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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For The Quarterly Period Ended November 1, 2003
Commission File Number 1-14770
PAYLESS SHOESOURCE, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 43-1813160
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
3231 SOUTHEAST SIXTH AVENUE, TOPEKA, KANSAS 66607-2207
(Address of principal executive offices) (Zip Code)
(785) 233-5171
(Registrant's telephone number,
including area code)
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 and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
---- ----
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Securities Exchange Act of 1934).
YES X NO
---- ----
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Common Stock, $.01 par value
68,052,402 shares as of December 5, 2003
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
PAYLESS SHOESOURCE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEET
(UNAUDITED)
(Dollars in millions)
NOVEMBER 1, NOVEMBER 2, FEBRUARY 1,
ASSETS 2003 2002 2003
- ------ ---- ---- ----
Current Assets:
Cash and cash equivalents $ 141.7 $ 149.1 $ 74.4
Restricted cash 33.5 28.0 28.5
Inventories 410.7 407.8 452.5
Current deferred income taxes 13.8 19.9 16.4
Other current assets 70.5 63.5 61.8
-------- -------- --------
Total current assets 670.2 668.3 633.6
Property and Equipment:
Land 8.0 8.0 7.6
Buildings and leasehold improvements 652.5 616.1 625.4
Furniture, fixtures and equipment 509.4 497.3 490.0
Property under capital leases 4.6 7.3 4.6
-------- -------- --------
Total property and equipment 1,174.5 1,128.7 1,127.6
Accumulated depreciation
and amortization (750.6) (690.2) (701.3)
-------- -------- --------
Property and equipment, net 423.9 438.5 426.3
Favorable leases, net 30.6 34.9 34.3
Deferred income taxes 22.8 22.4 29.0
Other assets 36.2 30.2 27.6
-------- -------- --------
Total Assets $1,183.7 $1,194.3 $1,150.8
======== ======== ========
LIABILITIES AND SHAREOWNERS' EQUITY
- -----------------------------------
Current Liabilities:
Current maturities of long-term debt $ 0.9 $ 70.6 $ 83.2
Notes payable 33.5 28.0 28.5
Accounts payable 131.2 119.0 106.4
Accrued expenses 120.6 149.8 123.7
-------- -------- --------
Total current liabilities 286.2 367.4 341.8
Long-term debt 202.9 159.2 140.7
Other liabilities 57.5 55.3 52.3
Minority interest 16.4 20.2 17.8
Total shareowners' equity 620.7 592.2 598.2
-------- -------- --------
Total Liabilities and Shareowners' Equity $1,183.7 $1,194.3 $1,150.8
======== ======== ========
See Notes to Condensed Consolidated Financial Statements.
2
PAYLESS SHOESOURCE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF EARNINGS
(UNAUDITED)
(Dollars and shares in millions, except per share)
13 WEEKS ENDED 39 WEEKS ENDED
----------------------------------- ------------------------------------
NOVEMBER 1, 2003 NOVEMBER 2, 2002 NOVEMBER 1, 2003 NOVEMBER 2, 2002
---------------- ---------------- ---------------- ----------------
Net sales $ 709.8 $ 713.0 $ 2,138.9 $ 2,227.4
Cost of sales 520.5 482.3 1,546.9 1,521.6
Selling, general and administrative expenses 190.2 181.9 558.9 538.1
Non-recurring item -- (1.2) -- (2.1)
--------- --------- --------- ---------
Operating (loss) profit (0.9) 50.0 33.1 169.8
Interest expense 6.0 5.9 15.4 18.4
Interest income (1.1) (1.3) (3.1) (3.1)
--------- --------- --------- ---------
(Loss) Earnings before income taxes and minority (5.8) 45.4 20.8 154.5
interest
(Benefit) Provision for income taxes (2.1) 16.5 7.6 56.4
--------- --------- --------- ---------
(Loss) Earnings before minority interest (3.7) 28.9 13.2 98.1
Minority interest 1.5 0.7 3.9 2.6
--------- --------- --------- ---------
Net (Loss) Earnings $ (2.2) $ 29.6 $ 17.1 $ 100.7
========= ========= ========= =========
Diluted (Loss) Earnings per Share $ (0.03) $ 0.43 $ 0.25 $ 1.47
========= ========= ========= =========
Basic (Loss) Earnings per Share $ (0.03) $ 0.44 $ 0.25 $ 1.49
========= ========= ========= =========
Diluted Weighted Average Shares Outstanding 68.1 68.4 68.1 68.3
========= ========= ========= =========
Basic Weighted Average Shares Outstanding 68.1 68.0 68.0 67.7
========= ========= ========= =========
See Notes to Condensed Consolidated Financial Statements.
3
PAYLESS SHOESOURCE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
(Dollars in millions) 39 WEEKS ENDED
------------------------------------
NOVEMBER 1, 2003 NOVEMBER 2, 2002
---------------- ----------------
Operating Activities:
Net earnings $ 17.1 $100.7
Adjustments for noncash items included
in net earnings:
Loss on disposal of assets 13.1 3.0
Depreciation and amortization 74.8 75.5
Amortization of unearned
restricted stock 0.5 0.9
Deferred income taxes 8.8 23.8
Minority interest (3.9) (2.6)
Tax benefit of stock option exercises -- 3.1
Changes in working capital:
Inventories 41.8 (68.3)
Other current assets (7.6) (7.4)
Accounts payable 24.8 45.5
Accrued expenses (6.6) 10.6
Other assets and liabilities, net 8.8 (5.8)
------ ------
Total Operating Activities 171.6 179.0
------ ------
Investing Activities:
Capital expenditures (81.9) (76.3)
Disposition of property and equipment 1.0 2.6
------ ------
Total Investing Activities (80.9) (73.7)
------ ------
Financing Activities:
Issuance of notes payable 5.0 18.5
Restricted cash (5.0) (18.5)
Issuance of long-term debt 196.7 --
Payment of deferred financing costs (5.5) --
Repayment of long-term debt (216.8) (81.2)
Net issuances (purchases) of common stock (0.3) 16.7
Contributions by minority owners 3.6 16.4
Other financing activities (1.1) (0.4)
------ ------
Total Financing Activities (23.4) (48.5)
------ ------
Increase in Cash and Cash Equivalents 67.3 56.8
Cash and Cash Equivalents, Beginning of Year 74.4 92.3
------ ------
Cash and Cash Equivalents, End of Period $141.7 $149.1
====== ======
Cash paid during the period:
Interest $ 11.6 $ 18.0
Income Taxes $ 17.1 $ 16.6
See Notes to Condensed Consolidated Financial Statements.
4
PAYLESS SHOESOURCE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. INTERIM RESULTS. These unaudited Condensed Consolidated Financial
Statements of Payless ShoeSource, Inc. (the "Company") have been prepared in
accordance with the instructions to Form 10-Q of the United States Securities
and Exchange Commission and should be read in conjunction with the Notes to
Consolidated Financial Statements (pages 19-25) in the Company's 2002 Annual
Report. Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to such rules and
regulations. In the opinion of management, the unaudited Condensed Consolidated
Financial Statements are fairly presented and all adjustments (consisting only
of normal recurring adjustments) necessary for a fair statement of the results
for the interim periods have been included; however, certain items are included
in these statements based upon estimates for the entire year. The results for
the three-month period and nine-month period ended November 1, 2003, are not
necessarily indicative of the results that may be expected for the entire fiscal
year ending January 31, 2004.
NOTE 2. STOCK-BASED COMPENSATION. The Company adopted the disclosure provisions
of Statement of Financial Accounting Standards ("SFAS") No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure, an amendment of FASB
Statement No. 123." The Statement requires prominent disclosures in both annual
and interim financial statements regarding the method of accounting for
stock-based employee compensation and the effect of the method used on reported
results. The Company accounts for stock compensation awards under the intrinsic
value method of Accounting Principles Board ("APB") Opinion No. 25. APB Opinion
No. 25 requires compensation cost to be recognized based on the excess, if any,
between the quoted market price of the stock at the date of grant and the amount
an employee must pay to acquire the stock. All options awarded under all of the
Company's plans are granted with an exercise price equal to the fair market
value on the date of the grant.
SFAS 123, "Accounting for Stock-Based Compensation," provides an alternative
method of accounting for stock-based compensation, which establishes a fair
value based method of accounting for employee stock options or similar equity
instruments. The Company uses the Black-Scholes option pricing model to estimate
the grant date fair value of its 1996 and later option grants. The fair value is
recognized over the option vesting period. The following table presents the
effect on net earnings and earnings per share had the Company adopted the fair
value based method of accounting for stock-based compensation under SFAS No.
