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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 2, 2002
Commission File Number 1-14770
PAYLESS SHOESOURCE, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 43-1813160
(State or other jurisdiction of (I.R.S. Employer
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 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
22,661,735 shares as of December 6, 2002
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
PAYLESS SHOESOURCE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEET
(UNAUDITED)
(Dollars in millions)
ASSETS NOVEMBER 2, 2002 NOVEMBER 3, 2001 FEBRUARY 2, 2002
------ ---------------- ---------------- ----------------
Current Assets:
Cash and cash equivalents $ 149.1 $ 52.7 $ 92.3
Restricted cash 28.0 -- 9.5
Inventories 407.8 387.3 339.5
Current deferred income taxes 19.9 21.0 31.0
Other current assets 70.1 61.5 64.2
--------- --------- ---------
Total current assets 674.9 522.5 536.5
Property and Equipment:
Land 8.0 9.3 8.1
Buildings and leasehold improvements 704.8 744.4 695.9
Furniture, fixtures and equipment 497.4 442.9 450.7
Property under capital leases 7.3 7.3 7.3
--------- --------- ---------
Total property and equipment 1,217.5 1,203.9 1,162.0
Accumulated depreciation
and amortization (744.1) (679.1) (683.8)
--------- --------- ---------
Property and equipment, net 473.4 524.8 478.2
Deferred income taxes 22.4 23.7 35.1
Other assets 23.6 17.0 19.4
--------- --------- ---------
Total Assets $ 1,194.3 $ 1,088.0 $ 1,069.2
========= ========= =========
LIABILITIES AND SHAREOWNERS'
----------------------------
EQUITY
------
Current Liabilities:
Current maturities of long-term debt $ 70.6 $ 58.7 $ 65.9
Notes payable 28.0 -- 9.5
Accounts payable 119.0 80.7 73.5
Accrued expenses 152.9 125.4 142.3
--------- --------- ---------
Total current liabilities 370.5 264.8 291.2
Long-term debt 159.2 260.5 245.1
Other liabilities 52.2 60.9 59.2
Minority interest 20.2 7.4 6.7
Total shareowners' equity 592.2 494.4 467.0
--------- --------- ---------
Total Liabilities and Shareowners' Equity $ 1,194.3 $ 1,088.0 $ 1,069.2
========= ========= =========
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 2, 2002 NOVEMBER 3, 2001 NOVEMBER 2, 2002 NOVEMBER 3, 2001
---------------- ---------------- ---------------- ----------------
Net retail sales $ 713.0 $ 697.1 $ 2,227.4 $ 2,271.4
Cost of sales 483.6 498.9 1,525.3 1,572.2
Selling, general and administrative expenses 180.6 170.2 534.4 549.3
Non-recurring item (1.2) -- (2.1) --
-------------- -------------- -------------- --------------
Operating profit 50.0 28.0 169.8 149.9
Interest expense, net 4.6 6.7 15.3 22.0
-------------- -------------- -------------- --------------
Earnings before income taxes and minority
interest 45.4 21.3 154.5 127.9
Provision for income taxes 16.5 8.2 56.4 49.1
-------------- -------------- -------------- --------------
Earnings before minority interest 28.9 13.1 98.1 78.8
Minority interest 0.7 0.2 2.6 0.6
-------------- -------------- -------------- --------------
Net Earnings $ 29.6 $ 13.3 $ 100.7 $ 79.4
============== ============== ============== ==============
Diluted Earnings per Share $ 1.30 $ 0.59 $ 4.42 $ 3.50
============== ============== ============== ==============
Basic Earnings per Share $ 1.31 $ 0.60 $ 4.46 $ 3.57
============== ============== ============== ==============
Diluted Weighted Average Shares Outstanding 22.8 22.6 22.8 22.7
============== ============== ============== ==============
Basic Weighted Average Shares Outstanding 22.7 22.2 22.6 22.2
============== ============== ============== ==============
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 2, 2002 NOVEMBER 3, 2001
----------------- -----------------
Operating Activities:
Net earnings $ 100.7 $ 79.4
Adjustments for non-cash items included
in net earnings:
Loss on disposal of assets 3.0 9.2
Depreciation and amortization 75.5 76.8
Amortization of unearned
restricted stock 0.9 3.5
Deferred income taxes 23.8 (2.7)
Minority interest (2.6) (0.6)
Changes in working capital:
Inventories (68.3) (31.7)
Other current assets (5.9) (7.7)
Accounts payable 45.5 (8.3)
Accrued expenses 10.6 2.1
Other assets and liabilities, net (7.3) 2.8
-------- --------
Total Operating Activities 175.9 122.8
-------- --------
Investing Activities:
Capital expenditures (76.3) (92.5)
Disposition of property and equipment 2.6 0.4
-------- --------
Total Investing Activities (73.7) (92.1)
-------- --------
Financing Activities:
Issuance of notes payable 18.5 --
Restricted cash (18.5) --
Repayment of long-term debt (81.2) (6.4)
Net issuances of common stock 19.8 11.5
Contributions by minority owners 16.4 6.8
Other investing activities (0.4) (0.3)
-------- --------
Total Financing Activities (45.4) 11.6
-------- --------
Increase in Cash and Cash Equivalents 56.8 42.3
Cash and Cash Equivalents, Beginning of Year 92.3 10.4
======== ========
Cash and Cash Equivalents, End of Period $ 149.1 $ 52.7
======== ========
Cash paid during the period:
Interest $ 18.0 $ 24.3
Income Taxes 16.6 41.7
See Notes to Condensed Consolidated Financial Statements.
