Brown Shoe Company 10-Q 2009
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Commission file number 1-2191
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As of May 30, 2009, 42,897,477 common shares were outstanding.
See notes to condensed consolidated financial statements.
See notes to condensed consolidated financial statements.
See notes to condensed consolidated financial statements.
The accompanying condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q of the United States Securities and Exchange Commission (“SEC”) and reflect all adjustments and accruals of a normal recurring nature, which management believes are necessary to present fairly the financial position, results of operations and cash flows of Brown Shoe Company, Inc. (the “Company”). These statements, however, do not include all information and footnotes necessary for a complete presentation of the Company's consolidated financial position, results of operations and cash flows in conformity with accounting principles generally accepted in the United States. The condensed consolidated financial statements include the accounts of the Company and its wholly-owned and majority-owned subsidiaries as well as a variable interest entity for which the Company is the primary beneficiary, after the elimination of intercompany accounts and transactions.
The Company’s business is seasonal in nature due to consumer spending patterns, with higher back-to-school, Easter and Christmas holiday season sales. Traditionally, the third fiscal quarter accounts for a substantial portion of earnings for the year. Interim results may not necessarily be indicative of results which may be expected for any other interim period or for the year as a whole.
Certain prior period amounts in the condensed consolidated financial statements have been reclassified to conform to the current period presentation. These reclassifications did not affect net (loss) earnings attributable to Brown Shoe Company, Inc.
For further information, refer to the consolidated financial statements and footnotes included in the Company's Annual Report on Form 10-K for the year ended January 31, 2009.
New Accounting Pronouncements
FASB Statement No. 157, Fair Value Measurement
In September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 157, Fair Value Measurement (“SFAS No. 157”). This statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (“GAAP”) and expands disclosures about fair value measurements. This statement was effective for financial statements issued for fiscal years beginning after November 15, 2007. In February 2008, the FASB issued FASB Staff Position FAS No. 157-2, Effective Date of FASB Statement No. 157 (“FSP No. 157-2”), which amends SFAS No. 157 by delaying its effective date by one year for non-financial assets and non-financial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis. The Company adopted the provisions of SFAS No. 157, as amended, for financial assets and financial liabilities at the beginning of 2008. The Company adopted SFAS No. 157 for non-financial assets and non-financial liabilities at the beginning of 2009. The adoption of SFAS No. 157 for non-financial assets and non-financial liabilities did not have a material impact on the Company’s condensed consolidated financial statements, although additional disclosures related to fair value measurements are required. See Note 12 to the condensed consolidated financial statements for additional information related to fair value measurements.
FASB Statement No. 141(R), Business Combinations
In December 2007, the FASB issued SFAS No. 141(R), Business Combinations, a replacement of FASB Statement No. 141 (“SFAS No. 141(R)”), which significantly changes the principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed and any noncontrolling interest in the acquiree. The statement also provides guidance for recognizing and measuring goodwill acquired in a business combination and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. This statement is effective prospectively, except for certain retrospective adjustments to deferred tax balances, for fiscal years beginning after December 15, 2008. SFAS No. 141(R) is effective for business combinations made by the Company on or after February 1, 2009.
In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51 (“SFAS No. 160”). This statement establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. Minority interests have been recharacterized as noncontrolling interests and classified as a component of equity separate from the parent’s equity. In addition, SFAS No. 160 establishes reporting requirements that provide sufficient disclosures that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. This statement is effective prospectively for fiscal years beginning after December 15, 2008, except for certain retrospective disclosure requirements. Accordingly, the Company adopted SFAS No. 160 at the beginning of 2009. The presentation and disclosure requirements of this standard impacted how the Company presents and discloses noncontrolling interests in the condensed consolidated financial statements and this standard was applied retrospectively for all periods presented.
FASB Statement No. 161, Disclosures about Derivative Instruments and Hedging Activities
In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133 (“SFAS No. 161”). This statement requires enhanced disclosures about an entity’s derivative and hedging activities and thereby seeks to improve the transparency of financial reporting. Entities are required to provide enhanced disclosures relating to: (a) how and why an entity uses derivative instruments; (b) how derivative instruments and related hedged items are accounted for under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, and its related interpretations; and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance and cash flows. This statement is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. The Company adopted SFAS No. 161 at the beginning of 2009. See Note 11 and Note 12 to the condensed consolidated financial statements for additional information related to derivative instruments.
