Footstar, Inc. announced today that while the restatement of its financial statements for fiscal years 1997 through June 2002 is ongoing, the Company does not expect to release financial statements for the five-and-one-half year period by the previously announced date of October 31, 2003. Since the Company is not releasing restated
financial statements as scheduled, it is providing further detail on the results of its internal investigation, its operating results for the restatement period, fiscal year 2002 and the first half of fiscal year 2003, and an update on its outlook for fiscal year 2003, as well as the waiver and extension until January 30, 2004 of the requirement to
provide audited financial statements that the Company has received from a syndicate of banks led by Fleet National Bank concerning the Company's $345 million senior secured credit facility.
The Company now expects that the restatement will reduce earnings
by an aggregate amount ranging from $51 million to $55 million
pre-minority interest and taxes (or $31 million to $38 million after
minority interest and taxes) over the five-and-one-half-year
restatement period (see “Deferred Tax Asset Write-down”), compared to
the range it had previously announced in its September 15, 2003 press
release of $48 million to $53 million pre-minority interest and taxes
(or $29 million to $32 million after minority interest and taxes).
Rather than the $48.2 million announced in its September 15, 2003
press release, the Company now expects the reduction in earnings will
be $52.3 million pre-minority interest and taxes, as detailed in the
restatement summary below. The Company continues to expect that the
restatement will not affect the over $10 billion in revenues generated
during the five-and-one-half-year period or net cash flows.
Credit Facility Waiver
The Company continues to have the benefit of its $345 million
senior secured credit facility with a syndicate of banks led by Fleet
National Bank, which was recently increased by $20 million in
September 2003. The Company has obtained a new waiver from its bank
group extending to January 30, 2004 its requirement to provide audited
financial statements for the fiscal year 2002, as well as unaudited
financial statements for the third quarter of fiscal year 2002 and the
first three quarters of fiscal year 2003. As a condition for the new
waiver, the Company has agreed with its lenders that the Company will
be subject to a prepayment premium of 100 basis points on all
terminations or reductions of commitments under the $255 million
revolving portion of the credit facility that are made on or prior to
July 31, 2004. In addition, the time period for the previously agreed
prepayment premium on the term loan portion of the credit facility was
extended from May 24, 2004 to July 31, 2004. All other terms of the
credit facility remain unchanged. As of September 27, 2003, there was
$90 million outstanding under the term portion of the credit facility
and approximately $180 million outstanding under the revolving portion
of the credit facility (including letters of credit). Based upon the
borrowing base availability calculation contained in the credit
facility, as of September 27, 2003, the Company had approximately $27
million of availability remaining after the application of the
required $20 million in minimum excess availability. While the Company
is continuing to consider whether its indebtedness under the credit
facility should be classified as current, the Company believes that
the classification of this indebtedness as current will not have any
effect on the covenants or representations of the Company under the
credit facility. The new waiver is also conditioned on a requirement
that the Company represent that the maximum impact on earnings with
respect to the restatement will not exceed $55 million in the
aggregate. If the final impact of the restatement on the Company's
earnings exceeds $55 million in the aggregate, the Company would have
to seek a further amendment and waiver from its lenders in order to
avoid an event of default under the credit facility.
Further Information on Internal Investigation
As discussed below, the previously disclosed investigation
conducted under the oversight of the Audit Committee determined that
there were numerous instances of incorrect accounting as well as
significant internal control failures at the Company. The Company is
addressing the incorrect accounting and internal control failures
identified during the investigation, also as discussed below. The
investigation determined that during the period at issue:
- Some members of senior management and some employees in finance-related positions failed to fulfill their responsibilities to ensure that the Company's accounting and financial reporting were accurate and to instill a culture that focused on robust internal controls and internal audit, i.e., to establish and maintain a proper tone at the top.
-
The Company did not design or maintain the systems, processes
or controls, or hire and retain personnel necessary to ensure
that its financial results would be reported accurately. An
undue focus was placed on controlling and reducing costs,
without sufficient consideration of the potential impact on
the Company's internal controls. This resulted in failures in
internal control over financial reporting. These failures in
internal controls were masked by manual entries, and these
failures also permitted the improper recording of manual
entries. Over time certain members of senior management
knowingly used manual entries to reach incorrect accounting
results.Examples included:
— manual journal entries in which accounts payable balances
were written off and corresponding reductions were made to
certain operating expenses; and
— offsetting unrelated items, such as unrecoverable
receivables and vendor credits with unmatched receipts
(accounts payable) and thereby misrepresenting the actual
results of operations of the Company.
The system did not contain adequate controls over manual entries,
and management did not appropriately document the process for making
manual entries.
