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 August 3, 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
22,656,527 shares as of September 10, 2002
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
PAYLESS SHOESOURCE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEET
(UNAUDITED)
(Dollars in millions)
<Table>
<Caption>
AUGUST 3, AUGUST 4, FEB. 2,
ASSETS 2002 2001 2002
--------- --------- --------
Current Assets:
Cash and cash equivalents $ 169.6 $ 51.3 $ 92.3
Restricted cash 18.5 -- 9.5
Inventories 337.3 382.2 339.5
Current deferred income taxes 22.3 15.9 31.0
Other current assets 72.5 61.6 64.2
-------- -------- --------
Total current assets 620.2 511.0 536.5
Property and Equipment:
Land 8.1 8.0 8.1
Buildings and leasehold improvements 694.2 749.6 695.9
Furniture, fixtures and equipment 485.7 416.5 450.7
Property under capital leases 7.3 7.3 7.3
-------- -------- --------
Total property and equipment 1,195.3 1,181.4 1,162.0
Accumulated depreciation
and amortization (724.4) (659.9) (683.8)
-------- -------- --------
Property and equipment, net 470.9 521.5 478.2
Deferred income taxes 34.8 32.1 35.1
Other assets 19.0 19.0 19.4
-------- -------- --------
Total Assets $1,144.9 $1,083.6 $1,069.2
======== ======== ========
LIABILITIES AND SHAREOWNERS' EQUITY
Current Liabilities:
Current maturities of long-term debt $ 48.9 $ 45.3 $ 65.9
Notes payable 18.5 -- 9.5
Accounts payable 109.5 83.0 73.5
Accrued expenses 164.1 123.9 142.3
-------- -------- --------
Total current liabilities 341.0 252.2 291.2
Long-term debt 182.5 278.5 245.1
Other liabilities 50.8 63.6 59.2
Minority interest 10.8 4.6 6.7
Total shareowners' equity 559.8 484.7 467.0
-------- -------- --------
Total Liabilities and Shareowners' Equity $1,144.9 $1,083.6 $1,069.2
======== ======== ========
</Table>
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)
<Table>
<Caption>
13 WEEKS ENDED 26 WEEKS ENDED
-------------------------- --------------------------
AUGUST 3, AUGUST 4, AUGUST 3, AUGUST 4,
2002 2001 2002 2001
--------- --------- --------- ---------
Net retail sales $ 776.2 $ 806.0 $ 1,514.4 $ 1,574.3
Cost of sales 523.3 548.2 1,041.8 1,073.3
Selling, general, and administrative expenses 177.1 191.7 353.8 379.1
Non-recurring item (0.9) -- (0.9) --
--------- --------- --------- ---------
Operating profit 76.7 66.1 119.7 121.9
Interest expense, net 5.1 7.2 10.6 15.2
--------- --------- --------- ---------
Earnings before income taxes and minority interest 71.6 58.9 109.1 106.7
Provision for income taxes 25.4 22.6 39.8 40.9
--------- --------- --------- ---------
Earnings before minority interest 46.2 36.3 69.3 65.8
Minority interest 1.0 0.1 1.8 0.3
--------- --------- --------- ---------
Net Earnings $ 47.2 $ 36.4 $ 71.1 $ 66.1
========= ========= ========= =========
Diluted Earnings per Share $ 2.07 $ 1.60 $ 3.12 $ 2.90
========= ========= ========= =========
Basic Earnings per Share $ 2.09 $ 1.64 $ 3.16 $ 2.98
========= ========= ========= =========
Diluted Weighted Average Shares Outstanding 22.8 22.8 22.8 22.8
========= ========= ========= =========
Basic Weighted Average Shares Outstanding 22.6 22.3 22.5 22.2
========= ========= ========= =========
</Table>
See Notes to Condensed Consolidated Financial Statements.
