2005essentially flat as compared with 2004the corresponding prior-year period.
2008 compared with 2007
Athletic Stores sales of $5,272$4,847 million increased 5.7decreased 4.4 percent in 2005,2008, as compared with $4,989$5,071 million in 2004.2007. Excluding the effect of foreign currency fluctuations, primarily related to the euro, sales from athletic store formats increased 5.5decreased by 4.8 percent in 2005.2008. Comparable-store sales increased by 2.6for the Athletic Stores segment declined 3.6 percent as compared with prior year. The decline in 2005. These increases weresales for the year ended January 31, 2009 was primarily driven by sales related to the Footaction division, which was acquireddomestic operations as the result of a decline in May 2004. Approximately $126 million of the increasemall traffic and consumer spending in Footaction represented the inclusion of their operations for the full year in 2005. Champs Sports experienced a strong increase in sales during 2005, as this format benefited from higher quantities of marquee athletic footwear and private-label apparel. Foot Locker Canada also experienced increased sales.general. Excluding the effect of foreign currency fluctuations, Foot Locker Europe’s sales were essentially flatin Europe decreased low single digits in 2008 as compared with 2007. The sales of low profile styles negatively affected the corresponding prior-year period.first three quarters of 2008. However, during the fourth quarter of 2008, sales of higher-priced marquee footwear and apparel increased, which more than offset the sales decline related to the low profile footwear styles.
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Division profit from Athletic Stores decreased by 0.2 percent to $419reported a loss of $59 million in 2005 from $420 million in 2004. Division profit as a percentage of sales decreased to 7.9 percent in 2005 from 8.4 percent in 2004. This decline is primarily a result of the decreased profit from the European operations2008 as compared with a loss of $27 million in 2007, which was primarily attributable to the prior year.U.S. operations. Included in the results for 2008 and 2007 are impairment charges and store closing costs totaling $241 million and $128 million, respectively. Athletic Stores division loss for 2008 includes a $167 million goodwill impairment charge, a $67 million write-down of long-lived assets such as store fixtures and leasehold improvements for 868 stores at the Company’s U.S. store operations, $5 million of exit costs related to the closure of underperforming stores comprising primarily lease terminations and $2 million in other intangible impairment charges related to its tradenames. The continued weak economy,Company performs its annual impairment test as of the increased competitive environmentbeginning of each year; however, due to the macroeconomic conditions affecting retail and the significant decline in the Company’s common stock and market capitalization, plus a reasonable control premium, in relation to the book value, the Company determined that a triggering event had occurred and, therefore, performed an interim impairment test.
During 2008, the fair value of the four reporting units containing goodwill was determined under step 1 of the goodwill impairment test based on a weighting of a discounted cash flow analysis using forward-looking projections of estimated future operating results and a fashion shift from higher priced marquee footwear to lower priced low-profile footwear negatively affected Europe’s operating results. In addition during 2005,guideline company methodology under the market approach. Based on this testing, the Company determined that the fair values, as determined under step 1 as described above, was less than the carrying values of the Foot Locker, Europe recorded significantly higher markdownsKids Foot Locker and Footaction reporting unit and the Champs Sports reporting unit. Accordingly, the Company performed a step 2 analysis to determine the extent of the goodwill impairment and concluded that the goodwill of these two reporting units was fully impaired, resulting in a non-cash impairment charge of $167 million. There were no goodwill impairment charges in 2007. Excluding the impairment charges and store exit costs from both 2008 and 2007, division profit would have increased to $182 million in 2008 from $101 million in 2007. This increase in division profit primarily related to the domestic divisions as a result of the continuedlower promotional environment, particularly in the U.K.markdowns and France,reduced depreciation and to clear excess inventory. Despite these factors, in 2005 Foot Locker Europe achieved a double-digit division profit margin. The decline in Europe was partially offset by the improved results at the Footaction, Champs Sports and Canadian divisions. The increase in Footaction is primarily a result of the inclusion of its results for the full year asamortization expense.