FASB Staff Position Emerging Issues Task Force No. 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities
In June 2008, the FASB issued FASB Staff Position Emerging Issues Task Force No. 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities (“FSP EITF No. 03-6-1”), which addresses whether instruments granted in share-based payment awards are participating securities prior to vesting and, therefore, must be included in the earnings allocation in calculating earnings per share under the two-class method described in SFAS No. 128, Earnings Per Share. Under FSP EITF No. 03-6-1, unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents should be treated as participating securities in computing earnings per share. However, in periods of net loss, no effect is given to the Company’s participating securities since they do not contractually participate in the losses of the Company. FSP EITF No. 03-6-1 is effective for fiscal years beginning after December 15, 2008 and for interim periods within those years, and shall be applied retrospectively to all prior periods. Accordingly, due to the adoption of FSP EITF No. 03-6-1 at the beginning of 2009, restricted stock awards are now considered participating units in the calculation of (loss) earnings per common share attributable to Brown Shoe Company, Inc. shareholders. The adoption of FSP EITF No. 03-6-1 did not have a material impact on the Company’s condensed consolidated financial statements for any periods presented. See Note 3 to the condensed consolidated financial statements for the calculation of (loss) earnings per common share attributable to Brown Shoe Company, Inc. shareholders.
Prospective Accounting Pronouncements
FASB Staff Position FAS No. 132(R)-1, Employers’ Disclosures about Postretirement Benefit Plan Assets
In December 2008, the FASB issued Staff Position FAS No. 132(R)-1, Employers’ Disclosures about Postretirement Benefit Plan Assets (“FSP No. 132(R)-1”). FSP No. 132(R)-1 requires enhanced disclosures about the plan assets of a Company’s defined benefit pension and other postretirement plans. The enhanced disclosures required by this FSP are intended to provide users of financial statements with a greater understanding of: (a) how investment allocation decisions are made, including the factors that are pertinent to an understanding of investment policies and strategies; (b) the major categories of plan assets; (c) the inputs and valuation techniques used to measure the fair value of plan assets; (d) the effect of fair value measurements using significant unobservable inputs (Level 3) on changes in plan assets for the period; and (e) significant concentrations of risk within plan assets. This requirement is effective for financial statements issued for fiscal years ending after December 15, 2009, with early application permitted. The Company will include the required disclosures of FSP No. 132(R)-1 in its 2009 and future Form 10-K filings.
In April 2009, the FASB issued Staff Position FAS No. 107-1 and Accounting Principles Bulletin (“APB”) No. 28-1, Interim Disclosures about Fair Value of Financial Instruments (“FSP No. 107-1 and APB No. 28-1”), to require, on an interim basis, disclosures about the fair value of financial instruments for public entities. FSP No. 107-1 and APB No. 28-1 is expected to improve the transparency and quality of information provided to financial statement users by increasing the frequency of disclosures about fair value for interim periods as well as annual periods. FSP No. 107-1 and APB No. 28-1 is effective for interim and annual periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. The Company will include the required disclosures of FSP No. 107-1 and APB No. 28-1 in its Form 10-Q filings starting in the second quarter of 2009.
FASB Statement No. 165, Subsequent Events
In May 2009, the FASB issued SFAS No. 165, Subsequent Events (“SFAS No. 165”). The objective of this statement is to establish general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. In particular, this statement sets forth: (a) the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements; (b) the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements; and (c) the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. In accordance with this statement, an entity should apply the requirements to interim or annual financial periods ending after June 15, 2009. The Company will adopt SFAS No. 165 in the second quarter of 2009 and it expects that the adoption will not have a material impact on its condensed consolidated financial statements.
As discussed in Note 2, the Company adopted FSP EITF 03-6-1 and began using the two-class method to compute basic and diluted (loss) earnings per common share attributable to Brown Shoe Company, Inc. shareholders. The following table sets forth the computation of basic and diluted (loss) earnings per common share attributable to Brown Shoe Company, Inc. shareholders for the periods ended May 2, 2009 and May 3, 2008:
Due to the Company’s net loss attributable to Brown Shoe Company, Inc. for the thirteen-week period ended May 2, 2009, the denominator for diluted loss per common share attributable to Brown Shoe Company, Inc. shareholders is the same as the denominator for basic loss per common share attributable to Brown Shoe Company, Inc. shareholders. Options to purchase 941,002 shares of common stock for the thirteen-week period ended May 3, 2008 were not included in the denominator for diluted earnings per common share attributable to Brown Shoe Company, Inc. shareholders because the effect would be antidilutive.
