The polite nod of approval from Nike in their conference call may have given Footstar, Inc. a bit of a bump towards the end of the week, but it wasn’t enough to erase the plunge earlier that saw FTS shares down 20.2% for the week to close at $8.31 Friday.

The sharp decline was a direct result of a release early Monday morning that had Footstar reveal the preliminary results of the investigation of the company’s accounting discrepancies that sent Mickey Robinson, Foostar Chairman and CEO, packing.

The investigation, conducted by the company’s audit committee, KPMG and legal advisors, revealed that there were “significant weaknesses in the company's internal controls and procedures”, its computer systems and organizational structure. The report also cited “instances” of incorrect accounting, insufficient communication by management and the accounting staff to the company's internal and external auditors, and insufficient attention and resources directed to accounting issues.

Board member and chairman of the Audit Committee, Neele E. Stearns, Jr., has assumed the role of chairman and CEO on an interim basis due to Robinson’s departure.
One of the surprises was that the restatement of results will go far beyond the fiscal 2002 and first half 2003 periods previously referenced in the accounting probe. The issues now cover a period of five and a half years and will see the company restate financial statements for fiscal 1997 through the first half of 2002 and its business performance for fiscal year 2002 and the first half of fiscal year 2003.

The company expects to release the restated financials by October 31, 2003.

Foostar now expects that the restatement will reduce earnings by an aggregate amount ranging from $48 million to $53 million pre-minority interest and pre-taxes (or $29 million to $32 million after minority interest and taxes) over the period from fiscal year 1997 through June 2002.
The reduction in earnings is expected to include restatement adjustments relating to the accounts payable discrepancies noted now totaling approximately $46 million and approximately $2 million to $7 million in restatement adjustments in five additional accounting areas. The amount is in excess of the $35 million initially reported in November 2002 and appears to be related to issues related to the Just for Feet acquisition.

Approximately $35.8 million over the restatement period related to errors in the monthly process of reconciling the accounts payable sub-systems to the general ledger and approximately $10.3 million related to integration issues following the JFF acquisition.

The investigation also revealed that a number of system-generated reports did not properly capture all inventory that had legally been transferred to Footstar.
The 2001 fiscal year will bear the brunt of the restatement, with operating profit decreasing — and accounts payable increasing — by approximately $19.9 million. The 2001 issues were said to be caused primarily by the switch in 2000 to an electronic funds transfer system for paying vendors. For the 2000 and 2001 fiscal years, Footstar's subsidiary accounts payable systems failed to properly reflect the transfers, leading to the high level of adjustment to A/P for fiscal year 2001.

While these errors primarily affect accounts payable, inventory, fixed assets, operating profits and net income or loss, Foostar said it does not expect the restatement to affect reported revenue or net cash flow. The investigation determined that all vendors had been paid in full during the five-and-one-half year period.

For the full fiscal year 2002, FTS's net loss is expected to range between $32 million, or $1.50 per diluted share, and $34 million, or $1.60 per diluted share.

The company expects a loss for fiscal year 2003 of approximately the same amount as fiscal year 2002. For the fiscal 2003 first quarter, FTS expects a loss of 75 cents to 85 cents per diluted share. The Q2 loss per diluted share is seen in the 35 cents to 45 cents range.

Footstar Athletic is expected to generate approximately $2.1 million in operating losses in Q1 2003 as a result of sales declines at Just for Feet, expenses related to startup ventures such as Consumer Direct and Uprise, as well as bearing approximately $1.9 million of additional costs for the investigation and restatement.

The Q2 operating loss for the division is expected to be about $10.5 million due to the negative impact of traffic and comparable store sales declines at Just for Feet. The division is expected to bear $1.9 million in costs associated with the investigation and restatement.

As a result of this initial report, the company is implementing a number of “corrective actions”, including the resignation of Robinson. For one, the company has created a new SVP of Financial Reporting position that is expected to help improve the issues related to the investigation.

Footstar keeps its $325 million senior secured credit facility intact with a syndicate of banks led by Fleet National Bank. FTS has obtained a waiver from its bank group extending to October 31, 2003 its requirement to provide audited financial statements.


>>> While there is no indication of deceit or willful reporting of incorrect figures, the management team prided itself in running a tight fiscal ship. FTS is a classic example of a company that should have a split executive team at the top…