123, "Accounting for Stock-Based Compensation."
(Dollars in millions, except per share amounts)
13 WEEKS ENDED 39 WEEKS ENDED
---------------------------------- -----------------------------------
NOVEMBER 1, 2003 NOVEMBER 2, 2002 NOVEMBER 1, 2003 NOVEMBER 2, 2002
---------------- ---------------- ---------------- ----------------
Net (loss) earnings:
As reported $ (2.2) $ 29.6 $ 17.1 $ 100.7
Less: Total stock-based employee
compensation expense determined under fair value
based method for all awards, net of related taxes $ 1.1 $ 1.9 $ 3.7 $ 5.6
Pro forma $ (3.3) $ 27.7 $ 13.4 $ 95.1
Diluted (loss) earnings per share:
As reported $ (0.03) $ 0.43 $ 0.25 $ 1.47
Pro forma $ (0.05) $ 0.40 $ 0.19 $ 1.39
Basic (loss) earnings per share:
As reported $ (0.03) $ 0.44 $ 0.25 $ 1.49
Pro forma $ (0.05) $ 0.41 $ 0.19 $ 1.41
NOTE 3. INVENTORIES. Merchandise inventories are valued by the retail method and
are stated at the lower of cost, determined using the first-in, first-out (FIFO)
basis, or market. Raw material and in-transit inventories are valued at the
lower of cost using the FIFO basis, or market. Raw materials of $15.6 million,
$21.0 million and $15.5 million are included in Inventories at November 1, 2003,
November 2, 2002, and February 1, 2003, respectively.
5
NOTE 4. INTANGIBLES. On February 3, 2002, the Company adopted SFAS No. 142,
"Goodwill and Other Intangible Assets," which established reporting and
accounting standards for goodwill and intangible assets. Under SFAS 142,
companies no longer amortize goodwill over the estimated useful life. Goodwill
is assessed each year during the first quarter for impairment by applying a fair
value based test. No impairment has been recorded during 2003.
Favorable lease rights subject to amortization pursuant to SFAS 142 are as
follows:
(Dollars in millions) November 1, 2003 November 2, 2002 February 1, 2003
- --------------------- ---------------- ---------------- ----------------
Gross carrying amount $88.4 $88.9 $89.4
Less: accumulated amortization (57.8) (54.0) (55.1)
----- ----- -----
Carrying amount, end of year $30.6 $34.9 $34.3
Amortization expense on intangible assets was as follows:
(Dollars in millions)
13 Weeks Ended 39 Weeks Ended
------------------------------------- -------------------------------------
November 1, 2003 November 2, 2002 November 1, 2003 November 2, 2002
---------------- ---------------- ---------------- ----------------
Amortization expense on
intangible assets $ 1.2 $ 1.5 $ 3.8 $ 4.2
The Company expects annual amortization expense for all intangible assets for
the next five years to be as follows (in millions):
Year Amount
---- ------
Remainder of 2003 $ 1.3
2004 4.6
2005 4.2
2006 3.8
2007 3.3
NOTE 5. LONG-TERM DEBT AND LINE OF CREDIT. On July 28, 2003, the Company sold
$200.0 million of 8.25% Senior Subordinated Notes (the "Notes") for $196.7
million, due 2013. The discount of $3.3 million is being amortized to interest
expense over the life of the Notes. The Notes are guaranteed by all of the
Company's domestic subsidiaries. Interest on the Notes is payable semi-annually,
beginning February 1, 2004. As of November 1, 2003, the fair value of the Notes
is $196.0 million. The fair value is based on recent trading activity of the
Notes. The Notes contain various covenants including those that limit the
Company's ability to make certain Restricted Payments, as defined in the
Indenture dated as of July 28, 2003, by and among the Company, the guarantors
named therein and Wells Fargo Bank Minnesota, National Association (the
"Indenture"). As of November 1, 2003, the Company is in compliance with all
covenants related to the Notes. On or after August 1, 2008, the Company may, on
any one or more occasions, redeem all or a part of the Notes at the redemption
prices set forth below, plus accrued and unpaid interest, if any, on the Notes
redeemed, to the applicable redemption date:
Year Percentage
---- ----------
2008 104.125%
2009 102.750%
2010 101.375%
2011 and thereafter 100.000%
6
On July 8, 2003, the Company amended its credit facility to, among other things,
modify the fixed charge coverage ratio and maximum leverage ratio requirements.
In conjunction with the issuance of Notes, the Company repaid the $200.0 million
then outstanding on the term loan portion of its credit facility. The amended
credit facility is now comprised of a $150.0 million revolving line of credit
subject to various covenants and restrictions including an asset coverage ratio
limitation. The credit facility is secured by a first priority perfected
security interest in all of the capital stock of the Company's domestic
subsidiaries and 65 percent of the capital stock of its first-tier foreign
subsidiaries. The revolving line of credit bears interest at the LIBOR rate plus
2.25 percent or the base rate, as defined in the credit agreement, plus 1.25
percent. A quarterly commitment fee of 0.5 percent per annum is payable on the
unborrowed balance of the revolving line of credit. While no amounts had been
drawn on the revolving line of credit as of November 1, 2003, the balance
available to the Company was reduced by $13.4 million in outstanding letters of
credit. As of November 1, 2003, the Company is in compliance with all covenants
under its credit facility.
NOTE 6. RESTRUCTURING CHARGE. During the fourth quarter of 2001, the Company
recorded a non-recurring charge of $70.0 million comprised of a $53.9 million
restructuring charge and a $16.1 million asset impairment charge. The cash
portion of the charge was $41.4 million. As part of the restructuring, the
Company centralized all domestic retail operations functions in Topeka, Kansas.
Four domestic division offices in Atlanta, Baltimore, Chicago, and Dallas were
closed. The Company also announced its intention to close 104 under-performing
stores, including 67 Parade stores and 37 Payless ShoeSource stores, as part of
the restructuring. The store closings differ from closings in the normal course
of business in that they have a longer remaining lease term. The remaining
Parade locations are concentrated in the Northeast and selected major
metropolitan areas. As of November 1, 2003, the Company has closed 96 stores and
has decided to continue to operate 7 of the 104 stores originally identified for
closure. The Company intends to close the remaining store in 2003. The Company
eliminated a total of 230 positions in conjunction with the restructuring. The
table below provides a roll-forward of the $41.4 million reserve established as
part of the 2001 non-recurring charge and the status of the reserve as of
November 1, 2003. Costs are being charged against the reserves as incurred.
Reserves are reviewed for adequacy on a periodic basis and are adjusted as
appropriate based on those reviews.
(Dollars in millions)
PRE-TAX CASH PAID
2001 IN 2001 ACCRUED AS OF CASH PAID ACCRUED AS OF
CASH CHARGE AND 2002 ADJUSTMENTS FEBRUARY 1, 2003 IN 2003 NOVEMBER 1, 2003
----------- -------- ----------- ---------------- ------- ----------------
Store closings (including lease terminations
and employee termination costs) $17.6 $(8.5) $(8.0) $ 1.1 $(0.7) $ 0.4
Division closings (including lease terminations
and employee termination costs) 3.3 (2.7) 1.8 2.4 (0.4) 2.0
Corporate employee termination costs 8.0 (8.0) -- -- -- --
Professional fees 6.4 (8.1) 2.0 0.3 -- 0.3
Inventory liquidation costs (recorded as
a component of cost of sales) 4.4 (2.4) (2.0) -- -- --
Other restructuring related costs 1.7 (3.1) 1.4 -- -- --
----- ----- ----- ----- ----- -----
Total $41.4 $(32.8) $(4.8) $ 3.8 $(1.1) $ 2.7
===== ===== ===== ===== ===== =====
In 2002, the Company recorded an additional charge of $2.0 million for
professional fees and $1.4 million for relocation costs associated with
implementing the restructuring that was announced during the fourth quarter of
2001. Also, in 2002, the Company decreased its reserve for store closings by
$8.0 million, inventory liquidations by $2.0 million and increased its reserve
for division closings by $1.8 million.
During 2002, in an effort to enhance global sourcing initiatives and align with
international expansion strategies, the Company reorganized its global sourcing
structure to focus on cost reduction initiatives from procurement of materials
through distribution of product. As part of these cost reduction initiatives,
the Company is now taking ownership of certain raw materials as the materials
enter the production process. These raw materials are included in Inventories on
the condensed consolidated balance sheet.