Comprehensive (loss) income includes changes in equity related to foreign currency translation adjustments and unrealized gains or losses from derivatives used for hedging activities.
The following table sets forth the reconciliation from net (loss) earnings to comprehensive (loss) income for the periods ended May 2, 2009 and May 3, 2008:
The following table sets forth the balance in accumulated other comprehensive (loss) income for the Company at May 2, 2009, May 3, 2008 and January 31, 2009:
See additional information related to derivative instruments in Note 2, Note 11 and Note 12 and additional information related to pension and other postretirement benefits in Note 9.
Information Technology Initiatives
During 2008, the Company announced plans to implement an integrated enterprise resource planning (“ERP”) information technology system provided by third-party vendors. The ERP information technology system will replace select existing internally developed and certain other third-party applications, and is expected to support the Company’s growth strategy while streamlining and transforming day-to-day operations for its integrated business model. The Company anticipates the implementation will enhance its profitability and deliver increased shareholder value through improved management and execution of its business operations, financial systems, supply chain efficiency and planning and employee productivity. The phased implementation began during the second quarter of 2008 and is expected to continue through 2011. The Company incurred costs of $2.6 million ($1.7 million on an after-tax basis, or $0.04 per diluted share) during the first quarter of 2009 as a component of restructuring and other special charges (recoveries), net related to its implementation of these initiatives, with no corresponding costs during the first quarter of 2008. The Company incurred costs of $3.7 million ($2.4 million on an after-tax basis, or $0.06 per diluted share) during the full year of 2008. Of the $2.6 million in costs recorded during the first quarter of 2009, $2.5 million was recorded in the Other segment and $0.1 million was recorded in the Wholesale Operations segment. All of the costs recorded during 2008 were reflected within the Other segment.
Expense and Capital Containment Initiatives
During 2008, the Company announced expense and capital containment initiatives in an effort to proactively position itself for continued challenges in the retail environment. These initiatives included a voluntary separation program, changes in compensation structure, further rationalization of operating expenses and the closing of certain functions at its Fredericktown, Missouri distribution center. The Company incurred no charges during the first quarter of 2009, but incurred charges of $30.9 million ($19.1 million on an after-tax basis, or $0.46 per diluted share) during the fourth quarter of 2008. These costs included employee-related costs for severance, including health care benefits and enhanced pension benefits, as well as facility and other costs.
The following is a summary of the charges and settlements by category of costs:
Of the $30.9 million in costs recorded during 2008, $14.4 million was recorded in the Wholesale Operations segment, $12.1 million was recorded in the Other segment, $3.8 million was recorded in the Famous Footwear segment and $0.6 million was recorded in the Specialty Retail segment. All of the costs recorded during 2008 were reflected as a component of restructuring and other special charges (recoveries), net. A tax benefit of $11.8 million was associated with the costs recorded during 2008. The write-off of assets of $0.5 million, included in facility costs, is a noncash item.
During 2008, the Company announced plans to relocate its Famous Footwear division headquarters from Madison, Wisconsin to St. Louis, Missouri. The relocation of the division was intended to foster collaboration, increase the Company’s speed to market and strengthen its connection with consumers. The Company incurred no charges during the first quarter of 2009, but incurred charges of $29.8 million ($18.2 million on an after-tax basis, or $0.44 per diluted share) during 2008. These costs included employee-related costs for relocation, severance, recruiting and retention, as well as facility and other costs. All of the costs recorded during 2008 were reflected within the Other segment as a component of restructuring and other special charges (recoveries), net. During 2008, a tax benefit of $11.6 million was associated with the costs recorded. The write-off of assets of $3.4 million, included in facility costs, is a noncash item.
During the first quarter of 2008, the Company incurred charges of $1.8 million ($1.1 million on an after-tax basis, or $0.03 per diluted share) related to the plan: $1.1 million for employee severance, $0.3 million for employee relocation, $0.2 million for facility and $0.2 million for other costs. A tax benefit of $0.7 million was associated with the costs recorded during the first quarter of 2008.