3
PAYLESS SHOESOURCE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
(Dollars in millions)
<Table>
<Caption>
26 WEEKS ENDED
--------------------------------------
AUGUST 3, 2002 AUGUST 4, 2001
-------------- --------------
Operating Activities:
Net earnings $ 71.1 $ 66.1
Adjustments for non-cash items included
in net earnings:
Loss on disposal of assets 1.8 4.8
Depreciation and amortization 51.1 51.0
Amortization of unearned
restricted stock 0.8 2.8
Deferred income taxes 9.0 (5.9)
Minority interest (1.8) (0.3)
Changes in working capital:
Restricted cash (9.0) --
Inventories 2.2 (26.6)
Other current assets (8.2) (7.8)
Accounts payable 36.0 (6.0)
Accrued expenses 21.8 0.6
Other assets and liabilities, net (5.9) 7.0
------ ------
Total Operating Activities 168.9 85.7
------ ------
Investing Activities:
Capital expenditures (47.3) (58.7)
Disposition of property and equipment 1.7 --
------ ------
Total Investing Activities (45.6) (58.7)
------ ------
Financing Activities:
Issuance of notes payable 9.0 --
Repayment of long-term debt (79.7) (1.7)
Net issuances of common stock 18.8 12.0
Contributions by minority owners 6.1 3.7
Other investing activities (0.2) (0.1)
------ ------
Total Financing Activities (46.0) 13.9
------ ------
Increase in Cash and Cash Equivalents 77.3 40.9
Cash and Cash Equivalents, Beginning of Year 92.3 10.4
------ ------
Cash and Cash Equivalents, End of Period $169.6 $ 51.3
====== ======
Cash paid during the period:
Interest $ 12.0 $ 16.7
Income Taxes (0.0) 27.8
</Table>
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 of America 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. The results for the three-month period and six-month period ended
August 3, 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 $9.2 million,
$ -, and $ -, are included in Inventories at August 3, 2002, August 4, 2001, and
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 August 3, 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 from 2002 to 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 has 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 August 3, 2002, the Company recorded an after-tax
loss of $0.8 million ($1.2 million pre-tax) to other accumulated comprehensive
income, representing the decline in fair value of its interest rate swap
agreements. At August 3, 2002, the Company had a cumulative after-tax loss of
$3.5 million ($5.6 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 August 3, 2002,
$1.6 million of after-tax losses ($2.5 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,
approximately $3.5 million of after-tax losses ($5.6 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
August 3, 2002, the Company has closed 71 stores and has decided to continue to
operate five of the 104 under-performing stores. The remaining 28
under-performing stores are expected to close by the end of the year. 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 August 3, 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)
<Table>
<Caption>
PRE-TAX ACCRUED AS OF PRE-TAX CASH PAID ACCRUED AS OF
CASH CHARGE PAID IN 2001 FEB. 2, 2002 2002 CHARGE IN 2002 ADJUSTMENTS AUG. 3, 2002
----------- ------------ ------------ ----------- --------- ----------- -------------
Store closings (including lease
terminations and employee
termination costs) $17.6 $ -- $17.6 $ -- $ (7.0) $(4.8) $ 5.8
Division closings (including lease
terminations and employee
termination costs) 3.3 0.2 3.1 -- (1.4) 1.0 2.7
Corporate employee termination costs 8.0 1.4 6.6 -- (6.2) -- 0.4
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 -- (2.0) -- 2.4
Other restructuring related costs 1.7 0.9 0.8 0.9 (1.4) -- 0.3
----- ----- ----- ----- ------ ----- -----
Total $41.4 $ 6.1 $35.3 $ 2.9 $(21.7) $(3.8) $12.7
===== ===== ===== ===== ====== ===== =====
</Table>
During the second quarter of 2002, the Company incurred and recorded an
additional $2.0 million for professional fees and $0.9 million for employee
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 any future charges to earnings
associated with the 2001 restructuring to be less than $1.0 million.
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 the restructuring charge of $3.8 million is
reflected in the accompanying condensed consolidated statement of earnings as a
non-recurring item.