NOTE 7. INCOME TAXES. The Company's effective income tax rate was 36.5 percent
in the third quarter and first nine months of 2003 and 2002.
7
NOTE 8. COMPREHENSIVE (LOSS) INCOME. The following table shows the computation
of comprehensive income:
(Dollars in millions)
13 WEEKS ENDED 39 WEEKS ENDED
---------------------------------- ------------------------------------
NOVEMBER 1, 2003 NOVEMBER 2, 2002 NOVEMBER 1, 2003 NOVEMBER 2, 2002
---------------- ---------------- ---------------- ----------------
Net (Loss) Income $ (2.2) $ 29.6 $ 17.1 $100.7
Other Comprehensive (Loss) Gain:
Change in fair value of derivatives -- (0.2) 0.1 (1.4)
Derivative losses reclassified into interest expense -- 1.0 1.7 4.5
Foreign currency translation adjustments (0.8) 0.9 3.4 0.8
------ ------ ------ ------
Total other comprehensive (loss) gain (0.8) 1.7 5.2 3.9
------ ------ ------ ------
Total Comprehensive (Loss) Income $ (3.0) $ 31.3 $ 22.3 $104.6
====== ====== ====== ======
The changes in the Company's cumulative foreign currency translation adjustment
were not adjusted for income taxes, as they relate to specific indefinite
investments in foreign subsidiaries.
NOTE 9. EARNINGS (LOSS) PER SHARE. Basic earnings or loss per share are computed
by dividing net earnings or loss by the weighted average number of shares of
common stock outstanding during the period. Diluted earnings or loss per share
include the effect of exercise of stock options.
NOTE 10. STOCK SPLIT. The Company completed a three-for-one stock split,
effected in the form of a stock dividend, to shareholders of record on March 13,
2003, payable on March 27, 2003. The Company issued approximately 44.4 million
shares of common stock as a result of the stock split. All references to the
number of shares and per share amounts of common stock have been restated to
reflect the stock split. The Company reclassified an amount equal to the par
value of the number of shares issued to common stock from retained earnings.
NOTE 11. SEGMENT REPORTING. The Company and its subsidiaries are principally
engaged in the operation of retail locations offering family footwear and
accessories. The Company operates its business in two reportable business
segments: Payless Domestic and Payless International. These segments have been
determined based on internal management reporting and management
responsibilities. The Payless International segment includes retail operations
in Canada, South America, Central America and the Caribbean. The Company's
operations in its Central and South America regions are operated as joint
ventures in which the Company maintains a 60-percent ownership interest. Certain
management costs for services performed by Payless Domestic and certain royalty
fees and sourcing fees charged by Payless Domestic are allocated to the Payless
International segment. These total costs and fees amounted to $4.3 million
during the third quarter of 2003 and $4.1 million during the same period in
2002. For the first nine months of 2003, these total costs and fees amounted to
$13.3 million, compared with $13.5 million for the same period in 2002. The
Payless Domestic segment includes retail operations in the United States, Guam
and Saipan. Information on the segments is as follows:
(Dollars in millions)
Payless Domestic Payless International Payless Consolidated
---------------- --------------------- --------------------
Quarter ended November 1, 2003
Revenues from external customers $ 631.3 $ 78.5 $ 709.8
Operating profit (loss) 0.8 (1.7) (0.9)
Nine months ended November 1, 2003
Revenues from external customers $1,909.1 $ 229.8 $2,138.9
Operating profit (loss) 38.5 (5.4) 33.1
Total assets 979.3 204.4 1,183.7
Quarter ended November 2, 2002
Revenues from external customers $ 641.1 $ 71.9 $ 713.0
Operating profit 46.0 4.0 50.0
Nine months ended November 2, 2002
Revenues from external customers $2,019.4 $ 208.0 $2,227.4
Operating profit 161.2 8.6 169.8
Total assets 999.0 195.3 1,194.3
8
NOTE 12. RECLASSIFICATIONS. Certain reclassifications have been made to prior
year balances to conform to the current year presentation.
NOTE 13. FOREIGN CURRENCY TRANSLATION. Local currencies are the functional
currencies for all subsidiaries. Accordingly, assets and liabilities of foreign
subsidiaries are translated at the rate of exchange at the balance sheet date.
Adjustments from the translation process are accumulated as part of other
comprehensive income and are included as a separate component of shareowners'
equity. Income and expense items of these subsidiaries are translated at average
rates of exchange.
NOTE 14. CONTINGENCIES. On or about December 20, 2001, a First Amended Complaint
was filed against the Company in the U.S. District Court for the District of
Oregon, captioned Adidas America, Inc. and Adidas-Salomon AG v. Payless
ShoeSource, Inc. The First Amended Complaint seeks injunctive relief and
unspecified monetary damages for trademark and trade dress infringement, unfair
competition, deceptive trade practices and breach of contract. The Company
believes it has meritorious defenses to claims asserted in the lawsuit and has
filed an answer and a motion for summary judgment which the court granted in
part. An estimate of the possible loss, if any, or the range of loss cannot be
made.
On or about January 20, 2000, a complaint was filed against the Company in the
U.S. District Court for the District of New Hampshire, captioned Howard J.
Dananberg, D.P.M. v. Payless ShoeSource, Inc. The Complaint seeks injunctive
relief, unspecified treble monetary damages, attorneys' fees, interest and costs
for patent infringement. The Company believes it has meritorious defenses to
claims asserted in the lawsuit. An estimate of the possible loss, if any, or the
range of loss cannot be made.
NOTE 15. IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS. In December 2002, the
FASB issued SFAS 148, "Accounting for Stock-Based Compensation - Transition and
Disclosure" ("SFAS 148"). SFAS 148 amends SFAS 123, "Accounting for Stock-Based
Compensation," and provides alternative methods of transition for a voluntary
change to the fair value based method of accounting for stock-based employee
compensation. SFAS 148 also amends the disclosure requirements of SFAS 123 to
require prominent disclosure in annual and interim financial statements about
the effects of stock-based compensation. The transition guidance and annual
disclosure provisions of SFAS 148 are effective for financial statements issued
for fiscal years ending after December 15, 2002. The interim disclosure
provisions of this statement are effective for financial reports containing
financial statements for interim periods beginning after December 15, 2002. The
Company has adopted the disclosure provisions of SFAS 148.
During May 2003, the FASB issued SFAS 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." SFAS 150
clarifies the accounting for certain financial instruments with characteristics
of both liabilities and equity and requires that those instruments be classified
as liabilities in statements of financial position. SFAS 150 is effective for
financial instruments entered into or modified after May 31, 2003, and otherwise
is effective at the beginning of the first interim period beginning after June
15, 2003, except that certain provisions have been deferred pursuant to FASB
Staff Position No. FAS 150-3. The application of SFAS 150 is not expected to
have a material impact on the Company's consolidated financial statements.
NOTE 16. SUBSIDIARY GUARANTORS OF SENIOR NOTES - CONDENSED CONSOLIDATING
FINANCIAL INFORMATION. The Company has issued Notes guaranteed by certain of its
subsidiaries (the "Guarantor Subsidiaries"). The Guarantor Subsidiaries are
direct or indirect wholly owned subsidiaries of the Company. The guarantees are
full and unconditional, to the extent allowed by law, and joint and several.
The following supplemental financial information sets forth, on a condensed
consolidating basis, the balance sheets for the Company (the "Parent Company"),
for the Guarantor Subsidiaries and for the Company's non-guarantor subsidiaries
(the "Non-guarantor Subsidiaries") and total consolidated Payless ShoeSource,
Inc. and subsidiaries as of November 1, 2003, November 2, 2002, and February 1,
2003, the related condensed consolidating statements of earnings for the
thirteen and thirty-nine week periods ended November 1, 2003 and November 2,
2002, and the related condensed consolidating statements of cash flows for the
thirty-nine week periods ended November 1, 2003 and November 2, 2002. The
intercompany investment for each subsidiary is recorded by its parent in Other
Assets.