Environmental Insurance Recoveries, Net
During 2008, the Company reached agreements with certain insurance carriers to recover environmental remediation costs associated with its facility in Denver, Colorado (the “Redfield” facility). As a result of these settlements, all claims among the parties were dismissed. The Company recorded income within its Other segment related to these recoveries, net of associated fees and costs, of $10.2 million ($6.2 million on an after-tax basis, or $0.15 per diluted share) as a component of restructuring and other special charges (recoveries), net. See Note 15 to the condensed consolidated financial statements for additional information related to these recoveries.
Applicable business segment information is as follows for the periods ended May 2, 2009 and May 3, 2008:
The Other segment includes corporate assets and administrative and other costs and recoveries which are not allocated to the operating units.
During the thirteen weeks ended May 2, 2009, operating earnings (loss) of the Other and Wholesale Operations segments included costs related to the Company’s information technology initiatives of $2.5 million and $0.1 million, respectively.
During the thirteen weeks ended May 3, 2008, operating earnings of the Other segment included environmental insurance recoveries, net of associated fees and costs, of $10.2 million and charges of $1.8 million related to the headquarters consolidation.
Following is a reconciliation of operating (loss) earnings to (loss) earnings before income taxes:
Goodwill and intangible assets were attributable to the Company's operating segments as follows:
The impairment of goodwill during the fourth quarter of 2008, as described below, resulted in a decline in goodwill and intangible assets for the Famous Footwear segment from May 3, 2008 to January 31, 2009 and May 2, 2009.
The significant decline in the goodwill and intangible assets of the Wholesale Operations segment from May 3, 2008 to January 31, 2009 and May 2, 2009 was the result of the impairment of goodwill and intangible assets during the fourth quarter of 2008, as described below.
During the fourth quarter of 2008, the Company acquired goodwill of $3.8 million and an intangible asset related to an owned trademark of $16.8 million in connection with the consolidation of Edelman Shoe, which resulted in an increase in goodwill and intangible assets for the Wholesale Operations segment.
The decrease in the intangible assets of the Company’s Wholesale Operations segment also reflects amortization of its licensed and owned trademarks.
The decline in the goodwill and intangible assets of the Company’s Specialty Retail segment from May 3, 2008 to January 31, 2009 and May 2, 2009 was due to an impairment of goodwill (described below), an additional investment in Shoes.com of $3.6 million during the fourth quarter of 2008 and changes in the Canadian dollar exchange rate.
As a result of the difficult market conditions and industry trends, and the resulting decline in the market price of the Company’s common stock at the end of 2008, the Company performed an impairment test as of January 31, 2009 and concluded that its entire goodwill balance of $140.9 million was impaired. As a result, the Company recorded a non-cash goodwill impairment charge of $140.9 million in the fourth quarter of 2008.
Intangible Asset Impairment
Due to declines experienced in the private label business, the Company performed an impairment test as of January 31, 2009 and determined that the Company’s private label customer relationships acquired during the Bennett acquisition during 2005 were impaired. As a result, the Company recorded a non-cash impairment charge of $8.2 million in the fourth quarter of 2008.
During the first quarter of 2009, the Company granted 189,900 stock options to certain employees with a weighted-average exercise price and grant date fair value of $3.33 and $1.13, respectively. These options vest in equal increments, with either 25% or 11% vesting over each of the next four or nine years, respectively. All options have a term of ten years. Compensation expense is recognized on a straight-line basis separately for each vesting portion of the stock option award.
The Company granted 406,000 performance share awards at target during the first quarter of 2009 with a weighted-average grant date fair value of $3.07. Vesting of performance-based awards is dependent upon the financial performance of the Company and the attainment of certain financial goals over the next three years. The performance share awards may pay out at a maximum of 150% of the target number of shares. Compensation expense is being recognized based on the fair value of the award on the date of grant and the anticipated number of shares to be awarded on a straight-line basis over the three-year service period.
The Company also granted 588,075 restricted shares with a weighted-average grant date fair value of $3.27 during the first quarter of 2009. The restricted shares granted vest in four years and compensation expense will be recognized on a straight-line basis over the four-year period.
The Company recognized share-based compensation expense (income) of $1.4 million and ($0.1) million during the first quarter of 2009 and the first quarter of 2008, respectively. Income was recognized during the first quarter of 2008 as a result of reductions in expected payout percentages in connection with stock performance plans granted in 2006 and 2007.