4
PAYLESS SHOESOURCE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1. INTERIM RESULTS. These unaudited Condensed Consolidated Financial
Statements of Payless ShoeSource, Inc., a Delaware corporation (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 20-25) in
the Company's 2001 Annual Report. Certain information and footnote disclosures
normally included in financial statements prepared in accordance with accounting
principles generally accepted in the United States 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 2, 2002, are not necessarily indicative of the results that may
be expected for the fiscal year ending February 1, 2003.
NOTE 2. 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 $21.0 million
are included in Inventories at November 2, 2002. There were no raw materials in
Inventories at November 3, 2001 or February 2, 2002, respectively.
NOTE 3. GOODWILL. Effective February 3, 2002, the Company has adopted Statement
of Financial Accounting Standard No. 142, "Goodwill and Other Intangible Assets"
("SFAS 142"). Under SFAS 142, goodwill and other intangible assets with
indefinite lives are no longer subject to amortization. They will be subject to
at least annual assessments for impairment. The adoption of SFAS 142 did not
have a material effect on the condensed consolidated financial statements.
NOTE 4. REVOLVING CREDIT LINE. As of November 2, 2002, no amounts were drawn
against the Company's $200.0 million line of credit. The availability under the
line of credit has been reduced, however, by $17.8 million in outstanding
letters of credit.
NOTE 5. ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES. In order
to mitigate the Company's exposure to fluctuations in interest rates, the
Company has entered into a series of interest rate swap agreements whereby the
Company will receive interest at the three-month LIBOR rate on a $120.0 million
notional amount and pay a weighted average rate of 6.9%. The interest-rate swaps
expire in 2003.
Effective February 4, 2001, the Company adopted Statement of Financial
Accounting Standard No. 133, "Accounting for Derivative Instruments and Hedging
Activities" ("SFAS 133"). The Company's interest rate swap agreements have been
designated as cash flow hedging instruments. Such instruments are those that
effectively convert variable interest payments on debt instruments into fixed
payments. For qualifying hedges, SFAS No. 133 allows derivative gains and losses
to offset related results on hedged items in the condensed consolidated
statement of earnings. As the critical terms of the Company's interest rate swap
agreements match those of the related hedged obligations, the Company has
concluded that there is no ineffectiveness in its hedges, and as a result, the
adoption of SFAS No. 133 had no impact on net earnings.
In connection with the adoption of SFAS No. 133, the Company recorded an
after-tax loss of $4.7 million ($7.7 million pre-tax) to other comprehensive
income as a cumulative effect of change in accounting principle during the first
quarter of 2001. Changes in the fair value of interest rate swap agreements
designated as cash flow hedging instruments are reported in accumulated other
comprehensive income.