9
CONDENSED CONSOLIDATED BALANCE SHEET
As of November 1, 2003
(Dollars in millions)
PARENT GUARANTOR NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------- ------------ ------------ ------------ ------------
ASSETS
Current Assets:
Cash and cash equivalents $ -- $ 106.3 $ 35.4 $ -- $ 141.7
Restricted cash -- -- 33.5 -- 33.5
Inventories -- 312.2 98.5 -- 410.7
Current deferred income taxes -- 13.1 0.7 -- 13.8
Other current assets 5.7 78.1 47.8 (61.1) 70.5
-------- -------- -------- --------- --------
Total current assets 5.7 509.7 215.9 (61.1) 670.2
Property and Equipment:
Land -- 8.0 -- -- 8.0
Buildings and leasehold improvements -- 584.3 68.2 -- 652.5
Furniture, fixtures and equipment -- 451.1 58.3 -- 509.4
Property under capital leases -- 4.6 -- -- 4.6
-------- -------- -------- --------- --------
Total property and equipment -- 1,048.0 126.5 -- 1,174.5
Accumulated depreciation and amortization -- (699.0) (51.6) -- (750.6)
-------- -------- -------- --------- --------
Property and equipment, net -- 349.0 74.9 -- 423.9
Favorable leases, net -- 30.6 -- -- 30.6
Deferred income taxes -- 13.0 9.8 -- 22.8
Other assets 1,105.5 431.9 12.5 (1,513.7) 36.2
-------- -------- -------- --------- --------
Total Assets $1,111.2 $1,334.2 $ 313.1 $(1,574.8) $1,183.7
======== ======== ======== ========= ========
LIABILITIES AND SHAREOWNERS' EQUITY
Current Liabilities:
Current maturities of long-term debt $ -- $ 0.9 $ -- $ -- $ 0.9
Notes payable -- -- 33.5 -- 33.5
Accounts payable -- 85.8 100.1 (54.7 131.2
Accrued expenses 10.6 98.8 17.6 (6.4 120.6
-------- -------- -------- --------- --------
Total current liabilities 10.6 185.5 151.2 (61.1) 286.2
Long-term debt 479.9 2.1 4.0 (283.1) 202.9
Other liabilities -- 101.6 8.5 (52.6) 57.5
Minority interest -- -- 16.4 -- 16.4
Total shareowners' equity 620.7 1,045.0 133.0 (1,178.0) 620.7
-------- -------- -------- --------- --------
Total Liabilities and Shareowners' Equity $1,111.2 $1,334.2 $ 313.1 $(1,574.8) $1,183.7
======== ======== ======== ========= ========
10
CONDENSED CONSOLIDATED BALANCE SHEET
As of November 2, 2002
(Dollars in millions)
PARENT GUARANTOR NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------- ------------ ------------ ------------ ------------
ASSETS
Current Assets:
Cash and cash equivalents $ -- $ 112.1 $ 37.0 $ -- $ 149.1
Restricted cash -- -- 28.0 -- 28.0
Inventories -- 319.3 93.7 (5.2) 407.8
Current deferred income taxes -- 19.8 0.1 -- 19.9
Other current assets 4.2 150.7 16.8 (108.2) 63.5
-------- -------- -------- --------- --------
Total current assets 4.2 601.9 175.6 (113.4) 668.3
Property and Equipment:
Land -- 8.0 -- -- 8.0
Buildings and leasehold improvements -- 558.5 57.6 -- 616.1
Furniture, fixtures and equipment -- 447.2 50.1 -- 497.3
Property under capital leases -- 7.3 -- -- 7.3
-------- -------- -------- --------- --------
Total property and equipment -- 1,021.0 107.7 -- 1,128.7
Accumulated depreciation and amortization -- (651.5) (38.7) -- (690.2)
-------- -------- -------- --------- --------
Property and equipment, net -- 369.5 69.0 -- 438.5
Favorable leases, net -- 34.9 -- -- 34.9
Deferred income taxes -- 16.8 5.6 -- 22.4
Other assets 1,054.4 505.9 16.4 (1,546.5) 30.2
-------- -------- -------- --------- --------
Total Assets $1,058.6 $1,529.0 $ 266.6 $(1,659.9) $1,194.3
======== ======== ======== ========= ========
LIABILITIES AND SHAREOWNERS' EQUITY
Current Liabilities:
Current maturities of long-term debt $ -- $ 70.6 $ 15.0 $ (15.0) $ 70.6
Notes payable -- -- 28.0 -- 28.0
Accounts payable -- 66.4 83.6 (31.0) 119.0
Accrued expenses 66.4 132.9 17.9 (67.4) 149.8
-------- -------- -------- --------- --------
Total current liabilities 66.4 269.9 144.5 (113.4) 367.4
Long-term debt 400.0 159.2 4.5 (404.5) 159.2
Other liabilities -- 84.8 9.8 (39.3) 55.3
Minority interest -- -- 20.2 -- 20.2
Total shareowners' equity 592.2 1,015.1 87.6 (1,102.7) 592.2
-------- -------- -------- --------- --------
Total Liabilities and Shareowners' Equity $1,058.6 $1,529.0 $ 266.6 $(1,659.9) $1,194.3
======== ======== ======== ========= ========
11
CONDENSED CONSOLIDATED BALANCE SHEET
As of February 1, 2003
(Dollars in millions)
PARENT GUARANTOR NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------- ------------ ------------ ------------ ------------
ASSETS
Current Assets:
Cash and cash equivalents $ -- $ 31.9 $ 42.5 $ -- $ 74.4
Restricted cash -- -- 28.5 -- 28.5
Inventories -- 369.2 89.0 (5.7) 452.5
Current deferred income taxes -- 15.8 0.6 -- 16.4
Other current assets 5.6 168.3 21.7 (133.8) 61.8
-------- -------- -------- -------- --------
Total current assets 5.6 585.2 182.3 (139.5) 633.6
Property and Equipment:
Land -- 7.6 -- -- 7.6
Buildings and leasehold improvements -- 563.2 62.2 -- 625.4
Furniture, fixtures and equipment -- 441.1 48.9 -- 490.0
Property under capital leases -- 4.6 -- -- 4.6
-------- -------- -------- -------- --------
Total property and equipment -- 1,016.5 111.1 -- 1,127.6
Accumulated depreciation and amortization -- (660.2) (41.1) -- (701.3)
-------- -------- -------- -------- --------
Property and equipment, net -- 356.3 70.0 -- 426.3
Favorable leases, net -- 34.3 -- -- 34.3
Deferred income taxes -- 20.8 8.2 -- 29.0
Other assets 1,062.6 508.6 18.1 (1,561.7) 27.6
-------- -------- -------- -------- --------
Total Assets $1,068.2 $1,505.2 $ 278.6 $(1,701.2) $1,150.8
======== ======== ======== ========= ========
LIABILITIES AND SHAREOWNERS' EQUITY
Current Liabilities:
Current maturities of long-term debt $ -- $ 83.2 $ 30.0 $ (30.0) $ 83.2
Notes payable -- -- 28.5 -- 28.5
Accounts payable -- 69.0 71.3 (33.9) 106.4
Accrued expenses 70.0 106.6 22.7 (75.6) 123.7
-------- -------- -------- -------- --------
Total current liabilities 70.0 258.8 152.5 (139.5) 341.8
Long-term debt 400.0 136.7 4.0 (400.0) 140.7
Other liabilities -- 95.1 5.2 (48.0) 52.3
Minority interest -- -- 17.8 -- 17.8
Total shareowners' equity 598.2 1,014.6 99.1 (1,113.7) 598.2
-------- -------- -------- -------- --------
Total Liabilities and Shareowners' Equity $1,068.2 $1,505.2 $ 278.6 $(1,701.2) $1,150.8
======== ======== ======== ========= ========
12
CONDENSED CONSOLIDATED STATEMENT OF EARNINGS
For the Thirteen Weeks Ended November 1, 2003
(Dollars in millions)
PARENT GUARANTOR NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------- ------------ ------------ ------------ ------------
Net sales $ -- $ 669.6 $ 162.3 $(122.1) $ 709.8
Cost of sales -- 508.9 132.2 (120.6) 520.5
Selling, general and administrative expense 1.3 166.8 23.5 (1.5) 190.2
------- ------- ------- ------- -------
Operating (loss) profit (1.3) (6.1) 6.6 -- (0.9)
Interest expense 5.3 2.0 1.0 (2.3) 6.0
Interest income -- (2.5) (0.9) 2.3 (1.1)
Equity in earnings of subsidiaries (2.0) (8.2) -- 10.2 --
------- ------- ------- ------- -------
(Loss) Earnings before income taxes and minority
interest (4.3) 2.5 6.5 (10.2) (5.8)
(Benefit) Provision for income taxes (2.4) 0.5 (0.2) -- (2.1)
------- ------- ------- ------- -------
(Loss) Earnings before minority interest (1.9) 2.0 6.7 (10.2) (3.7)
Minority interest -- -- 1.5 -- 1.5
------- ------- ------- ------- -------
Net (loss) earnings $ (2.2) $ 2.0 $ 8.2 $ (10.2) $ (2.2)
======= ======= ======= ======= =======
CONDENSED CONSOLIDATED STATEMENT OF EARNINGS
For the Thirteen Weeks Ended November 2, 2002
(Dollars in millions)
PARENT GUARANTOR NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------- ------------ ------------ ------------ ------------
Net sales $ -- $670.6 $123.1 $(80.7) $713.0
Cost of sales -- 461.5 96.1 (75.3) 482.3
Selling, general and administrative expense 0.2 163.2 23.9 (5.4) 181.9
Non-recurring item -- (1.2) -- -- (1.2)