The Company issued 593,114 shares of common stock during the first quarter of 2009 for restricted stock grants and directors’ fees. During the first quarter of 2009, the Company cancelled 7,313 shares of common stock as a result of forfeitures of restricted stock awards.
The following table sets forth the components of net periodic benefit (income) cost for the Company, including all domestic and Canadian plans:
On January 21, 2009, the Company and certain of its subsidiaries (the “Loan Parties”) entered into a Second Amended and Restated Credit Agreement (the “Credit Agreement”). The Credit Agreement matures on January 21, 2014. The Credit Agreement provides for revolving credit in an aggregate amount of up to $380.0 million, subject to the calculated borrowing base restrictions. Borrowing availability under the Credit Agreement is limited to the lesser of the total commitments and the borrowing base, which is based on stated percentages of the sum of eligible receivables and inventories, less applicable reserves. Under the Credit Agreement, the Loan Parties’ obligations are secured by a first priority security interest in receivables, inventories and certain other collateral.
Interest on borrowings is at variable rates based on the London Inter-Bank Offer Rate (“LIBOR”) or the prime rate, as defined in the Credit Agreement. The interest rate and fees for letters of credit varies based upon the level of excess availability under the Credit Agreement. There is an unused line fee payable on the excess availability under the facility and a letter of credit fee payable on the outstanding exposure under letters of credit.
The Credit Agreement limits the Company’s ability to incur additional indebtedness, create liens, make investments or specified payments, give guarantees, pay dividends, make capital expenditures and merge or acquire or sell assets. In addition, certain additional covenants would be triggered if excess availability were to fall below specified levels, including fixed charge coverage ratio requirements. Furthermore, if excess availability falls below the greater of (i) 17.5% of the lesser of (x) the borrowing base or (y) the total commitments and (ii) $25.0 million for three consecutive business days, or an event of default occurs, the lenders may assume dominion and control over the Company’s cash (a “cash dominion event”) until such event of default is cured or waived or the excess availability exceeds such amount for 30 consecutive days.
The Credit Agreement contains customary events of default, including, without limitation, payment defaults, breaches of representations and warranties, covenant defaults, cross-defaults to similar obligations, certain events of bankruptcy and insolvency, judgment defaults and the failure of any guaranty or security document supporting the agreement to be in full force and effect. In addition, if the excess availability falls below the greater of (i) 17.5% of the lesser of (x) the borrowing base or (y) the total commitments and (ii) $25.0 million and the fixed charge coverage ratio is less than 1.0 to 1.0, the Company would be in default under the Credit Agreement. The Credit Agreement also contains certain other covenants and restrictions, with which the Company was in compliance as of May 2, 2009.
At May 2, 2009, the Company had $39.0 million in borrowings outstanding and $10.6 million in letters of credit outstanding under the Credit Agreement. Total additional borrowing availability was $299.7 million as of May 2, 2009.
In April 2005, the Company issued $150.0 million of 8.75% senior notes due in 2012 (“Senior Notes”). The Senior Notes are guaranteed on a senior unsecured basis by each of the subsidiaries of Brown Shoe Company, Inc. that is an obligor under the Credit Agreement. Interest on the Senior Notes is payable on May 1 and November 1 of each year. The Senior Notes mature on May 1, 2012, but are callable any time on or after May 1, 2009, at specified redemption prices plus accrued and unpaid interest. The Senior Notes also contain certain other covenants and restrictions which limit certain activities including, among other things, levels of indebtedness, payments of dividends, the guarantee or pledge of assets, certain investments, common stock repurchases, mergers and acquisitions and sales of assets. As of May 2, 2009, the Company was in compliance with all covenants relating to the Senior Notes.
In the normal course of business, the Company’s financial results are impacted by currency rate movements in foreign currency denominated assets, liabilities and cash flows as it makes a portion of its purchases and sales in local currencies. The Company has established policies and business practices that are intended to mitigate a portion of the effect of these exposures. The Company uses derivative financial instruments, primarily forward contracts, to manage its currency exposures. These derivative instruments are viewed as risk management tools and are not used for trading or speculative purposes. Derivatives entered into by the Company are designated as cash flow hedges of forecasted foreign currency transactions.