5
During the three months ended November 2, 2002, the Company recorded an
after-tax loss of $0.2 million ($0.3 million pre-tax) to other accumulated
comprehensive income, representing the decline in fair value of its interest
rate swap agreements. At November 2, 2002, the Company had a cumulative
after-tax loss of $2.7 million ($4.3 million pre-tax) included in other
accumulated comprehensive income related to its interest rate swap agreements on
a notional amount of $120.0 million. The resulting liability is reflected in
other current liabilities in the accompanying condensed consolidated balance
sheet. The pre-tax loss is subsequently reclassified into interest expense as a
yield adjustment in the same period in which the related interest on the
floating rate debt obligations affects earnings. During the three months ended
November 2, 2002, $1.0 million of after-tax losses ($1.6 million pre-tax)
included in accumulated other comprehensive income related to interest rate swap
agreements was reclassified to interest expense. Over the course of the next
twelve months, based on current fair values, approximately $2.7 million of
after-tax losses ($4.3 million pre-tax) in accumulated other comprehensive
income related to interest rate swap agreements are expected to be reclassified
into interest expense as a yield adjustment on the Company's variable-rate
long-term debt.
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, of which $6.1 million was paid during
2001. 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 will be
concentrated in the Northeast and selected major metropolitan areas. As of
November 2, 2002, the Company has closed 85 stores and has decided to continue
to operate six of the 104 under-performing stores. The remaining 13
under-performing stores are expected to close by the end of fiscal 2002. The
Company also eliminated a total of 230 positions in conjunction with the
restructuring. The table below presents the activity of the $41.4 million
reserve established as part of the 2001 non-recurring charge and the status of
the reserve as of November 2, 2002. 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 2001 CASH PAID ACCRUED AS OF PRE-TAX 2002 CASH PAID ACCRUED AS OF
CASH CHARGE IN 2001 FEB. 2, 2002 CASH CHARGE IN 2002 ADJUSTMENTS NOV. 2 2002
----------- ------- ------------ ----------- ------- ----------- -----------
Store closings (including lease
terminations and employee
termination costs) $ 17.6 $ ( --) $ 17.6 $ -- $ (7.9) $ (4.8) $ 4.9
Division closings (including lease
terminations and employee
termination costs) 3.3 (0.2) 3.1 -- (1.9) 1.0 2.2
Corporate employee termination costs 8.0 (1.4) 6.6 -- (6.4) -- 0.2
Professional fees 6.4 (3.6) 2.8 2.0 (3.7) -- 1.1
Inventory liquidation costs (recorded
as a component of cost of sales) 4.4 (--) 4.4 -- (2.4) (1.5) 0.5
Other restructuring related costs 1.7 (0.9) 0.8 1.2 (2.0) -- --
------- ------ ------- ------ ------- ------ ------
Total $ 41.4 $ (6.1) $ 35.3 $ 3.2 $ (24.3) $ (5.3) $ 8.9
======= ====== ======= ====== ======= ====== ======
During the third quarter of 2002, the Company recorded an additional charge of
$0.3 million for relocation costs associated with implementing the restructuring
that was announced during the fourth quarter of 2001. These additional costs are
reflected in the accompanying condensed consolidated statement of earnings as a
non-recurring item. The Company anticipates that future charges to earnings
associated with the 2001 restructuring to be less than $0.7 million. Also,
during the third quarter of 2002, the Company decreased its reserve for
inventory liquidations by $1.5 million. This reversal is reflected in the
accompanying condensed consolidated statement of earnings as a non-recurring
item.
During the second quarter of 2002, the Company recorded an additional charge of
$2.0 million for professional fees and $0.9 million for employee relocation
costs associated with implementing the 2001 restructuring. These additional
costs are reflected in the accompanying condensed consolidated statement of
earnings as a non-recurring item. Also, during the second quarter of 2002, the
Company decreased its reserve for store closings by $4.8 million and increased
its reserve for division closings by $1.0 million. The net reversal of $3.8
million is reflected in the accompanying condensed consolidated statement of
earnings as a non-recurring item.
6
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.
NOTE 7. INCOME TAXES. The Company's effective income tax rate for fiscal year
2002 has been reduced to 36.5 percent from 38.4 percent during the third quarter
of 2001. The reduction reflects the tax impact of actions taken to restructure
operations to support the increasing globalization of the Company's business.
Costs associated with these actions were provided for in the restructuring
charge taken in the fourth quarter of 2001 and the second quarter of 2002.