------ ------ ------ ------ ------
Operating (loss) profit (0.2) 47.1 3.1 -- 50.0
Interest expense 3.6 5.2 0.7 (3.6) 5.9
Interest income -- (4.3) (0.6) 3.6 (1.3)
Equity in earnings of subsidiaries (32.0) (2.2) -- 34.2 --
------ ------ ------ ------ ------
Earnings before income taxes and minority
interest 28.2 48.4 3.0 (34.2) 45.4
(Benefit) Provision for income taxes (1.4) 16.4 1.5 -- 16.5
------ ------ ------ ------ ------
Earnings before minority interest 29.6 32.0 1.5 (34.2) 28.9
Minority interest -- -- 0.7 -- 0.7
------ ------ ------ ------ ------
Net earnings $ 29.6 $ 32.0 $ 2.2 $(34.2) $ 29.6
====== ====== ====== ====== ======
13
CONDENSED CONSOLIDATED STATEMENT OF EARNINGS
For the Thirty-nine Weeks Ended November 1, 2003
(Dollars in millions)
PARENT GUARANTOR NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------- ------------ ------------ ------------ ------------
Net sales $ -- $2,009.6 $ 519.7 $ (390.4) $2,138.9
Cost of sales -- 1,502.7 429.7 (385.5) 1,546.9
Selling, general and administrative expense 1.4 492.9 69.4 (4.8) 558.9
-------- -------- -------- -------- --------
Operating (loss) profit (1.4) 14.0 20.6 (0.1) 33.1
Interest expense 11.8 9.1 3.1 (8.6) 15.4
Interest income -- (9.1) (2.5) 8.5 (3.1)
Equity in earnings of subsidiaries (25.5) (25.1) -- 50.6 --
-------- -------- -------- -------- --------
Earnings before income taxes and minority 12.3 39.1 20.0 (50.6) 20.8
interest
(Benefit) Provision for income taxes (4.8) 13.6 (1.2) -- 7.6
-------- -------- -------- -------- --------
Earnings before minority interest 17.1 25.5 21.2 (50.6) 13.2
Minority interest -- -- 3.9 -- 3.9
-------- -------- -------- -------- --------
Net earnings $ 17.1 $ 25.5 $ 25.1 $ (50.6) $ 17.1
======== ======== ======== ======== ========
CONDENSED CONSOLIDATED STATEMENT OF EARNINGS
For the Thirty-nine Weeks Ended November 2, 2002
(Dollars in millions)
PARENT GUARANTOR NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------- ------------ ------------ ------------ ------------
Net sales $ -- $2,111.4 $ 264.4 $ (148.4) $2,227.4
Cost of sales -- 1,465.8 197.1 (141.3) 1,521.6
Selling, general and administrative expense 0.7 481.1 63.4 (7.1) 538.1
Non-recurring item -- (2.1) -- -- (2.1)
-------- -------- -------- -------- --------
Operating (loss) profit (0.7) 166.6 3.9 -- 169.8
Interest expense 10.9 17.3 1.1 (10.9) 18.4
Interest income -- (12.6) (1.4) 10.9 (3.1)
Equity in earnings of subsidiaries (108.1) (4.7) -- 112.8 --
-------- -------- -------- -------- --------
Earnings before income taxes and minority 96.5 166.6 4.2 (112.8) 154.5
interest
(Benefit) Provision for income taxes (4.2) 58.5 2.1 -- 56.4
-------- -------- -------- -------- --------
Earnings before minority interest 100.7 108.1 2.1 (112.8) 98.1
Minority interest -- -- 2.6 -- 2.6
-------- -------- -------- -------- --------
Net earnings $ 100.7 $ 108.1 $ 4.7 $ (112.8) $ 100.7
======== ======== ======== ======== ========
14
CONSOLIDATED STATEMENT OF CASH FLOWS
For the Thirty-nine Weeks Ended November 1, 2003
(Dollars in millions)
PARENT GUARANTOR NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------- ------------ ------------ ------------ ------------
Operating Activities:
Net Earnings $ 17.1 $ 25.5 $ 25.1 $(50.6) $ 17.1
Adjustments for noncash items included in
earnings:
Loss on disposal of assets -- 13.0 0.1 -- 13.1
Depreciation and amortization -- 64.7 10.1 -- 74.8
Amortization of unearned restricted stock -- 0.5 -- -- 0.5
Deferred income taxes -- 10.6 (1.8) -- 8.8
Minority interest -- -- (3.9) -- (3.9)
Changes in working capital:
Inventories -- 57.0 (9.5) (5.7) 41.8
Other current assets (0.1) 91.1 (26.0) (72.6) (7.6)
Accounts payable -- 16.8 28.9 (20.9) 24.8
Accrued expenses (59.4) (11.3) (5.1) 69.2 (6.6)
Other assets and liabilities, net (31.6) (52.4) 12.2 80.6 8.8
------ ------ ------ ------ ------
Total Operating Activities (74.0) 215.5 30.1 -- 171.6
------ ------ ------ ------ ------
Investing Activities:
Capital expenditures -- (66.8) (15.1) -- (81.9)
Disposition of property and
equipment -- 1.0 -- -- 1.0
Investment in subsidiaries -- (5.4) -- 5.4 --
Repayment of loan to parent/subsidiary -- 146.9 -- (146.9) --
------ ------ ------ ------ ------
Total Investing Activities -- 75.7 (15.1) (141.5) (80.9)
------ ------ ------ ------ ------
Financing Activities:
Issuance of notes payable -- -- 5.0 -- 5.0
Restricted cash -- -- (5.0) -- (5.0)
Issuance of long-term debt 196.7 -- -- -- 196.7
Payment of deferred financing costs (5.5) -- -- -- (5.5)
Repayment of long-term debt -- (216.8) -- -- (216.8)
Loan from parent/subsidiary (116.9) -- (30.0) 146.9 --
Net purchases of common stock (0.3) -- -- -- (0.3)
Contributions by parents -- -- 5.4 (5.4) --
Contributions by minority owners -- -- 3.6 -- 3.6
Other financing activities -- -- (1.1) -- (1.1)
------ ------ ------ ------ ------
Total Financing Activities 74.0 (216.8) (22.1) 141.5 (23.4)
------ ------ ------ ------ ------
Increase (decrease) in cash -- 74.4 (7.1) -- 67.3
Cash and Cash Equivalents,
Beginning of Period -- 31.9 42.5 -- 74.4
------ ------ ------ ------ ------
Cash and Cash Equivalents,
End of Period $ -- $106.3 $ 35.4 $ -- $141.7
====== ====== ====== ====== ======
15
CONSOLIDATED STATEMENT OF CASH FLOWS
For the Thirty-nine Weeks Ended November 2, 2002
(Dollars in millions)
PARENT GUARANTOR NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------- ------------ ------------ ------------ ------------
Operating Activities:
Net Earnings $100.7 $108.1 $ 4.7 $(112.8) $100.7
Adjustments for noncash items included in
earnings:
Loss on disposal of assets -- 2.7 0.3 -- 3.0
Depreciation and amortization -- 67.7 7.8 -- 75.5
Amortization of unearned restricted stock -- 0.9 -- -- 0.9
Deferred income taxes -- 25.9 (2.1) -- 23.8
Minority interest -- -- (2.6) -- (2.6)
Tax benefit of stock option
exercises -- 3.1 -- -- 3.1
Changes in working capital:
Inventories -- (4.0) (69.5) 5.2 (68.3)
Other current assets 6.3 (41.3) 2.1 25.5 (7.4)
Accounts payable (0.6) 14.0 45.1 (13.0) 45.5
Accrued expenses 12.3 (1.7) 2.7 (2.7) 10.6
Other assets and liabilities, net (135.4) 38.3 (6.5) 97.8 (5.8)
------ ------ ------ ------ ------
Total Operating Activities (16.7) 213.7 (18.0) -- 179.0
------ ------ ------ ------ ------
Investing Activities:
Capital expenditures -- (53.0) (23.3) -- (76.3)
Disposition of property and
equipment -- 2.6 -- -- 2.6
Investment in subsidiaries -- (24.6) -- 24.6 --
Repayment of loan to parent/subsidiary -- (15.0) -- 15.0 --
------ ------ ------ ------ ------
Total Investing Activities -- (90.0) (23.3) 39.6 (73.7)
------ ------ ------ ------ ------
Financing Activities:
Issuance of notes payable -- -- 18.5 -- 18.5
Restricted cash -- -- (18.5) -- (18.5)
Repayment of long-term debt -- (81.2) -- -- (81.2)
Loan from parent/subsidiary -- -- 15.0 (15.0) --
Net issuances of common stock 16.7 -- -- -- 16.7
Contributions by parents -- -- 24.6 (24.6) --
Contributions by minority owners -- -- 16.4 -- 16.4
Other financing activities -- -- (0.4) -- (0.4)
------ ------ ------ ------ ------
Total Financing Activities 16.7 (81.2) 55.6 (39.6) (48.5)
------ ------ ------ ------ ------
Increase in cash -- 42.5 14.3 -- 56.8
Cash and Cash Equivalents,
Beginning of Period -- 69.6 22.7 -- 92.3
------ ------ ------ ------ ------
Cash and Cash Equivalents,
End of Period $ -- $112.1 $ 37.0 $ -- $149.1
====== ====== ====== ====== ======
16
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This discussion and analysis should be read in conjunction with the Condensed
Consolidated Financial Statements and Notes to the Condensed Consolidated
Financial Statements included in this Form 10-Q.