The Company principally uses foreign currency forward contracts as cash flow hedges to offset a portion of the effects of exchange rate fluctuations. The Company’s cash flow exposures include anticipated foreign currency transactions, such as foreign currency denominated sales, costs, expenses, intercompany charges, as well as collections and payments. The Company performs a quarterly assessment of the effectiveness of the hedge relationship and measures and recognizes any hedge ineffectiveness in the condensed consolidated statement of earnings. Hedge ineffectiveness is evaluated using the hypothetical derivative method, and the ineffective portion of the hedge is reported in the Company’s condensed consolidated statement of earnings. The amount of hedge ineffectiveness for the quarter ended May 2, 2009 was not material.
The Company’s hedging strategy uses forward contracts as cash flow hedging instruments, which are recorded in the Company’s condensed consolidated balance sheet at fair value. The effective portion of gains and losses resulting from changes in the fair value of these hedge instruments are deferred in accumulated other comprehensive (loss) income and reclassified to earnings in the period that the hedged transaction is recognized in earnings.
As of May 2, 2009, the Company had forward contracts maturing at various dates through January 2010. The contract amount represents the net amount of all purchase and sale contracts of a foreign currency.
As of May 2, 2009, the fair values of derivative instruments included within the condensed consolidated balance sheet were as follows:
Additional information related to the Company’s derivative financial instruments are disclosed within Note 2 and Note 12 to the condensed consolidated financial statements.
Fair Value Hierarchy
SFAS No. 157 specifies a hierarchy of valuation techniques based upon whether the inputs to those valuation techniques reflect assumptions other market participants would use based upon market data obtained from independent sources (“observable inputs”) or reflect the Company’s own assumptions of market participant valuation (“unobservable inputs”). In accordance with SFAS No. 157, the hierarchy is broken down into three levels based on the reliability of the inputs as follows:
In determining fair value in accordance with SFAS No. 157, the Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible as well as considers counterparty credit risk in its assessment of fair value. Classification of the financial or non-financial asset or liability within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement.
Measurement of Fair Value
The Company measures fair value as an exit price, the price to sell an asset or transfer a liability in an orderly transaction between market participants at the measurement date, using the procedures described below for all financial and non-financial assets and liabilities measured at fair value.
The Company maintains a non-qualified deferred compensation plan (the “Deferred Compensation Plan”) for the benefit of certain management employees. The investment funds selected by the participant generally correspond to the funds offered in the Company’s 401(k) plan, and the account balance fluctuates with the investment returns on those funds. The Deferred Compensation Plan permits the deferral of up to 50% of base salary and 100% of compensation received under the Company’s annual incentive plan. The deferrals are held in a separate trust, which has been established by the Company to administer the Deferred Compensation Plan. The assets of the trust are subject to the claims of the Company’s creditors in the event that the Company becomes insolvent. Consequently, the trust qualifies as a grantor trust for income tax purposes (i.e. a “Rabbi Trust”). In accordance with the provisions of EITF No. 97-14, Accounting for Deferred Compensation Arrangements Where Amounts Earned are Held in a Rabbi Trust and Invested (“EITF 97-14”), the liabilities of the Deferred Compensation Plan are presented in accrued expenses and the assets held by the trust are classified as trading securities within prepaid expenses and other current assets in the accompanying condensed consolidated balance sheets. Changes in deferred compensation are charged to selling and administrative expenses. The fair value is based on unadjusted quoted market prices for the funds in active markets with sufficient volume and frequency (Level 1).
Derivative Financial Instruments
The Company uses derivative financial instruments, primarily foreign exchange contracts, to reduce its exposure to market risks from changes in foreign exchange rates. These foreign exchange contracts are measured at fair value using quoted forward foreign exchange prices from counterparties corroborated by market-based pricing (Level 2). Additional information related to the Company’s derivative financial instruments are disclosed within Note 2 and Note 11 to the condensed consolidated financial statements.
The following table presents the Company’s assets and liabilities that are measured at fair value on a recurring basis at May 2, 2009, consistent with the fair value hierarchy provisions of SFAS No. 157.