NOTE 8. COMPREHENSIVE INCOME. The following table shows the computation of
comprehensive income:
(Dollars in millions)
13 WEEKS ENDED 39 WEEKS ENDED
-------------- --------------
NOVEMBER 2, NOVEMBER 3, NOVEMBER 2, NOVEMBER 3,
----------- ----------- ----------- -----------
2002 2001 2002 2001
---- ---- ---- ----
Net Income $ 29.6 $ 13.3 $ 100.7 $ 79.4
Other Comprehensive Loss:
After-tax cumulative effect of a change
in accounting for derivatives -- -- -- (4.7)
Change in fair value of derivatives (0.2) (3.0) (1.4) (5.0)
Derivative losses reclassified into interest
expense 1.0 1.2 4.5 2.9
Foreign currency translation adjustments 0.9 (2.2) 0.8 (2.8)
------- ------- -------- -------
Total other comprehensive gain (loss) 1.7 (4.0) 3.9 (9.6)
Total Comprehensive Income $ 31.3 $ 9.3 $ 104.6 $ 69.8
======= ======= ======== =======
NOTE 9. EARNINGS PER SHARE. Basic earnings per share are computed by dividing
net earnings by the weighted average number of shares of common stock
outstanding during the period. Diluted earnings per share include the effect of
conversions of stock options.
NOTE 10. RECLASSIFICATIONS. Certain reclassifications have been made to prior
year balances to conform to the current year presentation.
NOTE 11. 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 12. CONTINGENCIES. On or about November 8, 2001, a lawsuit was commenced
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 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. An estimate of the possible loss, if any, or the range of
loss cannot be made.
On or about January 18, 2000, a lawsuit was commenced 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 13. IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS. Effective fiscal 2002,
the Company adopted the provision of Financial Accounting Standards Board (FASB)
Statement No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets to Be Disposed Of" ("SFAS 144"). This statement addresses accounting and
reporting for the impairment or disposal of long-lived assets. The statement
superseded SFAS 121, while retaining many of the fundamental provisions covered
by that statement. SFAS 144 differs fundamentally from SFAS 121 in that goodwill
and other intangible assets that are not amortized are excluded from the scope
of SFAS 144. Additionally, SFAS 144 addresses and clarifies implementation and
estimation issues arising from Statement No. 121.
7
SFAS 144 also superseded the accounting and reporting provisions of APB Opinion
No. 30, "Reporting the Results of Operations--Reporting the Effects of Disposal
of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions," for the disposal of a segment of a business.
SFAS 144 retains the basic provisions of APB Opinion No. 30 for the presentation
of discontinued operations in the income statement but broadens that
presentation to apply to a component of an entity rather than a segment of a
business. The application of SFAS 144 in 2002 did not have a material impact on
the Company's condensed consolidated financial statements.
During April 2002, the FASB issued SFAS 145, "Rescission of FASB Statements No.
4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections"
("SFAS 145"). This Statement rescinds SFAS 4, "Reporting Gains and Losses from
Extinguishment of Debt" and SFAS 44, "Accounting for Intangible Assets of Motor
Carriers." This Statement amends SFAS 13, "Accounting for Leases," so that
certain lease modifications that have economic effects that are similar to
sale-leaseback transactions are accounted for the same way as sale-leaseback
transactions. Additionally, SFAS 13 is amended so that the original lessee under
an operating lease agreement that becomes secondarily liable shall recognize the
fair value of the guarantee obligation. SFAS 145 also stipulates that gains or
losses on extinguishment of debt would have to meet the criteria of Accounting
Principles Board Opinion No. 30, "Reporting the Results of Operations -
Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary,
Unusual and Infrequently Occurring Events and Transactions" to be classified as
an extraordinary item. In addition, extraordinary gains and losses on
extinguishment of debt in prior periods presented would require
reclassification. SFAS 145 is effective for fiscal years beginning after May 15,
2002. The application of SFAS 145 is not expected to have a material impact on
the Company's condensed consolidated financial statements.
On July 30, 2002, the FASB issued SFAS 146, "Accounting for Costs Associated
with Exit or Disposal Activities" ("SFAS 146"). This Statement supercedes
Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)." SFAS 146 is different
from EITF Issue No. 94-3 in that SFAS 146 requires that a liability be
recognized for a cost associated with an exit or disposal activity only when the
liability is incurred, that is when it meets the definition of a liability in
the FASB's conceptual framework. SFAS 146 also establishes fair value as the
objective for initial measurement of liabilities related to exit or disposal
activities. In contrast, under EITF Issue 94-3, a company recognized a liability
for an exit cost when it committed to an exit plan. SFAS 146 is effective for
exit or disposal activities that are initiated after December 31, 2002. The
application of this statement is not expected to have an impact on the Company's
exit activity initially applied prior to the adoption of SFAS 146; however, the
adoption of SFAS 146 can be expected to impact the timing of liability
recognition associated with any future exit activities.
