adjustment to the Company’s minimum pension liability recorded in the fourth quarter of 2006.

During the first quarter of 2007, the Company granted 165,743 stock options to certain employees with a weighted-average exercise price and grant date fair value of $35.25 and $15.94, respectively.  These options vest on a straight-line basis 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 also granted 150,000 stock performance share awards at target level during the first quarter of 2007. Vesting of the 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 stock performance awards may payout 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 83,250 restricted shares with a weighted average grant date fair value of $35.25 during the first 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 $2.6 million and $2.5 million during the first quarter of 2007 and 2006, respectively.

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 May 5, 2007, the Company had $9.5 million of borrowings outstanding and $10.1 million in letters of credit outstanding under the Agreement. Total additional borrowing availability was $279 million at May 5, 2007.

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.

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 $21.7 million. During the thirteen weeks ended May 5, 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 May 5, 2007 are $18.2 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 May 5, 2007, is $9.6 million, of which $1.0 million is accrued within accrued expenses and $8.6 million is accrued within other noncurrent liabilities. Of the total $9.6 million reserve, $5.3 million is for on-site remediation and $4.3 million is for off-site remediation. The Company expects to spend approximately $0.2 million in each of the next five succeeding years and $20.7 million thereafter related to the on-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 $2.1 million at May 5, 2007, related to these sites, which has been discounted at 6.4%. On an undiscounted basis, this liability would be $3.3 million. The Company expects to spend approximately $0.2 million in each of the next five succeeding years and $2.3 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 $11.9 million as of May 5, 2007, to complete the cleanup, maintenance and monitoring at all sites. Of the $11.9 million liability, $1.0 million is included in accrued expenses, and $10.9 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 have filed an appeal of the December 2003 jury verdict, and the ultimate outcome and cost to the Company 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 $3.0 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 May 5, 2007, the Company does not believe this is reasonably likely to occur.

In April 2005, Brown Shoe Company, Inc. issued senior notes which are fully and unconditionally and jointly and severally guaranteed by all existing and future subsidiaries of Brown Shoe Company, Inc. 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 Guarantors are all direct or indirect wholly-owned (100%) subsidiaries of the Parent.

Our net earnings for the first quarter of 2007 were slightly lower than last year as a result of costs incurred related to our Earnings Enhancement Plan. From an operating standpoint, our businesses performed well. Our Famous Footwear chain led the way, generating a 3.4% same-store sales gain in the quarter, which was fueled by its fashion-right merchandise selection. Our Specialty Retail segment achieved solid progress during the quarter, also generating a 3.4% same-store sales gain. Although our Wholesale Operations segment recorded lower sales than last year, we achieved higher operating margins as a percent of sales. The following is a summary of the financial highlights for the first quarter:

The most significant factor affecting the comparability of our financial results for the first quarter of 2007, as compared to the first quarter of 2006, is the recognition of incremental costs in 2007 associated with our Earnings Enhancement Plan of approximately $5.1 million ($3.3 million on an after-tax basis, or $0.07 per diluted share). No such charges were incurred during the first quarter of 2006. See further discussions of our Earnings Enhancement Plan under the Recent Developments section below.

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

During the second quarter of 2006, we introduced 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. Annual after-tax savings expected to be achieved upon the anticipated completion of the initiatives in 2008 are estimated to be $17–$20 million.

In the past twelve months, we made substantial progress in implementing a number of initiatives under this plan, including:

These actions resulted in charges of $6.3 million in 2006 ($3.9 million on an after-tax basis, or $0.09 per diluted share). We incurred charges of $5.1 million ($3.3 million on an after-tax basis, or $0.07 per diluted share) during the first quarter of 2007, with no corresponding charges in the first quarter of 2006. See Note 5 to the condensed consolidated financial statements for additional information related to these charges.

While much has been accomplished, certain of the initiatives are still in early stages of development, and we will update our costs and savings estimates as they are further developed. However, our current estimates are as follows:

Net sales decreased $9.2 million, or 1.6%, to $566.3 million in the first quarter of 2007 as compared to $575.5 million in the first quarter of the prior year. Although our retail segments achieved improvements in net sales, our Wholesale Operations segment reported a decline in net sales, due in part to the discontinuance of our Bass business at the end of 2006 and our planned reduction in private label product sales. However, Famous Footwear’s sales increased by $23.0 million over the year-ago quarter, reflecting a 3.4% same-store sales increase and a higher store count in the current period. Our Specialty Retail segment also improved sales as a result of higher sales at our e-commerce subsidiary, Shoes.com, and a same-store sales gain of 3.4% in our stores.

Gross profit increased $6.8 million, or 3.1%, to $229.8 million for the first quarter of 2007 as compared to $223.0 million in the first quarter of the prior year. As a percent of net sales, our gross profit rate increased to 40.6% in the first quarter from 38.7% in the first quarter of the prior year, driven by higher margin rates in our Famous Footwear and Wholesale Operations divisions as well as a greater mix of retail sales which carry a higher gross profit rate. Famous Footwear’s rate was fueled by its fashion-right merchandise selection, resulting in lower required markdowns. Our gross profit rate for our Wholesale Operations division improved due to a greater mix of branded product sales versus private label and as a result of discontinuing the lower margin Bass business in 2006.