REVIEW OF OPERATIONS
The following discussion summarizes the significant factors affecting operating
results for the quarters ended November 1, 2003 (2003) and November 2, 2002
(2002).
NET (LOSS) EARNINGS
The Company posted a net loss of $2.2 million in the third quarter of 2003
compared with net earnings of $29.6 million in the third quarter of 2002. For
the first nine months of 2003 net earnings were $17.1 million compared with
$100.7 million in the 2002 period.
The following table presents the components of costs and expenses, as a percent
of revenues, for the third quarter and first nine months of 2003 and 2002.
THIRD QUARTER FIRST NINE MONTHS
--------------------- --------------------
2003 2002 2003 2002
------ ------ ------ ------
Cost of sales 73.3% 67.6% 72.3% 68.3%
Selling, general and administrative expense 26.8 25.5 26.1 24.2
Non-recurring item -- (0.1) -- (0.1)
------ ------ ------ ------
Operating (loss) profit (0.1) 7.0 1.6 7.6
Interest expense, net 0.7 0.6 0.6 0.7
------ ------ ------ ------
(Loss) Earnings before income taxes and minority
interest (0.8) 6.4 1.0 6.9
Effective income tax rate* 36.5% 36.5% 36.5% 36.5%
------ ------ ------ ------
(Loss) Earnings before minority interest (0.5) 4.1 0.6 4.4
Minority interest 0.2 0.1 0.2 0.1
------ ------ ------ ------
Net (Loss) Earnings (0.3)% 4.2% 0.8% 4.5%
====== ====== ====== ======
* Percent of pre-tax earnings
NET SALES
Net sales represent all sales during the period net of estimated returns.
Same-store sales is calculated on a weekly basis. If a store is open the entire
week in each of the two years being compared, its sales are included in the
same-store sales calculation for that week. Relocated and remodeled stores are
also included in the same-store sales calculation if they were open during the
entire week in each of the two years being compared. During the third quarter of
2003 total sales decreased 0.5 percent compared to the third quarter of 2002,
consisting of a 0.1 percent increase in unit volume and a 0.6 percent decrease
in average selling prices. Footwear unit volume increased 4.0 percent and
footwear average selling prices decreased 5.5 percent in the third quarter of
2003 compared with the third quarter of 2002. The third quarter decrease in the
average selling price for footwear reflects the aggressive markdowns the Company
has taken to remain competitive in a highly promotional footwear market. During
the first nine months of 2003 total sales decreased 4.0 percent compared to the
same period in 2002, consisting of an 5.7 percent decrease in unit volume and a
1.8 percent increase in average selling prices. Footwear unit volume decreased
5.9 percent and footwear average selling prices increased 0.6 percent in the
first nine months of 2003 compared with the first nine months of 2002. The
year-to-date increase in the average selling price for footwear reflects the
Company's strategy to increase the leather and fashion content of its product
assortment. Sales percent (decreases) increases are as follows:
THIRD QUARTER FIRST NINE MONTHS
--------------------- ------------------------
2003 2002 2003 2002
---- ---- ---- ----
Net Sales (0.5)% 2.3% (4.0)% (1.9)%
Same-Store Sales (1.4)% 0.7% (4.7)% (4.0)%
17
The decrease in dollar and unit sales reflects the weak retail environment and
particularly poor performance of sandals and canvas footwear during the spring
season due to unseasonably cold and wet weather. The Company expects the retail
environment to remain highly promotional in the fourth quarter. Therefore,
margins and financial results are expected to remain under intense pressure
through the end of the year.
COST OF SALES
Cost of sales includes cost of merchandise sold and the Company's buying and
occupancy costs. Cost of sales was $520.5 million in the 2003 third quarter, up
7.9 percent from $482.3 million in the 2002 third quarter. For the first nine
months of 2003, cost of sales was $1,546.9 million, up 1.7 percent from $1,521.6
million in the 2002 period.
As a percentage of net sales, cost of sales was 73.3 percent in the third
quarter of 2003, compared with 67.6 percent in the third quarter of 2002. For
the first nine months of 2003, as a percentage of net sales, cost of sales was
72.3 percent, compared with 68.3 percent in the 2002 period. The increase in
cost of sales as a percentage of net sales results from an increase in markdowns
reflecting the competitive, highly promotional footwear market. Additionally,
cost of sales benefited in the third quarter of 2002 from a lower level of
markdowns in anticipation of potential supply interruptions resulting from the
West Coast port situation.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses were $190.2 million in the third
quarter of 2003, up 4.6 percent from $181.9 million in the third quarter of
2002. For the first nine months of 2003, selling, general and administrative
expenses were $558.9 million, up 3.9 percent from $538.1 million in the 2002
period.
As a percentage of net sales, selling, general and administrative expenses were
26.8 percent during the third quarter of 2003 compared with 25.5 percent in the
third quarter of 2002. For the first nine months of 2003, selling, general and
administrative expenses as a percentage of net sales were 26.1 percent in 2003
compared with 24.2 percent in 2002. The increase in the third quarter is
primarily the result of an additional $7.8 million of advertising and negative
leverage due to lower same-store sales. The increase in the first nine months of
2003 is primarily the result of an additional $9.0 million of advertising, $3.4
million in increased insurance costs, the second-quarter write-off of $2.1
million in deferred financing costs and negative leverage due to lower sales.
The $3.4 million increase in insurance costs from last year is partially the
result of the recognition of a $2.0 million benefit recorded in the second
quarter of 2002 for lower self-insurance costs as a result of actuarial
calculations resulting from favorable claims experience over the past several
years.
INTEREST EXPENSE, NET
Net interest expense increased to $4.9 million in the third quarter of 2003 from
$4.6 million in the third quarter of 2002, reflecting the higher interest rate
on the $200.0 million senior subordinated notes due 2013 that were issued in the
second quarter. For the first nine months of 2003, net interest expense
decreased to $12.3 million from $15.3 million in the same period in 2002. The
decrease over the first nine months reflects the lower average balance of
outstanding indebtedness. See Financing Activities, below.
EFFECTIVE INCOME TAX RATE
The Company's effective income tax rate was 36.5 percent in the third quarter
and first nine months of 2003 and 2002.
LIQUIDITY AND CAPITAL RESOURCES
CASH FLOW
Cash flow from operations during the nine months ended November 1, 2003 was
$171.6 million. As a percentage of net sales, cash flow from operations was 8.0
percent in the first nine months of 2003 and 2002.
Internally generated funds are expected to continue to be the most important
component of the Company's capital resources; however, the Company may from time
to time draw on its revolving credit line to fund seasonal cash flow needs.
18
CAPITAL EXPENDITURES
Capital expenditures during the first nine months of 2003 totaled $81.9 million,
including $3.1 million from the Company's joint venture partners. The Company
estimates that capital expenditures for the remainder of the year will be $28.1
million, including $1.9 million contributed by the Company's joint venture
partners in Central and South America. The Company anticipates that cash flow
from operations, the revolving line of credit, and its joint venture partners
will be sufficient to finance projected capital expenditures.