Store Impairment Charges
In accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (“SFAS No. 144”), the Company assesses the impairment of long-lived assets whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors the Company considers important that could trigger an impairment review include underperformance relative to expected historical or projected future operating results, a significant change in the manner of the use of the asset or a negative industry or economic trend. When the Company determines that the carrying value of long-lived assets may not be recoverable based upon the existence of one or more of the aforementioned factors, impairment is measured based on a projected discounted cash flow method. Certain factors, such as estimated store sales and expenses, used for this nonrecurring fair value measurement are considered Level 3 inputs as defined by SFAS No. 157. In accordance with the provisions of SFAS No. 144, long-lived store assets held and used with a carrying amount of $71.3 million were written down to their fair value, resulting in an impairment charge of $1.6 million, which was recorded within selling and administrative expenses for the quarter ended May 2, 2009.
In 2007, the Company invested cash of $7.1 million in Edelman Shoe, Inc. (“Edelman Shoe”), acquiring 42.5% of the outstanding stock. On November 3, 2008, the Company invested an additional $4.1 million of cash in Edelman Shoe, acquiring 7.5% of the outstanding stock, bringing the Company’s total equity interest to 50%. The Company has an option to buy the remaining interest in the future.
The Sam Edelman brand was launched in 2004 and is sold in department stores and independent and specialty stores across the country. The Company believes the investment in Edelman Shoe complements its portfolio of wholesale footwear brands by adding owned brands that sell primarily in the bridge/designer footwear price zones.
As a part of the Company’s qualitative and quantitative analyses, it determined that Edelman Shoe is a variable interest entity (“VIE”) as defined by FASB Interpretation No. 46, Consolidation of Variable Interest Entities (“FIN 46”) for which the Company is the primary beneficiary; therefore, the Company’s condensed consolidated financial statements include the accounts of Edelman Shoe beginning November 3, 2008. The Company determined that it is the primary beneficiary as it absorbs the majority of the entity's expected losses. Prior to consolidation, the Company accounted for the investment in accordance with the equity method. The Company’s variable interests in Edelman Shoe include the equity investments described above and amounts payable from Edelman Shoe to the Company. At May 2, 2009, Edelman Shoe had assets of approximately $17.4 million and liabilities of approximately $14.0 million. During the quarter ended May 2, 2009, Edelman Shoe had net sales of approximately $13.5 million.
Hongguo International Holdings
The Company entered into a joint venture agreement with a subsidiary of Hongguo International Holdings Limited (“Hongguo”) to begin marketing Naturalizer footwear in China in 2007. The Company is a 51% owner of the joint venture (“B&H Footwear”), with Hongguo owning the other 49%. B&H Footwear began operations in 2007 and distributes the Naturalizer brand in department store shops and free-standing stores in several of China’s largest cities. In addition, B&H Footwear sells Naturalizer footwear to Hongguo on a wholesale basis. Hongguo then sells Naturalizer products through retail stores in China. During the first quarter of 2009 and the first quarter of 2008, the Company, through its consolidated subsidiary, B&H Footwear, sold $0.5 million and $0.9 million, respectively, of Naturalizer footwear on a wholesale basis to Hongguo.
Edelman Shoe, Inc.
A consolidated subsidiary of the Company sold footwear to Edelman Shoe on a wholesale basis, which was then sold by Edelman Shoe to department stores and independent specialty stores across the country. During the first quarter of 2008, this consolidated subsidiary of the Company sold $0.5 million of footwear on a wholesale basis to Edelman Shoe, prior to consolidation. Beginning in the fourth quarter of 2008, Edelman Shoe is included within the Company’s condensed consolidated financial statements. Accordingly, all intercompany sales activity is eliminated.
While the Company currently does not operate manufacturing facilities, prior operations included numerous manufacturing and other facilities for which the Company may have responsibility under various environmental laws for the remediation of conditions that may be identified in the future. The Company is involved in environmental remediation and ongoing compliance activities at several sites.