Direct-to-Customers
 | | | | | | |
| | 2009 | | 2008 | | 2007 |
| | | (in millions) |
| Sales | | $ | 406 | | | $ | 390 | | | $ | 364 | |
| Division profit | | $ | 32 | | | $ | 43 | | | $ | 40 | |
| Division profit margin | | | 7.9 | % | | | 11.0 | % | | | 11.0 | % |
2009 compared with a partial year during 2004.2008
Direct-to-Customers
| | 2006 | | | 2005 | | | 2004 | |
| | (in millions) |
| Sales | $ | 380 | | | $ | 381 | | | $ | 366 | |
| Division profit | $ | 45 | | | $ | 48 | | | $ | 45 | |
| Sales as a percentage of consolidated total | | 7 | % | | | 7 | % | | | 7 | % |
| Division profit margin | | 11.8 | % | | | 12.6 | % | | | 12.3 | % |
2006 compared with 2005
Direct-to-Customers sales decreased to $380 million in 2006, as compared with $381 million in 2005. Internet sales increased to $270 million, increasing by 11.1 percent as compared with 2005. Catalog sales decreased by 20.3 percent to $110 million in 2006 from $138 million in 2005. Management believes that the decrease in catalog sales, which was substantially offset by the increase in Internet sales, is a result of customers browsing and selecting products through its catalogs and then making their purchases via the Internet. Sales for the Direct-to-Customer business were negatively affected by the termination of a third party arrangement in the early part of 2006.
The Direct-to-Customers business generated division profit of $45 million in 2006, as compared with $48 million in 2005. Division profit, as a percentage of sales, decreased to 11.8 percent in 2006 from 12.6 percent in 2005. Several initiatives were implemented to mitigate the loss of revenue from the cancelled third party contract, such as expanding the ESPN offerings. However, these iniatitives did not fully offset the loss in profit which resulted in a decline in division profit. The effect of the 53rd week on this segment was not significant.
2005 compared with 2004
Direct-to-Customers sales increased 4.1 percent to $381$406 million in 2005,2009, as compared with $366$390 million 2004. The growthin 2008, reflecting a comparable-store sales decrease of 6.8 percent, offset by additional sales from CCS, which was acquired during the Internet business continued to drive sales in 2005.fourth quarter of 2008. Internet sales increased by 14.66.8 percent to $243$344 million, from $212 millionas compared with 2008 reflecting continued growth in 2004.the store brands’ websites. Catalog sales decreased by 10.48.8 percent to $138$62 million in 20052009 from $154$68 million in 2004.2008. Management believes that the decrease in catalog sales, which was substantially offset by the increase in Internet sales, is a result of customers browsing and selecting products through its catalogs and then making their purchases via the Internet.
The Direct-to-Customers business generated division profit of $48$32 million in 2005,2009, as compared with $45$43 million in 2004.2008. Division profit, as a percentage of sales, increased to 12.6was 7.9 percent in 2005 from 12.32009 and 11.0 percent in 2004. This2008. Included in division profit is a $4 million impairment charge, which was recorded to write off certain software development costs as a result of management’s decision to terminate the project. Gross margin was negatively affected by the lack of close-out inventory purchases during the year. Additionally, division profit, as compared with the corresponding prior-year period, was negatively affected by $3 million in additional amortization expense related to the CCS customer list intangible asset.
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2008 compared with 2007
Direct-to-Customers sales increased 7.1 percent to $390 million in 2008, as compared with $364 million in 2007, reflecting a comparable-store sales increase of 1.0 percent and additional sales from CCS, which was acquired during the fourth quarter of 2008. Internet sales increased by 12.2 percent to $322 million, as compared with 2007. Catalog sales decreased by 11.7 percent to $68 million in 2008 from $77 million in 2007. Management believes that the decrease in catalog sales, which was substantially offset by the increase in Internet sales, is a result of customers browsing and selecting products through its catalogs and then making their purchases via the Internet.
The Direct-to-Customers business generated division profit of $43 million in 2008, as compared with $40 million in 2007. Division profit, as a percentage of sales, was 11.0 percent in 2008 and 2007. The increase in division profit reflects the Company’s alliances with third parties, such asaccretive effect of the USOC and ESPN.acquisition of CCS.
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Liquidity and Capital Resources
Liquidity
Liquidity
Generally, the Company’s primary source of cash has been from operations. The Company usuallygenerally finances real estate with operating leases. The principal uses of cash have been to fundfinance inventory requirements, capital expenditures related to store openings, store remodelings, and management information systems, and other support facilities, and other general working capital requirements.
Management believes operating cash flows and current credit facilities will be adequate to fund its working capital requirements, scheduled pensionretirement plan contributions, for the Company’s retirement plans, scheduled debt repayments, anticipated quarterly dividend payments, potential share repurchases, andinterest payments, other cash requirements to support the development of its short-term and long-term operating strategies.strategies, and to fund other working capital requirements.