- With respect to the Company's acquisition of Just For Feet in
2000, it was determined that the original purchase price
allocation contained errors as a result of the Company not
utilizing all of the detailed information available at that
time. When it should have become clear to some members of
management after the acquisition of Just For Feet that the
allocation of the purchase price relating to inventory should
have been adjusted, these members of senior management allowed
incorrect entries to be made to the Company's income statement
rather than making such adjustments to the purchase price
allocation. This resulted in overstating profitability and
gross margins in 2000. They also did not adequately disclose
the impact of those adjustments to the Board or to the
internal or independent auditors, nor did they ensure that the
Company's public disclosures regarding the adjustments were
adequate.
- The problems caused by the Company's inadequate control over
financial reporting and the misuse of manual entries by
certain members of senior management were compounded by the
repeated failure of such members of senior management and some
employees in finance-related positions to attach sufficient
importance to the role of the internal auditors or to follow
up in a timely manner with the Audit Committee or the
independent auditor on issues raised by the internal auditors.
- The deficiencies in the internal control systems as well as
the human intervention in such systems resulted in inaccurate
financial statements, which are being restated. As a result,
the Company has taken and is taking steps to remediate the
issues that were raised in the investigation. The Company's
Chairman and Chief Executive Officer, as well as four key
finance employees are no longer with the Company, and the
Company's accounting and other finance-related staffing is in
the process of being increased and upgraded to enhance the
effectiveness of the Company's financial reporting, internal
controls and public disclosure.
On September 15, 2003, the Company announced the implementation of
its Remediation Plan and Disclosure Controls policy. The Company is
committed to focusing its management team and associates on the
effective implementation of this Remediation Plan and Disclosure
Controls policy. As part of this effort, the Company recently hired
Richard Robbins as Senior Vice President of Financial Reporting. In
this new position, Mr. Robbins oversees the Company's accounting and
financial reporting functions and reports directly to Steve Wilson,
the Company's Chief Financial Officer. Mr. Robbins also has a
dotted-line responsibility to the Chief Executive Officer with respect
to financial reporting matters. Mr. Robbins has over 30 years of
experience in public accounting with Arthur Andersen, where he was a
Partner for 24 years until 2002. Since 2002, Mr. Robbins has provided
financial, accounting and operational consulting services to private
and public companies.
Update on Restatement
All financial information provided in this release is unaudited. The final impact of the restatement will depend upon the final determinations being made by the Company and the completion of the audit and review by KPMG LLP. As a result, there may be changes to the financial information provided in this release that are material, individually or in the aggregate, to the Company's financial
condition, results of operations or liquidity.
The following tables summarize the Company's updated estimates of
the impact of the accounts payable discrepancies as well as the five
additional accounting areas requiring restatement that were described
in the Company's September 15, 2003 press release, with an explanation
of the principal reasons for the changes:
Restatement Summary
Current September
Estimate Estimate Change
-------- --------- -------
Original A/P Reconciliation
Discrepancies
Reconciliation $35.8 $35.8 $0.0
Unrecorded Inventory 10.3 10.3 0.0
Elimination Adjustments 4.6 4.6 0.0
Excess Fee Payments (5.9) (5.9) 0.0
Just for Feet Acquisition Accounting 3.8 2.9 0.9 A
Timing Adjustments (1.7) 0.5 (2.2)B
Reserve for Potentially
Uncollectible Contingent Fees 5.4 0.0 5.4 C
-------- --------- -------
Sub-total 52.3 48.2 4.1
Minority Interest (0.2) (4.0) 3.8 D
-------- --------- -------
Pre- Tax Total 52.1 44.2 7.9
Income Taxes (1) (16.2) (15.5) (0.7)
-------- --------- -------
Total $35.9 $28.7 $7.2
======== ========= =======
(1) See "Deferred Tax Assets Write-down."
A As a result of the continuing review of the acquisition accounting
for Just for Feet, an additional $0.9 million of errors are being
corrected, which relate to the finalization of the purchase price
allocation in connection with a customer loyalty program
liability.
B The Company has identified further accrual adjustments that relate
principally to the reduction of restructuring reserves in its
Meldisco segment.
C As the restatement adjustments have affected various contingent
fee calculations, a reserve of $5.4 million has been established
to provide for estimated uncollectible amounts.
D A reserve has been established for the effect of the restatement
on minority interest for periods prior to fiscal year 2002.
The areas of restatement described in the preceding table are
expected to have the following impact on the Company's financials by
period and by segment:
Six Fiscal
Months 1999
Total Ended Fiscal Fiscal and
Restatement 6/29/02 2001 2000 prior
----------- ------- -------- -------- --------
Athletic $29.3 $2.5 $8.9 $18.4 $(0.5)
Meldisco 18.4 (1.4) 8.5 5.1 6.2
Corporate 4.6 0.4 2.4 0.5 1.3
----------- ------- -------- -------- --------
Total pre-tax 52.3 1.5 19.8 24.0 7.0
Income taxes (1) (16.2) (0.5) (6.3) (8.7) (0.7)
Minority interest (0.2) (0.2) -- -- --
----------- ------- -------- -------- --------
Total reduction to
income $35.9 $0.8 $13.5 $15.3 $6.3
=========== ======= ======== ======== ========
(1) See "Deferred Tax Assets Write-down."