FINANCING ACTIVITIES
On July 28, 2003, the Company sold $200.0 million of 8.25% Senior Subordinated
Notes (the "Notes") for $196.7 million, due 2013. The discount of $3.3 million
is being amortized to interest expense over the life of the Notes. The Notes are
guaranteed by all of the Company's domestic subsidiaries. Interest on the Notes
is payable semi-annually, beginning February 1, 2004. The Notes contain various
covenants including those that limit the Company's ability to make certain
Restricted Payments, as defined in the Indenture dated as of July 28, 2003, by
and among the Company, the guarantors named therein and Wells Fargo Bank
Minnesota, National Association (the "Indenture"). As of November 1, 2003, the
fair value of the Notes is $196.0 million. The fair value is based on recent
trading activity of the Notes. On or after August 1, 2008, the Company may, on
any one or more occasions, redeem all or a part of the Notes at the redemption
prices set forth below, plus accrued and unpaid interest, if any, on the Notes
redeemed, to the applicable redemption date:
Year Percentage
---- ----------
2008 104.125%
2009 102.750%
2010 101.375%
2011 and thereafter 100.000%
On July 8, 2003, the Company amended its credit facility to, among other things,
modify the fixed charge coverage ratio and maximum leverage ratio requirements.
In conjunction with the issuance of Notes, the Company repaid the $200.0 million
then outstanding on the term loan portion of its credit facility. The amended
credit facility is now comprised of a $150.0 million revolving line of credit
subject to various covenants and restrictions including an asset coverage ratio
limitation. The credit facility is secured by a first priority perfected
security interest in all of the capital stock of the Company's domestic
subsidiaries and 65 percent of the capital stock of its first-tier foreign
subsidiaries. The revolving line of credit bears interest at the LIBOR rate plus
2.25 percent or the base rate, as defined in the credit agreement, plus 1.25
percent. A quarterly commitment fee of 0.5 percent per annum is payable on the
unborrowed balance of the revolving line of credit. While no amounts had been
drawn on the revolving line of credit as of November 1, 2003, the balance
available to the Company was reduced by $13.4 million in outstanding letters of
credit. As of November 1, 2003, the Company is in compliance with all covenants
under its credit facility.
The Company's financial commitments include required principal payments on the
Notes, required payments under operating leases and capital leases and certain
royalty payments as of November 1, 2003 as follows:
(Dollars in millions)
SENIOR
YEAR SUBORDINATED NOTES OPERATING LEASES ROYALTIES CAPITAL LEASES OTHER
---- ------------------ ---------------- --------- -------------- -----
Remainder of 2003 $ -- $ 67.3 $ 1.1 $ 0.2 $ 0.1
2004 -- 239.6 9.7 0.7 1.0
2005 -- 200.0 10.2 0.5 --
2006 -- 169.2 10.3 0.5 --
2007 -- 139.9 7.6 0.5 --
Thereafter 200.0 243.2 5.4 0.1 4.0
----- ----- --- --- ---
Total $ 200.0 $ 1,059.2 $ 44.3 $ 2.5 $ 5.1
======== ========== ======== ======== ========
The Company's royalty commitment consists of minimum royalty payments for the
purchase of branded merchandise.
19
Amounts Not Reflected in the Table Above:
The Company also maintains demand notes payable of $33.5 million entered into to
efficiently finance its Latin American subsidiaries. The Company maintains cash
balances of $33.5 million in certificates of deposit as compensating balances to
collateralize the notes payable. The certificates of deposit are reflected as
restricted cash in the accompanying condensed consolidated balance sheet.
The Company has recently announced that it has entered into a joint venture
agreement to operate Payless stores in Japan. The Company has committed to
making capital contributions to its Japanese joint venture in the amount of
120.0 million yen, 611.4 million yen and 412.9 million yen in 2003, 2004 and
2005, respectively. Additionally, if the Japanese joint venture achieves certain
performance targets, the Company will be committed to contribute an additional
2.9 billion yen and 3.4 billion yen in 2006 and 2007, respectively. In U.S.
dollars, based on the exchange rate of 110 yen to 1 U.S. dollar as of November
1, 2003, the committed contributions are $1.1 million, $5.6 million, $3.8
million, $26.4 million and $30.9 million for 2003, 2004, 2005, 2006 and 2007,
respectively. The Company will own 60 percent of the Japanese joint venture and,
therefore, will fully consolidate the results of such operations in its
financial statements. The Company intends to open the first test store in Japan
in 2004.
FINANCIAL CONDITION RATIOS
A summary of key financial information for the periods indicated is as follows:
NOVEMBER 1, NOVEMBER 2, FEBRUARY 1,
2003 2002 2003
---- ---- ----
Current Ratio 2.3 1.8 1.9
Debt-Capitalization Ratio* 27.7% 30.3% 29.7%
Fixed Charge Coverage Ratio** 1.2x 1.9x 2.5x
* Debt-to-capitalization has been computed by dividing total debt by
capitalization. Total debt is defined as long-term debt including current
maturities, notes payable and borrowings under the revolving line of
credit. Capitalization is defined as total debt and shareowners' equity.
The debt-to-capitalization ratio, including the present value of future
minimum rental payments under operating leases as debt and as
capitalization, was 65.3%, 65.0% and 65.4% respectively, for the periods
referred to above.
** Fixed charge coverage ratio, which is presented for the trailing 52 weeks
in each period ended above, is defined as earnings before income taxes,
gross interest expense, and the interest component of rent expense,
divided by gross interest expense and the interest component of rent
expense.
STORE ACTIVITY
At the end of the third quarter of 2003, the Company operated 5,050 stores
offering quality family footwear and accessories in all 50 states, Puerto Rico,
Guam, Saipan, the U.S. Virgin Islands, Canada, Chile, Costa Rica, the Dominican
Republic, Ecuador, El Salvador, Guatemala, Honduras, Nicaragua, Panama, Peru,
and Trinidad & Tobago. The following table presents the change in store count
for the third quarter and first nine months of 2003 and 2002.
THIRD QUARTER FIRST NINE MONTHS
----------------- -----------------
2003 2002 2003 2002
------ ------ ------ ------
Beginning of period 5,020 4,960 4,992 4,964
Stores opened 84 40 202 160
Stores closed (54) (38) (144) (162)
------ ------ ------ ------
Ending store count 5,050 4,962 5,050 4,962
====== ====== ====== ======
Included in the 2003 year-to-date store openings are 22 net new stores in
Central America and the Caribbean operated under a joint venture agreement. This
brings total store count in this region to 143. The Company intends to open 3 to
8 additional stores in this region during the remainder of 2003. Management
believes this region represents an opportunity to open a total of 150 to 200
stores.
20
During the first nine months of 2003 the Company also opened 13 new stores in
South America. This brings total store count in this region to 55. These stores
are operated under a joint venture agreement. The Company does not expect the
store count to change significantly through the end of 2003 as it continues to
focus on achieving its performance standards in all countries in this region.
The Andean region of South America could represent approximately a 300-store
opportunity.
RESTRUCTURING
During the fourth quarter of 2001, the Company recorded a non-recurring charge
of $70.0 million comprised of a $53.9 million restructuring charge and a $16.1
million asset impairment charge. The cash portion of the charge was $41.4
million. As part of the restructuring, the Company centralized all domestic
retail operations functions in Topeka, Kansas. Four domestic division offices in
Atlanta, Baltimore, Chicago, and Dallas were closed. The Company also announced
its intention to close 104 under-performing stores, including 67 Parade stores
and 37 Payless ShoeSource stores, as part of the restructuring. The store
closings differ from closings in the normal course of business in that they have
a longer remaining lease term. The remaining Parade locations are concentrated
in the Northeast and selected major metropolitan areas. As of November 1, 2003,
the Company has closed 96 stores and has decided to continue to operate 7 of the
104 stores originally identified for closure. The Company intends to close the
remaining store in 2003. The Company eliminated a total of 230 positions in
conjunction with the restructuring. The table below provides a roll-forward of
the $41.4 million reserve established as part of the 2001 non-recurring charge
and the status of the reserve as of November 1, 2003. Costs are being charged
against the reserves as incurred. Reserves are reviewed for adequacy on a
periodic basis and are adjusted as appropriate based on those reviews.