Planned capital expenditures for 2007 are approximately $170 million, of which $144 million relatesManagement believes its cash, cash equivalents, future cash flow from operations, and the Company’s current revolving credit facility will be adequate to new store openings and modernizations of existing stores, and $26 million reflects the development of information systemsfund these requirements. The Company may also from time to time repurchase its common stock or seek to retire or purchase outstanding debt through open market purchases, privately negotiated transactions or otherwise. Such repurchases, if any, will depend on prevailing market conditions, liquidity requirements, contractual restrictions and other support facilities.factors. The Company has the ability to revise and reschedule the anticipated capital expenditure program, shouldamounts involved may be material. On February 16, 2010, the Company’s financial position require it.Board of Directors approved the extension of the Company’s 2007 common share repurchase program for an additional three years in the amount of $250 million.
Maintaining access to merchandise that the Company considers appropriate for its business may be subject to the policies and practices of its key vendors. Therefore, the Company believes that it is critical to continue to maintain satisfactory relationships with its key vendors. The Company purchased approximately 7882 percent in 20062009 and 7580 percent in 20052008 of its merchandise from its top five vendors in each respective year, and expects to continue to obtain a significant percentage of its athletic product from these vendors in future periods. Approximately 5068 percent in 20062009 and 4964 percent in 20052008 was purchased from one vendor — Nike, Inc. During 2006, two
Planned capital expenditures for 2010 are approximately $103 million, of our key vendors merged,which $65 million relates to modernizations of existing stores and new store openings, and $38 million reflects the development of information systems and other support facilities. In addition, planned lease acquisition costs related to the Company’s purchases from this vendor totaled 14 percent.operations in Europe are $7 million. The Company has the ability to revise and reschedule the anticipated capital expenditure program, should the Company’s financial position require it.
Any materiallymaterial adverse change in customer demand, fashion trends, competitive market forces or customer acceptance of the Company’s merchandise mix and retail locations, uncertainties related to the effect of competitive products and pricing, the Company’s reliance on a few key vendors for a significant portion of its merchandise purchases, and risks associated with foreign global sourcing or economic conditions worldwide could affect the ability of the Company to continue to fund its needs from business operations.
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Cash Flow
Operating activities from continuing operations provided cash of $189$346 million in 20062009 as compared with $349$383 million in 2005.2008. These amounts reflect income from continuing operations adjusted for non-cash items and working capital changes. During 2006,2009, the Company recorded a non-cash impairment chargeand other charges of $17$36 million primarily related to the operations in Europe. The decline in operating cash flowsimpairment of $160 million is primarily due to a reduction of accounts payable at year-end reflecting an acceleration of inventory receipts earlierstore-level assets in the fourth quarterdomestic operations. Merchandise inventories represented a $111 million source of 2006. In addition, duecash in 2009 as inventory purchases were reduced to keep inventory levels in line with sales as well as reflecting the calendar shift related to the 53rd week, approximately $47 millionaffect of the decline represents the timing of lease payments. Additionally,store closings. During 2009, the Company contributed $68$100 million to its U.S. and Canadian qualified pension plans in 2006, as compared with contributions$6 million contributed in 2008. Additionally, during 2009 the Company terminated its interest rate swaps for a gain of $26$19 million. The other changes primarily reflect the timing of February 2010 rent payments, which totaled $34 million and were due and paid in 2005.2010 as compared with the February 2009 rent payments that were due and paid in 2008, as well as income tax refunds of $32 million.
Operating activities from continuing operations provided cash of $349$383 million in 20052008 as compared with $272$283 million in 2004. The net increase in operating cash flows2007. During 2008, the Company recorded non-cash impairment charges and store closing program costs of $77$259 million is primarily due to improved operating performance and changes in working capital primarily related to changesits domestic operations. Merchandise inventories represented a $128 million source of cash in merchandise inventories, offset by2008 as inventory purchases were reduced to keep inventory levels in line with sales. Additionally, the related payables and lowerCompany contributed $6 million to its Canadian qualified pension contributions of $26 millionplan in 2005 as compared with $106 million in 2004.2008.
Net cash used inby investing activities of the Company’s continuing operations was $108$72 million in 20062009 as compared with $182$272 million used in 2005. The Company’s purchaseinvesting activities in 2008. During 2009, the Company received $16 million from the Reserve International Liquidity Fund representing further redemptions. Capital expenditures were $89 million primarily related to store remodeling and to the development of short-term investments, netinformation systems and other support facilities, representing a decrease of sales, decreased by $49$57 million in 2006 as compared with an increasethe prior year. The Company made a strategic decision to conserve cash in 2009 and, therefore, reduced capital spending, focusing on projects that improved the customer experience.