Selling and administrative expenses increased $7.8 million, or 3.8%, to $212.2 million for the first quarter as compared to $204.4 million in the first quarter of the prior year. As a percentage of sales, selling and administrative expenses of 37.5% are higher than last year’s first quarter of 35.5%. The largest contributor to higher first quarter expenses is our Earnings Enhancement Plan, for which we incurred charges of $5.1 million during the first quarter of 2007, with no corresponding charges during the first quarter of 2006. In addition, our higher mix of retail business has increased our expense base as a percentage of sales.

Interest expense decreased $0.4 million to $4.1 million in the first quarter as compared to $4.5 million in the first quarter of the prior year. The decrease in interest expense is a result of the lower average borrowings under our revolving credit facility.

Our consolidated effective tax rate was 32.1% in the first quarter of 2007 as compared to 30.3% in the first quarter of the prior year. The increase is primarily attributable to a higher mix of domestic earnings, which are taxed at higher rates than our international operations.

Net earnings decreased $0.4 million, or 3.9%, to $9.6 million in the first quarter as compared to $10.0 million in the first quarter of the prior year. The decrease in net earnings is primarily attributable to the charges for our Earnings Enhancement Plan, for which we incurred $3.3 million on an after-tax basis in the first quarter of 2007, and no charges in the corresponding year-ago period. Higher earnings at our Famous Footwear division substantially offset the charges for the Earnings Enhancement Plan.

Net sales increased $23.0 million, or 7.6%, to $325.3 million in the first quarter of 2007 as compared to $302.3 million in the first quarter of the prior year, due to a higher store count and a same-store sales increase of 3.4%, despite poor weather that dampened sales for several weeks during the important Easter period. We attribute the same-store sales gain to having a fresh, fashion-right merchandise selection. The ratio of customers making purchases increased, as well as the number of pairs per transaction and the average unit retail prices. During the first quarter of 2007, we opened 18 new stores and closed 8, resulting in 1,009 stores at the end of the first quarter as compared to 952 at the end of the first quarter of the prior year. Sales per square foot increased to $46, up from $45 a year ago.

Same-store sales changes are calculated by comparing the sales in stores that have been open at least 13 months. This method avoids the distorting effect that grand opening sales have in the first month of operation. Relocated stores are treated as new stores. Closed stores are excluded from the calculation. Sales change from new and closed stores, net, reflects the change in net sales due to stores that have been opened or closed during the period and are thereby excluded from the same-store sales calculation.

Gross profit increased $12.9 million, or 9.7%, to $144.5 million in the first quarter of 2007, as compared to $131.6 million in the first quarter of the prior year. The increase reflects both a volume and a rate increase. The volume increase is due to the higher store count and higher sales compared to the prior year. As a percent of sales, our gross profit rate was 44.4% in the first quarter of 2007, up from 43.5% in the first quarter of the prior year. The improvement in the rate was primarily due to a fresher inventory base and a fashion-right merchandise selection. Inventory was more current and, therefore, lower markdowns were necessar

Selling and administrative expenses increased $7.8 million, or 6.7%, to $123.5 million for the first quarter of 2007 as compared to $115.7 million in the first quarter of the prior year. This increase is primarily attributable to the higher sales volume and a higher store count resulting in higher retail facilities and selling costs. As a percentage of net sales, selling and administrative costs have decreased to 38.0% from 38.2% last year.

Operating earnings increased $5.1 million, or 31.8%, to $21.0 million for the first quarter of 2007 as compared to $15.9 million in the first quarter of the prior year. The increase in operating earnings was due to the higher sales volume, a higher gross profit rate and a better leveraging of the expense base. As a percent of sales, operating earnings improved to 6.4% in the first quarter of 2007 compared to 5.3% in the same period last year.

Net sales decreased $36.1 million, or 16.6%, to $180.7 million in the first quarter of 2007 as compared to $216.8 million in the first quarter of the prior year. Solid performances from Naturalizer, Etienne Aigner, Dr. Scholl’s and LifeStride were offset by the exiting of the Bass business at the end of 2006 and the reduced emphasis on lower-margin private label business. Sales of our private label, Children’s, and Franco Sarto product were below last year.

Gross profit decreased $6.8 million, or 10.5%, to $58.1 million in the first quarter of 2007 as compared to $64.9 million in the first quarter of the prior year. As a percentage of net sales, our gross profit rate increased to 32.1% in the first quarter from 29.9% in the first quarter of the prior year. The improvement in our gross profit rate is due to a number of factors, including the discontinuance of the lower margin Bass business and a greater mix of branded product sales versus private label. In addition, we are experiencing higher gross profit rates for our branded products, as we transition to a business model that focuses on a continuous flow of smaller quantities of new goods versus large pre-season sell-ins, thereby minimizing markdowns and allowances.

Operating earnings decreased $1.1 million, or 7.8%, to $13.0 million for the first quarter of 2007 as compared to $14.1 million in the first quarter of the prior year. The decrease in net earnings is primarily attributable to the charges recorded related to our Earnings Enhancement Plan, for which we incurred $2.1 million in the first quarter of 2007, and no charges in the corresponding year-ago period. An increase in the gross profit rate and a reduction in expenses, primarily marketing, partially offset the charges related to the Earnings Enhancement Plan. As a percent of sales, operating earnings improved to 7.2% in the first quarter of 2007 compared to 6.5% in the same period last year.