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 2, 2002 (2002), and November 3, 2001
(2001).
NET EARNINGS
Net earnings totaled $29.6 million in the third quarter of 2002 compared with
$13.3 million in the third quarter of 2001. For the first nine months of 2002
net earnings were $100.7 million, compared with $79.4 million in the 2001
period.
8
The following table presents the components of costs and expenses, as a percent
of revenues, for the third quarter and first nine months of 2002 and 2001.
THIRD QUARTER FIRST NINE MONTHS
------------- -----------------
2002 2001 2002 2001
---- ---- ---- ----
Cost of sales 67.8% 71.6% 68.5% 69.2%
Selling, general and administrative expense 25.3 24.4 24.0 24.2
Non-recurring item (0.1) -- (0.1) --
---- ---- ---- ----
Operating profit 7.0 4.0 7.6 6.6
Interest expense, net 0.6 0.9 0.7 1.0
---- ---- ---- ----
Earnings before income taxes and minority interest 6.4 3.1 6.9 5.6
Effective income tax rate* 36.5% 38.4% 36.5% 38.4%
---- ---- ---- ----
Earnings before minority interest 4.1 1.9 4.4 3.5
Minority interest 0.1 -- 0.1 --
---- ---- ---- ----
Net Earnings 4.2% 1.9% 4.5% 3.5%
==== ==== ==== ====
* Percent of pre-tax earnings
NET RETAIL SALES
Net retail sales represent the sales of stores operating during the period.
Same-store sales represent sales of stores open during comparable periods.
During the third quarter of 2002 total sales increased 2.3% compared with the
third quarter of 2001, consisting of a 15.5% increase in unit volume and an
11.5% decrease in average selling prices, primarily reflecting the growth of the
Company's accessories sales. Footwear unit volume increased 4.6% and footwear
average selling prices decreased 4.2% in the third quarter of 2002 compared with
the third quarter of 2001. During the first nine months of 2002 total sales
decreased 1.9% compared with the same period in 2001, consisting of a 12.2%
increase in unit volume and a 12.6% decrease in average selling prices. Footwear
unit volume increased 0.8% and footwear average selling prices decreased 4.7%
during the first nine months of 2002 compared with the first nine months of
2001. The reduction in footwear average selling prices was offset with reduced
product costs. Sales percent (decreases) increases are as follows:
THIRD QUARTER FIRST NINE MONTHS
------------- -----------------
2002 2001 2002 2001
---- ---- ---- ----
Net Retail Sales 2.3% (3.6)% (1.9)% 1.0%
Same-Store Sales 0.7% (6.3)% (4.0)% (2.1)%
Improvements in net retail sales and same-store sales in the third quarter of
2002 reflect the favorable performance in women's footwear as a result of
efforts designed to offer more fashion-forward merchandise. Women's boots and
casual shoes performed very well. The accessories business also contributed with
a double-digit same-store sales increase. Sales were weaker in children's and
men's footwear.
Reductions in net retail sales and same-store sales for the first nine months of
the year reflect the weak consumer economy. In addition, lower inventory levels
maintained during the first six months of the year may have negatively impacted
sales; however, the strategy to maintain tight control of inventory enabled the
Company to avoid taking additional markdowns.
COST OF SALES
Cost of sales includes cost of merchandise sold, buying and occupancy costs.
Cost of sales was $483.6 million in the 2002 third quarter, down 3.1% from
$498.9 million in the 2001 third quarter. For the first nine months of 2002,
cost of sales was $1,525.3 million, a 3.0% decrease from $1,572.2 million in the
2001 period.