Net cash used by investing activities of $31the Company’s continuing operations was $272 million in 2005.2008 as compared with $117 million provided by investing activities in 2007. The net cash used by investing activities for 2008 reflects the asset purchase from dELiA*s, Inc. of CCS for $106 million (including capitalized acquisition costs). Investing activities in 2008 also included a $3 million gain related to the sale of two lease interests in Europe. The Company did not purchase or sell short-term investments during 2008. Reflected in investing activities in 2008 is the reclassification of the $23 million investment in the Reserve International Liquidity Fund from cash and cash equivalents to short-term investments. Capital expenditures of $165$146 million in 20062008 and $155$148 million in 20052007 were primarily related to store remodeling and new stores. During 2006, the Company received net proceeds of $4 million as a result of a lease termination. The Company also received $4 million of insurance proceeds from its insurance carriers related to the final settlement of the property and equipment claims for the 2005 hurricane.
Net cash used in investing activities of the Company’s continuing operations was $182 million in 2005 as compared with $407 million in 2004. During 2004, the Company paid $226 million for the purchase of 349 Footaction stores from Footstar, Inc. and paid €13 million (approximately $16 million) for the purchase of 11 stores in the Republic of Ireland.
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During 2005, the Company received $1 million from an escrow account upon the resolution of a Footaction lease matter relating to the 2004 acquisition. The Company’s purchase of short-term investments, net of sales, increased by $31 million in 2005 as compared with an increase of $9 million in 2004. Capital expenditures of $155 million in 2005 and $156 million in 2004 primarily related to store remodeling and new stores. The Company also received $3 million of insurance proceeds related to the hurricanes in 2005, representing the portion of insurance recoveries in excess of losses recorded.
Net cash used in financing activities of continuing operations was $142$94 million in 20062009 as compared with $105$185 million in 2005.2008. During 2006,2009 and 2008, the Company repaid $50purchased and retired $3 million and $6 million, respectively, of its 8.50 percent debentures. During 2008, the Company reduced its long-term debt by repaying the balance of its term loan and purchased and retired $38 million of its 8.50 percent debentures payable in 2022 at a $2 million discount from face value. As required by SFAS No. 123(R),$88 million. Additionally, the Company recorded an excess tax benefit related to stock-based compensation of $2 million as a financing activity. The Company declared and paid dividends totaling $61$94 million and $93 million in 20062009 and $49 million2008, respectively, representing a quarterly rate of $0.15 per share in 2005.both 2009 and 2008. During 20062009 and 2005,2008, the Company received proceeds from the issuance of common stock and treasury stock in connection with the employee stock programs of $12$3 million and $14$2 million, respectively. On February 15, 2006, the Company announced that its Board of Directors authorized a $150 million, three-year share repurchase program. This program was subsequently terminated on March 7, 2007, upon the Board of Directors authorization of a new $300 million, three-year share repurchase program. Under the share repurchase program, subject to legal and contractual restrictions, the Company may make purchases of its common stock, from time to time, depending on market conditions, availability of other investment opportunities and other factors. During 2006, the Company purchased 334,200 shares of its common stock for approximately $8 million.
Net cash used in financing activities of continuing operations was $105$185 million in 20052008 as compared with net cash provided of $167$138 million in 2004.2007. The Company repaid $35 million of its 5-year, $175 million term loan during 2005 and declared and paid dividends totaling $49$93 million in 20052008 and $39$77 million in 2004.2007. During 20052008 and 2004,2007, the Company received proceeds from the issuance of common stock and treasury stock in connection with the employee stock programs of $14$2 million and $33$9 million, respectively. As part
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Capital Structure
Credit Agreement
On March 20, 2009, the Company entered into a new credit agreement (the “2009 Credit Agreement”) with its banks, providing for a $200 million asset-based revolving credit facility maturing on March 20, 2013, which replaced the Company’s prior credit agreement. The 2009 Credit Agreement also provides for an incremental facility of up to $100 million under certain circumstances. The 2009 Credit Agreement provides for a security interest in certain of the $50 million stock repurchase program in effect in 2005,Company’s domestic assets, including certain inventory assets. The Company is not required to comply with any financial covenants as long as there are no outstanding borrowings. If the Company purchased 1.6 million shares of its common stock during 2005 for approximately $35 million.
Capital Structure
During 2004, the Company obtained a 5-year, $175 million term loan to finance a portion of the purchase price of the Footaction stores. Concurrent with the financing of a portion of the Footaction acquisition, the Company amended its revolving credit agreement, thereby extending the maturity date to May 2009 from July 2006. The agreement includes various restrictive financial covenants with which the Company was in compliance on February 3, 2007. During 2005, the Company prepaid the first and second principal payments totaling $35 million, which would have been due in May 2005 and May 2006. During 2006, the Company repaid an additionalis borrowing, then it may not make Restricted Payments, such as dividends or share repurchases, unless there is at least $50 million of Excess Availability (as defined in the term loan, thereby reducing2009 Credit Agreement), and the loanCompany’s projected fixed charge coverage ratio, which is a Non-GAAP financial ratio pursuant to $90 million.