NOTE 7. INCOME TAXES. During the second quarter of 2002, the Company's effective
income tax rate for fiscal year 2002 has been reduced from 38.4 to 36.5 percent.
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.
6
NOTE 8. COMPREHENSIVE INCOME. The following table shows the computation of
comprehensive income:
(Dollars in millions)
<Table>
<Caption>
13 WEEKS ENDED 26 WEEKS ENDED
------------------------------- -------------------------------
AUGUST 3, 2002 AUGUST 4, 2001 AUGUST 3, 2002 AUGUST 4, 2001
-------------- -------------- -------------- --------------
Net Income $47.2 $36.4 $71.1 $66.1
Other Comprehensive Loss:
After-tax cumulative effect of a change in accounting for
derivatives -- -- -- (4.7)
Change in fair value of derivatives (0.8) (1.2) (1.2) (2.9)
Derivative losses reclassified into interest expense 1.6 0.9 3.5 1.8
Foreign currency translation adjustments (1.7) 0.7 (0.1) (0.6)
----- ----- ----- -----
Total other comprehensive gain (loss) (0.9) 0.4 2.2 (6.4)
Total Comprehensive Income 46.3 36.8 72.3 59.7
===== ===== ===== =====
</Table>
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. 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.
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 amends other existing
authoritative pronouncements to make various technical corrections, clarify
meanings, or describe their applicability under changed conditions. The
amendment to SFAS 13 is effective for transactions occurring after May 15, 2002
and the remainder of SFAS 145 is effective for fiscal years beginning after May
15, 2002. The application of SFAS 145 did not have a material impact on the
Company's condensed consolidated financial statements.
7
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)." Statement 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 did not 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 August 3, 2002 (2002) and August 4, 2001 (2001).
NET EARNINGS
Net earnings totaled $47.2 million in the second quarter of 2002 compared with
$36.4 million in the second quarter of 2001. For the first six months of 2002
net earnings were $71.1 million, compared with $66.1 million in the 2001 period.
The following table presents the components of costs and expenses, as a percent
of revenues, for the second quarter and first six months of 2002 and 2001.
<Table>
<Caption>
SECOND QUARTER FIRST SIX MONTHS
----------------- -----------------
2002 2001 2002 2001
---- ---- ---- ----
Cost of sales 67.4% 68.0% 68.8% 68.2%
Selling, general, and administrative expense 22.8 23.8 23.4 24.1
Non-recurring item (0.1) -- (0.1) --
---- ---- ---- ----
Operating profit 9.9 8.2 7.9 7.7
Interest expense, net 0.7 0.9 0.7 0.9
---- ---- ---- ----
Earnings before income taxes and minority interest 9.2 7.3 7.2 6.8
Effective income tax rate* 35.5% 38.4% 36.5% 38.4%
---- ---- ---- ----
Earnings before minority interest 6.0 4.5 4.6 4.2
Minority interest 0.1 -- 0.1 --
---- ---- ---- ----
Net Earnings 6.1% 4.5% 4.7% 4.2%
==== ==== ==== ====
</Table>
* Percent of pre-tax earnings
8
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 second quarter of 2002 total sales decreased 3.7% compared to the
second quarter of 2001, consisting of an 8.4% increase in unit volume and an
11.2% decrease in average selling prices, reflecting the growth of the Company's
accessories sales. Footwear unit volume increased 1.2% and footwear average
selling prices decreased 6.3% in the second quarter of 2002 compared to the
second quarter of 2001. During the first six months of 2002 total sales
decreased 3.8% compared to the same period in 2001, consisting of a 10.9%
increase in unit volume and a 13.2% decrease in average selling prices. Footwear
unit volume decreased 0.6% and footwear average selling prices decreased 5.1%
during the first six months of 2002 compared to the first six months of 2001.