9
As a percentage of net retail sales, cost of sales was 67.8% in the third
quarter of 2002, compared with 71.6% in the third quarter of 2001. The
improvement resulted from reduced promotional activity during the quarter and
lower merchandise costs compared to the same period last year, partially offset
by costs incurred from actions taken in response to the work stoppage at the
ports on the West Coast. For the first nine months of 2002, as a percentage of
net retail sales, cost of sales was 68.5%, compared with 69.2% in the 2001
period. The decrease in cost of sales as a percentage of net retail sales for
the first nine months of 2002 is due to lower merchandise costs compared to the
same period last year and benefits associated with the Company's restructuring.
The Company anticipates that additional costs will be incurred during the fourth
quarter of 2002 from actions taken in response to the work stoppage at the ports
on the West Coast.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses were $180.6 million, 25.3% of net
retail sales, in the third quarter of 2002, up 6.1% from $170.2 million, 24.4%
of net retail sales, in the third quarter of 2001. The increase is primarily due
to additional accruals for employee incentive programs. For the first nine
months of 2002, selling, general and administrative expenses were $534.4
million, 24.0% of net retail sales, down 2.7% from $549.3 million, 24.2% of net
retail sales, in the 2001 period. The decrease is primarily the result of
planned benefits associated with the Company's restructuring.
INTEREST EXPENSE, NET
Interest expense decreased to $4.6 million in the third quarter of 2002 from
$6.7 million in the third quarter of 2001. For the first nine months of 2002,
interest expense decreased to $15.3 million from $22.0 million in the same
period in 2001. The decrease is the result of the repayment of long-term debt
during 2002, including a $50.0 million voluntary prepayment in the second
quarter of 2002, the maturity of interest rate swap agreements, short-term
borrowings during the first quarter of 2001 under the revolving line of credit
versus no borrowings in 2002, and lower interest rates during the first nine
months of 2002.
EFFECTIVE INCOME TAX RATE
The Company's effective income tax rate was 36.5% in the third quarter and for
the first nine months of 2002, compared with 38.4% in the first nine months of
2001. The reduction reflects the tax impact of actions taken to restructure
operations to support the increasing globalization of the Company's business.
Costs associated with these actions were provided for in the restructuring
charge taken in the fourth quarter of 2001 and the second quarter of 2002.
LIQUIDITY AND CAPITAL RESOURCES
CASH FLOW
Cash flow from operations during the nine months ended November 2, 2002, was
$175.9 million. This figure represented 7.9% of net retail sales in the first
nine months of 2002 compared with 5.0% in the comparable period in 2001. The
increase in cash in the first nine months of 2002 was attributed to the
improvement in earnings, realization of deferred tax assets and the cash flow
impact of an increase in accounts payable due to the timing of merchandise and
non-merchandise payments.
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.
CAPITAL EXPENDITURES
Capital expenditures during the first nine months of 2002 totaled $76.3 million,
including $8.6 million from the Company's joint venture partners. The Company
estimates that total capital expenditures for fiscal 2002 will be $110.0
million, including a $10.0 million contribution from the Company's joint venture
partners in Central and South America. The Company anticipates that cash flow
from operations, the revolving credit line, and its joint venture partners will
be sufficient to finance projected capital expenditures.
10
FINANCING ACTIVITIES
As of November 2, 2002, no amounts were drawn against the Company's $200.0
million line of credit. The availability under the line of credit has been
reduced, however, by $17.8 million in outstanding letters of credit. During the
second quarter of 2002, a voluntary prepayment of $50.0 million was made on the
Company's term loan. The Company's financial commitments include required
principal payments on the term loan and required payments under operating leases
and capital leases as of November 2, 2002, as follows:
(Dollars in millions)
YEAR TERM LOAN OPERATING LEASES CAPITAL LEASES OTHER
---- --------- ---------------- -------------- -----
Remainder of 2002 $ 9.5 $ 63.7 $ 0.3 $ 0.1
2003 82.0 232.2 0.8 0.4
2004 106.0 188.5 0.7 1.0
2005 28.1 149.3 0.5 --
2006 -- 120.4 0.5 --
Thereafter -- 298.0 0.6 --
-------- ---------- ------ -----------
Total $ 225.6 $ 1,052.1 $ 3.4 $ 1.5
======== ========== ====== ===========
The Company also maintains demand notes payable of $28.0 million entered into to
efficiently finance its Latin American subsidiaries. The Company maintains cash
balances of $28.0 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.