The Company is remediating, under the oversight of Colorado authorities, the groundwater and indoor air at its owned facility in Colorado (the “Redfield site” or, when referring to remediation activities at or under the facility, the “on-site remediation”) and residential neighborhoods adjacent to and near the property (the “off-site remediation”) that have been affected by solvents previously used at the facility. The on-site remediation calls for the operation of a pump and treat system (which prevents migration of contaminated groundwater off the property) as the final remedy for the site, subject to monitoring and periodic review of the on-site conditions and other remedial technologies that may be developed in the future. Off-site groundwater concentrations have been reducing over time, since installation of the pump and treat system in 2000 and injection of clean water beginning in 2003. However, localized areas of contaminated bedrock just beyond the property line continue to impact off-site groundwater. The modified workplan for addressing this condition proposes converting the off-site bioremediation system into a monitoring well network and employing different remediation methods in these recalcitrant areas. In accordance with the workplan, a pilot test was conducted of certain groundwater remediation methods and the results of that test were used to develop more detailed proposals for remedial activities in the off-site areas, which were approved by the authorities and are to be implemented in a phased manner. The results of groundwater monitoring will be used to evaluate the effectiveness of these activities. The liability for the on-site remediation was discounted at 4.8%. On an undiscounted basis, the on-site remediation liability would be $16.7 million as of May 2, 2009. The Company expects to spend approximately $0.2 million in each of the next five years and $15.7 million in the aggregate thereafter related to the on-site remediation.
The cumulative expenditures for both on-site and off-site remediations through May 2, 2009 are $21.5 million. The Company has recovered a portion of these expenditures from insurers and other third parties. The reserve for the anticipated future remediation activities at May 2, 2009, is $8.3 million, of which $1.2 million is accrued within accrued expenses and $7.1 million is accrued within other liabilities. Of the total $8.3 million reserve, $5.0 million is for on-site remediation and $3.3 million is for off-site remediation. During the first quarter of 2009 and the first quarter of 2008, the Company recorded no expense related to either the on-site or off-site remediation, other than the accretion of interest expense.
The Company has completed its remediation efforts at its closed New York tannery and two associated landfills. In 1995, state environmental authorities reclassified the status of these sites as being properly closed and requiring only continued maintenance and monitoring over the next 15 years. The Company has an accrued liability of $1.9 million at May 2, 2009, related to these sites, which has been discounted at 6.4%. On an undiscounted basis, this liability would be $2.8 million. The Company expects to spend approximately $0.2 million in each of the next five years and $1.8 million in the aggregate thereafter related to these sites. In addition, various federal and state authorities have identified the Company as a potentially responsible party for remediation at certain other sites. However, the Company does not currently believe that its liability for such sites, if any, would be material.
Based on information currently available, the Company had an accrued liability of $10.2 million as of May 2, 2009, to complete the cleanup, maintenance and monitoring at all sites. Of the $10.2 million liability, $1.4 million is included in accrued expenses and $8.8 million is included in other liabilities. The Company continues to evaluate its estimated costs in conjunction with its environmental consultants and records its best estimate of such liabilities. However, future actions and the associated costs are subject to oversight and approval of various governmental authorities. Accordingly, the ultimate costs may vary, and it is possible costs may exceed the recorded amounts.
The Company is involved in legal proceedings and litigation arising in the ordinary course of business. In the opinion of management, the outcome of such ordinary course of business proceedings and litigation currently pending will not have a material adverse effect on the Company’s results of operations or financial position. All legal costs associated with litigation are expensed as incurred.
In 2004, the Company was notified of the insolvency of an insurance company that insured the Company for workers’ compensation and casualty losses from 1973 to 1989. That company is now in liquidation. Certain claims from that time period are still outstanding, for which the Company has an accrued liability of $2.7 million as of May 2, 2009. While management believes it has an appropriate reserve for this matter, the ultimate outcome and cost to the Company may vary.
At May 2, 2009, the Company was contingently liable for remaining lease commitments of approximately $2.2 million in the aggregate, which relate to former retail locations that we exited in prior years. These obligations will continue to decline over the next several years as leases expire. In order for the Company to incur any liability related to these lease commitments, the current owners would have to default.
In 2005, Brown Shoe Company, Inc. issued Senior Notes, which are fully and unconditionally and jointly and severally guaranteed by all of its existing and future subsidiaries that are guarantors under its existing Credit Agreement. The following table presents the condensed consolidating financial information for each of Brown Shoe Company, Inc. (“Parent”), the Guarantors and subsidiaries of the Parent that are not Guarantors (the “Non-Guarantors”), together with consolidating eliminations, as of and for the periods indicated.
The condensed consolidating financial statements have been prepared using the equity method of accounting in accordance with the requirements for presentation of such information. Management believes that the information, presented in lieu of complete financial statements for each of the Guarantors, provides meaningful information to allow investors to determine the nature of the assets held by, and operations and cash flows of, each of the consolidating groups.