CAL

Business Context and Reporting Period

This Form 10-Q covers the thirteen-week period ended May 1, 2004, for Brown Shoe Company, Inc. (operating as Caleres Inc.). The company operates in three primary segments: Famous Footwear (retail), Wholesale Operations, and Naturalizer Retail. The quarter included the assimilation of the Bass licensed footwear business, which began in February 2004.

Key Financial Metrics

Cash Flow: Net cash used by operating activities was $4.6 million, compared to $19.7 million provided in the prior year. This shift was primarily due to a $14 million investment in Bass inventory and a $13 million buildup in accounts receivable. Net cash provided by financing activities was $22.3 million, driven by an increase in short-term notes payable.

Material Changes vs. Prior Period

• Revenue Growth: Consolidated net sales increased 10.2% year-over-year. The Wholesale segment saw a 21.7% sales increase, largely driven by $15.3 million in Bass footwear sales. Famous Footwear sales rose 4.2% with a 2.6% same-store sales increase.
• Profitability: Despite higher sales, net earnings declined 4.8% due to $3.3 million in pretax transition and assimilation costs related to the Bass license. Gross margin percentage decreased 100 basis points to 40.5% due to a higher mix of lower-margin wholesale sales.
• Segment Performance: Famous Footwear operating earnings rose 17.0% to $12.4 million. Wholesale operating earnings dipped slightly to $12.8 million due to Bass transition costs. Naturalizer Retail reported an operating loss of $2.2 million, widening from $1.4 million, attributed to Canadian same-store sales declines and margin compression during a product transition.
• Liquidity: The debt-to-total capital ratio improved to 28.2% from 32.5%. Cash balances increased by $10.8 million during the quarter.

Outlook, Risks, and Contingencies

Management Commentary: Management expressed satisfaction with the quarter, citing successful assimilation of the Bass business and improved results at Famous Footwear. They anticipate realizing synergies from integrating U.S. and Canadian Naturalizer operations and expect improved performance in the fall.

Risks and Contingencies:

• Redfield Litigation: A jury awarded $1.0 million in damages to plaintiffs in a class action suit regarding groundwater contamination at the Redfield site. The company recorded a total pretax charge of $3.7 million for this matter. Plaintiffs have filed a motion for a new trial, and the company is pursuing insurance recovery for costs and damages.
• Environmental Remediation: The company has an accrued liability of $9.8 million for remediation at various sites, with an additional $7.7 million in anticipated future costs for the Redfield site. Ultimate costs may vary.
• Supply Chain: Risks include political and economic conditions affecting inventory flow from Brazil and China.

Investor Verification Checklist

• Verify the timeline and cost impact of the Bass footwear license assimilation on future quarters.
• Monitor the status of the Redfield litigation, specifically the motion for a new trial and insurance recovery negotiations.
• Assess the turnaround strategy for the Naturalizer Retail segment, particularly the Canadian operations and margin recovery.
• Review the sustainability of the 2.6% same-store sales growth at Famous Footwear as the company moves into the back-to-school season.
• Confirm the company's ability to manage working capital requirements given the significant inventory buildup for the Bass line.