Update on Financial Performance and Outlook
The Company today also updated the expectations it provided in its
September 15, 2003 press release for its operating results for the
second half of fiscal year 2002, the full fiscal year 2002, and the
first half of fiscal year 2003, as well as guidance for the full
fiscal year 2003. Since its September 15, 2003 press release, the
Company has continued to reassess all significant estimates and
judgments made in its financial statements. While the table below
reflects the Company's most current estimates regarding operating
profit, as well as the amounts by which these estimates have changed
from the Company's estimates reported in its September 15, 2003 press
release, the Company is unable at this time to provide estimates of
net income or earnings per diluted share or estimated ranges of net
income or earnings per diluted share because the restatement is
ongoing.
Q3 2002 Q4 2002 Full Year 2002
---------------- ---------------- ----------------
Current Change Current Change Current Change
-------- ------- -------- ------- -------- -------
(In millions)
Operating profit:
Meldisco $12.0 $0.9 $41.6 $(0.9) $79.3 $1.4
Athletic 5.3 (0.3) (24.6) 1.0 (24.5) 0.9
Unallocated
corporate expenses (4.5) (0.4) (0.5) -- (9.5) (0.4)
-------- ------- -------- ------- -------- -------
Footstar $12.8 $0.2 $16.5 $0.1 $45.3 $1.9
======== ======= ======== ======= ======== =======
Q1 2003 Q2 2003
---------------- ----------------
Current Change Current Change
-------- ------- -------- -------
Operating profit:
Meldisco $(11.6) $(0.6) $15.6 $(0.9)
Athletic (2.2) (0.1) (10.4) 0.1
Unallocated corporate expenses (6.3) (0.7) (1.9) 0.2
-------- ------- -------- -------
Footstar $(20.1) $(1.4) $3.3 $(0.6)
======== ======= ======== =======
Deferred Tax Asset Write-down
As discussed in the September 15, 2003 press release, in connection with the ongoing audit of its fiscal year 2002 financial statements, the Company reviewed the valuation of its deferred tax assets based on projections of its future taxable earnings. Although the Company anticipates future profitability, due to the Company's
historical losses, for accounting purposes the Company cannot rely on expected future profits to utilize its deferred tax assets. As a result, the Company could not conclude that it is more likely than not that the deferred tax assets will be realized and expects to record a
non-cash valuation allowance in the range of $74 million to $78 million, or $3.62 to $3.82 per diluted share, for fiscal year 2002 in accordance with the Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes.” This allowance will be primarily
recorded during the third quarter of fiscal year 2002 and adjusted in future periods for deferred tax activity.
Fiscal Year 2003 Outlook
In addition, the Company provided its current expectations for its
financial performance in fiscal year 2003, as follows:
- Due to the continued highly promotional retail environment in
the discount footwear market, sales are expected to be lower
than planned at Meldisco. As a result, net sales for fiscal
year 2003 are now expected to be in the range of $1,990
million to $2,020 million. The Company had previously
anticipated that net sales in fiscal year 2003 would be in the
range of $2,010 million to $2,030 million.
- The Company now expects a fiscal year 2003 operating loss in
the range of $0 to $5 million versus the previously
anticipated profit range of $0 to $10 million, after net
unallocated corporate expense of approximately $17 million and
depreciation and amortization expense of approximately $50
million. This reflects the lower than anticipated sales at
Meldisco described above, as well as additional costs related
to the delay in the completion of the investigation and
restatement, which the Company now expects to total $14
million in fiscal year 2003, compared to its previous estimate
of $12 million.
- Meldisco's operating profit for fiscal year 2003 is now
expected to be approximately $31 million versus the previously
anticipated $33 million, after depreciation and amortization
expense of approximately $16 million, due to the lower than
planned sales and higher markdowns driven by the continued
promotional environment in the discount footwear market
described above, as well as additional restatement expenses.
- The Athletic segment is now expected to produce an operating
loss of approximately $14 million in fiscal year 2003 versus
the previously anticipated $11 million, after depreciation and
amortization expenses of approximately $30 million, due to
additional expenses related to the investigation and
restatement, higher depreciation and amortization expense and
higher than anticipated losses in startup ventures such as
Consumer Direct.
- The Company's full year blended rate of interest is now
expected to be 11.4% (including increased fees) in fiscal year
2003, down slightly from the Company's previous expectation of
11.7%.
- Fiscal year end 2003 inventory is now expected to be
approximately $360 million, which is approximately the same as
expected fiscal year end 2002 inventory. The Company had
previously anticipated inventory at fiscal year end 2003 to be
$340 million. Although there are fewer stores in operation in
2003, some additional early receipts related to the timing of
the Chinese New Year factory shutdown have increased this
expected fiscal year end 2003 inventory.