Sales percent (decreases) increases are as follows:
<Table>
<Caption>
SECOND QUARTER FIRST SIX MONTHS
---------------- ----------------
2002 2001 2002 2001
---- ---- ---- ----
Net Retail Sales (3.7)% (1.3)% (3.8)% 3.2%
Same-Store Sales (5.8)% (4.1)% (6.1)% (0.1)%
</Table>
Reductions in net retail sales and same-store sales reflect the weak consumer
economy and a change in the Company's promotional calendar. The Company
eliminated a promotion from the second quarter of 2002, which required increased
markdowns in the second quarter of 2001. This action resulted in a reduction in
sales but aided the improvement in profitability in the second quarter of 2002.
In addition, lower inventory levels may have negatively affected 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 $523.3 million in the 2002 second quarter, down 4.5% from
$548.2 million in the 2001 second quarter. For the first six months of 2002,
cost of sales was $1,041.8, a 2.9% decrease from $1,073.3 million in the 2001
period.
As a percentage of net retail sales, cost of sales was 67.4% in the second
quarter of 2002, compared with 68.0% in the second quarter of 2001. The
improvement reflects lower markdowns than last year in the second quarter, and
benefits from the Company's restructuring. For the first six months of 2002, as
a percentage of net retail sales, cost of sales was 68.8%, compared with 68.2%
in the 2001 period. The increase in cost of sales as a percentage of net retail
sales for the first six months of 2002 is due to an increase in markdowns taken
in the first quarter, and the impact of lower sales on occupancy and buying
costs as a percent of sales.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses were $177.1 million in the second
quarter of 2002, down 7.6% from $191.7 million in the second quarter of 2001.
For the first six months of 2002, selling, general and administrative expenses
were $353.8 million, down 6.7% from $379.1 million in the 2001 period.
As a percentage of net retail sales, selling, general and administrative
expenses were 22.8% during the second quarter of 2002 compared with 23.8% in the
second quarter of 2001. For the first six months of 2002, selling, general and
administrative expenses as a percentage of net retail sales were 23.4% in 2002,
compared with 24.1% in 2001. The improvement was the result of reducing expenses
consistent with lower sales performance, planned benefits from the Company's
restructuring, and lower self-insurance costs due to favorable claims
experience.
INTEREST EXPENSE, NET
Interest expense decreased to $5.1 million in the second quarter of 2002 from
$7.2 million in the second quarter of 2001. For the first six months of 2002,
interest expense decreased to $10.6 million from $15.2 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, the maturity of
interest rate swap agreements to a $120.0 million notional amount, short-term
borrowings during the first quarter of 2001 under the revolving line of credit,
and lower interest rates during the first six months of 2002.
9
EFFECTIVE INCOME TAX RATE
The Company's effective income tax rate was 35.5% in the second quarter of 2002
and 36.5% for the first six months of 2002, compared to 38.4% in the first six
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 six months ended August 3, 2002 was $168.9
million. This figure represented 11.2% of net retail sales in the first six
months of 2002 compared with 5.4% in the comparable period in 2001. The increase
in cash in the first six months of 2002 was attributed to the cash flow impact
of a decrease in inventory in the first six months of 2002 compared with the
first six months of 2001. Additionally, the Company experienced a large increase
in accounts payable and accrued expenses during the first six months of 2002 due
primarily to an increase in current income taxes payable, a decline in the fair
value of the Company's interest rate swaps and 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 six months of 2002 totaled $47.3 million,
including $5.5 million from the Company's joint venture partners. The Company
estimates that total capital expenditures for fiscal 2002 will be $120.0
million, including a $15.0 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.
FINANCING ACTIVITIES
As of August 3, 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.
FINANCIAL CONDITION RATIOS
A summary of key financial information for the periods indicated is as follows:
<Table>
<Caption>
AUGUST 3, AUGUST 4, FEB. 2,
2002 2001 2002
--------- --------- -------
Current Ratio 1.8 2.0 1.8
Debt-Capitalization Ratio* 30.9% 40.2% 40.0%
Fixed Charge Coverage Ratio** 1.7x 2.7x 1.7x
</Table>
* 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 66.1%, 71.0% and 71.7% 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. The reduction in the fixed charge coverage ratio as of
the first six months of 2002 compared to the first six 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.