FINANCIAL CONDITION RATIOS
A summary of key financial information for the periods indicated is as follows:
NOVEMBER 2, 2002 NOVEMBER 3, 2001 FEBRUARY 2, 2002
---------------- ---------------- ----------------
Current Ratio 1.8 2.0 1.8
Debt-Capitalization Ratio* 30.3% 39.2% 40.0%
Fixed Charge Coverage Ratio** 1.9x 2.4x 1.7x
* Debt-capitalization has been computed by dividing total debt, which includes
current and long-term capital lease obligations, by capitalization, which
includes notes payable and current and long-term capital lease obligations,
non-current deferred income taxes and equity. The debt-capitalization ratio,
including the present value of future minimum rental payments under
operating leases as debt and capitalization, would be 65.0%, 70.1% and 71.7%
respectively, for the periods referred to above. The reduction in the debt
to capitalization ratio reflects payments made on the Company's outstanding
indebtedness and an increase in equity due to the Company's earnings.
** 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. The
reduction in the fixed charge coverage ratio as of the first nine months of
2002 compared with the first nine months of 2001 is primarily attributable
to the $70.0 million non-recurring charge recorded during the fourth quarter
of 2001 for restructuring initiatives and asset impairments.
11
STORE ACTIVITY
At the end of the third quarter of 2002, the Company operated 4,962 stores
offering quality family footwear and accessories in 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 2002 and 2001.
THIRD QUARTER FIRST NINE MONTHS
------------- -----------------
2002 2001 2002 2001
---- ---- ---- ----
Beginning of period 4,918 4,912 4,960 4,964
Stores opened 40 96 160 213
Stores closed (38) (50) (162) (161)
----- ----- ----- -----
Ending store count 4,962 4,964 4,962 4,964
===== ===== ===== =====
Included in the 2002 year-to-date store openings are 35 store openings in
Central America and the Caribbean operated under a joint venture agreement. This
brings total store count in this region to 101. The Company intends to open
approximately nine additional stores in this region during the remainder of
2002. Management believes this region represents an opportunity to open a total
of 150 to 200 stores.
During the first nine months of 2002, the Company began its expansion into South
America by opening 29 stores. These stores are operated under a joint venture
agreement. The Company intends to open a total of approximately 35 South
American stores during 2002 in the countries of Ecuador, Peru, and Chile. The
Andean region of South America could represent approximately a 300-store
opportunity.
RESTRUCTURING
During the fourth quarter of 2001, the Company initiated a restructuring plan
which included the closing of its four domestic division offices, centralizing
domestic retail operations in Topeka, Kansas, and the closing of 104
under-performing stores by the end of 2002. The store closings differ from
closings in the normal course of business in that they have a longer remaining
lease term. As of November 2, 2002, the Company has closed 85 stores and has
decided to continue to operate six of the 104 under-performing stores. The
remaining 13 under-performing stores are expected to close by the end of fiscal
2002. The Company expects pre-tax annualized savings from these initiatives to
total $25.0 million to $30.0 million.
(Dollars in millions)
PRE-TAX 2001 CASH PAID ACCRUED AS OF PRE-TAX 2002 CASH PAID ACCRUED AS OF
CASH CHARGE IN 2001 FEB. 2, 2002 CASH CHARGE IN 2002 ADJUSTMENTS NOV. 2 2002
----------- ------- ------------ ----------- ------- ----------- -----------
Store closings (including lease
terminations and employee
termination costs) $ 17.6 $ (--) $ 17.6 $ -- $ (7.9) $ (4.8) $ 4.9
Division closings (including lease
terminations and employee
termination costs) 3.3 (0.2) 3.1 -- (1.9) 1.0 2.2
Corporate employee termination costs 8.0 (1.4) 6.6 -- (6.4) -- 0.2
Professional fees 6.4 (3.6) 2.8 2.0 (3.7) -- 1.1
Inventory liquidation costs (recorded as
a component of cost of sales) 4.4 (--) 4.4 -- (2.4) (1.5) 0.5
Other restructuring related costs 1.7 (0.9) 0.8 1.2 (2.0) -- --
------- ------- ------- ------- ------- ------ ------
Total $ 41.4 $ (6.1) $ 35.3 $ 3.2 $ (24.3) $ (5.3) $ 8.9
======= ======= ======= ======= ======= ====== ======
12
During the third quarter of 2002, the Company recorded an additional charge of
$0.3 million for relocation costs associated with implementing the restructuring
that was announced during the fourth quarter of 2001. These additional costs are
reflected in the accompanying condensed consolidated statement of earnings as a
non-recurring item. The Company anticipates that future charges to earnings
associated with the 2001 restructuring to be less than $0.7 million. Also,
during the third quarter of 2002, the Company decreased its reserve for
inventory liquidations by $1.5 million. This reversal is reflected in the
accompanying condensed consolidated statement of earnings as a non-recurring
item. The net non-recurring item of $1.2 million benefited diluted earnings per
share by $0.03 in the third quarter of 2002.