(Dollars in millions)
ACCRUED
PRE-TAX CASH PAID AS OF
2001 IN 2001 FEBRUARY 1, CASH PAID ACCRUED AS OF
CASH CHARGE AND 2002 ADJUSTMENTS 2003 IN 2003 NOVEMBER 1, 2003
----------- -------- ----------- ---- ------- ----------------
Store closings (including lease terminations
and employee termination costs) $17.6 $(8.5) $(8.0) $ 1.1 $(0.7) $ 0.4
Division closings (including lease terminations
and employee termination costs) 3.3 (2.7) 1.8 2.4 (0.4) 2.0
Corporate employee termination costs 8.0 (8.0) -- -- -- --
Professional fees 6.4 (8.1) 2.0 0.3 -- 0.3
Inventory liquidation costs (recorded as
a component of cost of sales) 4.4 (2.4) (2.0) -- -- --
Other restructuring related costs 1.7 (3.1) 1.4 -- -- --
----- ----- ----- ----- ----- -----
Total $41.4 $(32.8) $(4.8) $ 3.8 $(1.1) $ 2.7
===== ===== ===== ===== ===== =====
In 2002, the Company recorded an additional charge of $2.0 million for
professional fees and $1.4 million for relocation costs associated with
implementing the restructuring that was announced during the fourth quarter of
2001. Also, in 2002, the Company decreased its reserve for store closings by
$8.0 million, inventory liquidations by $2.0 million and increased its reserve
for division closings by $1.8 million.
During 2002, in an effort to enhance global sourcing initiatives and align with
international expansion strategies, the Company reorganized its global sourcing
structure to focus on cost reduction initiatives from procurement of materials
through distribution of product. As part of these cost reduction initiatives,
the Company is now taking ownership of certain raw materials as the materials
enter the production process. These raw materials are included in Inventories.
CRITICAL ACCOUNTING POLICIES
In preparing the accompanying condensed consolidated financial statements,
management makes estimates and assumptions that affect the amounts reported
within the financial statements. Actual results could differ from these
estimates. For more information regarding the Company's critical accounting
policies, estimates and judgments, see the discussion under Management's
Discussion and Analysis of Financial Condition and Results of Operations in the
Company's Form 10-K for the year ended February 1, 2003.
21
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATE RISK
Interest on the Company's Credit Facility, which is entirely comprised of a
revolving line of credit, is based on the London Inter-Bank Offered Rate
("LIBOR") plus 2.25 percent, or the Base Rate, as defined in the credit
agreement, plus 1.25 percent. There are no outstanding borrowings on the
revolving line of credit; however, if the Company were to borrow against its
revolving line of credit, borrowing costs may fluctuate depending upon the
volatility of LIBOR.
FOREIGN CURRENCY RISK
The Company has retail operations in foreign countries; therefore, its cash
flows in U.S. dollars are impacted by fluctuations in foreign currency exchange
rates. The Company adjusts its retail prices, when possible, to reflect changes
in exchange rates to mitigate this risk. To further mitigate this risk, the
Company may, from time to time, enter into forward contracts to purchase or sell
foreign currencies. For the thirteen and thirty-nine weeks ended November 1,
2003, and November 2, 2002, fluctuations in foreign currency exchange rates did
not have a material impact on the Company's operations or cash flows and the
Company did not enter into any forward contracts to purchase or sell foreign
currencies.
ITEM 4 - CONTROLS AND PROCEDURES
The Company's principal executive officer and principal financial officer, with
the participation of the Company's management group, evaluated the Company's
disclosure controls and procedures as of November 1, 2003. Based on that
evaluation, the Company's principal executive officer and principal financial
officer concluded that the Company's disclosure controls and procedures are
effective. There have not been changes in the Company's internal control over
financial reporting that occurred during the Company's last fiscal quarter that
have materially affected, or are reasonably likely to materially affect, the
Company's internal control over financial reporting.
FORWARD-LOOKING STATEMENTS
This report contains, and from time to time the Company may publish,
forward-looking statements relating to such matters as anticipated financial
performance, business prospects, technological developments, new products,
future store openings, international expansion, possible strategic alternatives,
new business concepts, capital expenditures and similar matters. Statements
including the words "expects," "anticipates," "intends," "plans," "believes,"
"seeks," or variations of such words and similar expressions are forward-looking
statements. The Company notes that a variety of factors could cause its actual
results and experience to differ materially from the anticipated results or
other expectations expressed in its forward-looking statements. The risks and
uncertainties that may affect the operations, performance, development and
results of the Company's business include, but are not limited to, the
following: changes in consumer spending patterns; changes in consumer
preferences and overall economic conditions; the impact of competition and
pricing; changes in weather patterns; the financial condition of the suppliers
and manufacturers from whom the Company sources its merchandise; changes in
existing or potential duties, tariffs or quotas; changes in relationships
between the United States and foreign countries; changes in relationships
between Canada and foreign countries; economic and political instability in
foreign countries or restrictive actions by the governments of foreign countries
in which suppliers and manufacturers from whom the Company sources are located
or in which the Company operates stores; changes in trade and/or tax laws;
fluctuations in currency exchange rates; availability of suitable store
locations on appropriate terms; the ability to hire, train and retain
associates; general economic, business and social conditions in the countries
from which the Company sources products, supplies or has or intends to open
stores; the performance of our partners in joint ventures; the ability to comply
with local laws in foreign countries; threats or acts of terrorism or war; and
strikes, work stoppages or slowdowns by unions that play a significant role in
the manufacture, distribution or sale of product. In addition, severe acute
respiratory syndrome (SARS) or other illnesses could cause a disruption in the
Company's supply chain or consumer purchasing patterns. All subsequent written
and oral forward-looking statements attributable to the Company or persons
acting on its behalf are expressly qualified in their entirety by these
cautionary statements. The Company does not undertake any obligation to release
publicly any revisions to such forward-looking statements to reflect events or
circumstances after the date hereof or to reflect the occurrence of
unanticipated events.
22
PART II - OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS
Other than as described below, there are no material pending legal proceedings
other than ordinary, routine litigation incidental to the business to which the
Company is a party or of which any of its property is subject.
On or about December 20, 2001, a First Amended Complaint was filed against the
Company in the U.S. District Court for the District of Oregon, captioned Adidas
America, Inc. and Adidas-Salomon AG v. Payless ShoeSource, Inc. The First
Amended Complaint seeks injunctive relief and unspecified monetary damages for
trademark and trade dress infringement, unfair competition, deceptive trade
practices and breach of contract. The Company believes it has meritorious
defenses to claims asserted in the lawsuit and has filed an answer and a motion
for summary judgment which the court granted in part. An estimate of the
possible loss, if any, or the range of loss cannot be made.
On or about January 20, 2000, a complaint was filed against the Company in the
U.S. District Court for the District of New Hampshire, captioned Howard J.
Dananberg, D.P.M. v. Payless ShoeSource, Inc. The Complaint seeks injunctive
relief, unspecified monetary damages, attorneys' fees, interest and costs for
patent infringement. The Company believes it has meritorious defenses to claims
asserted in the lawsuit. An estimate of the possible loss, if any, or the range
of loss cannot be made.
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
NUMBER DESCRIPTION
------ -----------
11.1 Computation of Net Earnings Per Share*
31.1 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
of the Chairman of the Board and Chief Executive Officer*
31.2 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
of the Senior Vice President, Chief Financial Officer and Treasurer*
32.1 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
of the Chairman of the Board and Chief Executive Officer*
32.2 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
of the Senior Vice President, Chief Financial Officer and Treasurer*
* Filed herewith
(b) Reports on Form 8-K
On August 13, 2003, the Company filed a Current Report on Form 8-K furnishing
under Items 9 and 12 the Company's results for the quarter ended August 2, 2003
and its Press Release dated August 13, 2003.
On November 11, 2003, the Company filed a Current Report on Form 8-K furnishing
under Items 9 and 12 the Company's results for the quarter ended November 1,
2003 and its Press Release dated November 11, 2003.
23
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Company
has duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
PAYLESS SHOESOURCE, INC.
Date: December 11, 2003 By: /s/ Steven J. Douglass
-----------------------------
Steven J. Douglass
Chairman of the Board and
Chief Executive Officer
Date: December 11, 2003 By: /s/ Ullrich E. Porzig
----------------------------
Ullrich E. Porzig
Senior Vice President
Chief Financial Officer
and Treasurer
24
Exhibit Index
NUMBER DESCRIPTION
------ -----------
11.1 Computation of Net Earnings Per Share*
31.1 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
of the Chairman of the Board and Chief Executive Officer*
31.2 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
of the Senior Vice President, Chief Financial Officer and Treasurer*
32.1 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
of the Chairman of the Board and Chief Executive Officer*
32.2 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
of the Senior Vice President, Chief Financial Officer and Treasurer*