10
STORE ACTIVITY
At the end of the second quarter of 2002, the Company operated 4,960 stores
offering quality family footwear and accessories in 50 states, Guam, Puerto
Rico, 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 second quarter and first six months of 2002 and 2001.
<Table>
<Caption>
SECOND QUARTER FIRST SIX MONTHS
-------------------- --------------------
2002 2001 2002 2001
------ ------ ------ ------
Beginning of period 4,985 4,908 4,964 4,912
Stores opened 59 48 120 117
Stores closed (84) (38) (124) (111)
------ ------ ------ ------
Ending store count 4,960 4,918 4,960 4,918
====== ====== ====== ======
</Table>
Included in the 2002 year-to-date store openings are 33 store openings in
Central America and the Caribbean operated under a joint venture agreement. This
brings total store count in this region to 99. The Company intends to open
approximately 30 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 six months of 2002, the Company began its expansion into South
America by opening 17 stores. These stores are operated under a joint venture
agreement. The Company intends to open a total of 60 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 August 3, 2002, the Company has closed 71 stores and has
decided to continue to operate five of the 104 under-performing stores. The
remaining 28 under-performing stores are expected to close by the end of 2002.
The Company expects pre-tax annualized savings from these initiatives to total
$25 million to $30 million.
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 restructuring that was announced during
the fourth quarter of 2001. These additional costs are reflected as a
non-recurring item. The Company anticipates any future charges to earnings
associated with the 2001 restructuring to be less than $1.0 million.
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 the restructuring charge of $3.8 million is
reflected as a non-recurring item. The Company has estimated the cost of lease
terminations for the store and division office closings based on historical
costs incurred to terminate leases and based on its current progress in
completing these closings. Lease termination costs represent a significant
component of the restructuring charge, and the Company may negotiate lease
terminations for more or less than currently estimated.
During the first six months of 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.
11
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 in Management's Discussion
and Analysis of Financial Condition and Results of Operations in 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
Not applicable.
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; and 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.
12
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.
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
NUMBER DESCRIPTION
11.1 Computation of Net Earnings Per Share*
99.1 Statement Under Oath of the Principal Executive
Officer*
99.2 Statement Under Oath of the Principal Financial
Officer*
99.3 Certification Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 of the Chairman of
the Board and Chief Executive Officer*
99.4 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
The Company filed one report on Form 8-K during the last quarter dated May
24, 2002 reporting matters under Item 4, Changes in Registrant's Certifying
Accountant.
13
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: 9/13/02 By: /s/ Steven J. Douglass
-------------------------
Steven J. Douglass
Chairman of the Board and
Chief Executive Officer
Date: 9/13/02 By: /s/ Ullrich E. Porzig
-------------------------
Ullrich E. Porzig
Senior Vice President
Chief Financial Officer
and Treasurer
14
CERTIFICATION
I, Steven J. Douglass, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Payless ShoeSource,
Inc.;
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;
Date: September 13, 2002
/s/ Steven J. Douglass
-------------------------
Steven J. Douglass
Chairman of the Board and
Chief Executive Officer
15
CERTIFICATION
I, Ullrich E. Porzig, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Payless ShoeSource,
Inc.;
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;
Date: September 13, 2002
/s/ Ullrich E. Porzig
--------------------------------------
Ullrich E. Porzig
Senior Vice President, Chief Financial
Officer and Treasurer
16
EXHIBIT INDEX
<Table>
<Caption>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
11.1 Computation of Net Earnings Per Share*
99.1 Statement Under Oath of the Principal Executive
Officer*
99.2 Statement Under Oath of the Principal Financial
Officer*
99.3 Certification Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 of the Chairman of
the Board and Chief Executive Officer*
99.4 Certification Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 of the Senior Vice
President, Chief Financial Officer and
Treasurer*
</Table>
* Filed herewith