During the second quarter of 2002, the Company recorded an additional charge of
$2.0 million for professional fees and $0.9 million for employee relocation
costs associated with implementing the 2001 restructuring. These additional
costs are reflected in the accompanying condensed consolidated statement of
earnings as a non-recurring item. Also, during the second quarter of 2002, the
Company decreased its reserve for store closings by $4.8 million and increased
its reserve for division closings by $1.0 million. The net reversal of $3.8
million is reflected in the accompanying condensed consolidated statement of
earnings as a non-recurring item. The net non-recurring item of $0.9 million
benefited diluted earnings per share by $0.03 in the second quarter of 2002.
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
Form 10-K for the year ended February 2, 2002.
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATE RISK
Interest on the Company's Credit Facility is based on the London Interbank
Offered Rate ("LIBOR") plus a variable margin as defined in the credit
agreement. Therefore, the Company's future borrowing costs may fluctuate
depending upon the volatility of LIBOR. The Company currently mitigates a
portion of its interest rate risk through the use of interest rate swap
agreements, whereby the Company has agreed to exchange, at specific intervals,
the difference between fixed and variable interest amounts calculated by
reference to an agreed-upon notional amount.
FOREIGN CURRENCY RISK
Although the Company has international operating subsidiaries, the Company's
exposure to foreign currency rate fluctuations is not significant to the
financial condition or results of the Company.
ITEM 4 - CONTROLS AND PROCEDURES
The Company's principal executive officer and principal financial officer, with
the participation of the Company's management group, have evaluated the
Company's disclosure controls and procedures within 90 days of the filing date
of this Quarterly Report on Form 10-Q. Based on that evaluation, these officers
have concluded that the Company's disclosure controls and procedures are
effective. There were no significant changes in the Company's internal controls
or in other factors that could significantly affect the disclosure controls
since the date such controls were evaluated.
13
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 and international expansion, possible strategic
alternatives and new business concepts 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; and strikes,
work stoppages or slowdowns by Longshoremen or other unions that play a
significant role in the manufacture, distribution or sale of product. 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.
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 or any of its subsidiaries is a party or of which any of their property
is the subject.
On or about November 8, 2001, a lawsuit was commenced 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 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. An
estimate of the possible loss, if any, or the range of loss cannot be made.
On or about January 18, 2000, a lawsuit was commenced 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.
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
NUMBER DESCRIPTION
11.1 Computation of Net Earnings Per Share*
99.1 Certification Pursuant to Section 906
of the Sarbanes-Oxley Act of 2002 of the
Chairman of the Board and Chief Executive
Officer*
99.2 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
None.
14
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: 12/13/02 By: /s/ Steven J. Douglass
-----------------------
Steven J. Douglass
Chairman of the Board and
Chief Executive Officer
Date: 12/13/02 By: /s/ Ullrich E. Porzig
---------------------
Ullrich E. Porzig
Senior Vice President
Chief Financial Officer
and Treasurer
15
CERTIFICATION
I, Steven J. Douglass, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Payless
ShoeSource, Inc., a Delaware corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: December 13, 2002
/s/ Steven J. Douglass
-----------------------
Steven J. Douglass
Chairman of the Board and
Chief Executive Officer
16
CERTIFICATION
I, Ullrich E. Porzig, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Payless
ShoeSource, Inc., a Delaware corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: December 13, 2002
/s/ Ullrich E. Porzig
----------------------
Ullrich E. Porzig
Senior Vice President,
Chief Financial Officer and
Treasurer
17
EXHIBIT INDEX
NUMBER DESCRIPTION
11.1 Computation of Net Earnings Per Share
99.1 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002 of the Chairman of the Board and Chief Executive
Officer
99.2 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002 of the Senior Vice President, Chief Financial Officer
and Treasurer
18