During 2006, the Company purchased and retired $38 million of the $200 million 8.50 percent debentures payable in 2022 at2009 Credit Agreement designed as a $2 million discount from face value bringing the outstanding amount to $134 million as of February 3, 2007.
In 2004, the Company redeemed its entire $150 million 5.50 percent convertible subordinated notes. All of the convertible subordinated notes were cancelled and approximately 9.5 million new sharesmeasure of the Company’s common stock were issued.ability to meet current and future obligations (Consolidated EBITDA less capital expenditures less cash taxes divided by Debt Service Charges and Restricted Payments), is at least 1.1 to 1.0. The Company reclassifiedCompany’s management does not currently expect to borrow under the remaining $3 millionfacility in 2010.
Credit Rating
As of unamortized deferred costs related toMarch 29, 2010, the original issuance of the convertible debt to equity as a result of the conversion.
Credit Rating
The Company’s corporate credit ratings from Standard & Poor’s and Moody’s Investors Service are BB+B+ and Ba1,Ba3, respectively. Additionally, as of March 29, 2010, Moody’s Investors Service has rated the Company’s senior unsecured notes B1.
Debt Capitalization and Equity
For purposes of calculating debt to total capitalization, the Company includes the present value of operating lease commitments. These commitments in total net debt. Total net debt including the present value of operating leases is considered a non-GAAP financial measure. The present value of operating leases is discounted using various interest rates ranging from 4 percent to 15 percent, which represent the Company’s incremental borrowing rate at inception of the lease. Operating leases are the primary financing vehicle forused to fund store expansion and, therefore, we believe that the Company. inclusion of the present value of operating leases in total debt is useful to our investors, credit constituencies, and rating agencies.
The following table sets forth the components of the Company’s capitalization, both with and without the present value of operating leases:
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| | | | |
| | 2009 | | 2008 |
| | | (in millions) |
| Long-term debt | | $ | 138 | | | $ | 142 | |
| Present value of operating leases | | | 1,923 | | | | 1,952 | |
| Total debt including the present value of operating leases | | | 2,061 | | | | 2,094 | |
Less:
| | | | | | | | |
| Cash and cash equivalents | | | 582 | | | | 385 | |
| Short-term investments | | | 7 | | | | 23 | |
| Total net debt including the present value of operating leases | | | 1,472 | | | | 1,686 | |
| Shareholders’ equity | | | 1,948 | | | | 1,924 | |
| Total capitalization | | $ | 3,420 | | | $ | 3,610 | |
| Total net debt capitalization percent including the present value of operating leases | | | 43.0 | % | | | 46.7 | % |
| | 2006 | | | 2005 | |
| | (in millions) |
| Cash, cash equivalents and short-term investments, net of debt and | | | | | | | |
| capital lease obligations | $ | 236 | | | $ | 261 | |
| Present value of operating leases | | 2,069 | | | | 1,934 | |
| Total net debt | | 1,833 | | | | 1,673 | |
| Shareholders’ equity | | 2,295 | | | | 2,027 | |
| Total capitalization | $ | 4,128 | | | $ | 3,700 | |
| Net debt capitalization percent | | 44.4 | % | | | 45.2 | % |
| Net debt capitalization percent without operating leases | | — | % | | | — | % |
Excluding the present value of operating leases, the Company’s cash, cash equivalents, and short-term investments, net of debt and capital lease obligations, decreased to $236 million at February 3, 2007 from $261 million at January 28, 2006. TABLE OF CONTENTS
The Company reduced debt and capital lease obligations by $92$4 million and decreasedincreased cash, cash equivalents, and short-term investments by $117 million.$181 million during 2009. Additionally, the present value of the operating leases increaseddecreased by $135$29 million representing the net changeeffect of the store closures, offset, in part, by lease renewals and the effect of foreign currency fluctuations primarily related to the euro.translation. Including the present value of operating leases, the Company’s net debt capitalization percent decreased 80370 basis points in 2006.2009. The increase in shareholders’ equity of $24 million in 2009 primarily relates to the following: net income of $251$48 million, $94 million in 2006,dividends paid, $17 million related to stock plans, and an increase of $27 million in the foreign exchange currency translation adjustment, primarily related to the value of the euro in relation to the U.S. dollar and a decrease of $6 million resulting from the adoption of SAB 108. The Company recorded a reduction to shareholders’ equity as permitted by SAB 108 to correct for previous misstatements. The Company declared and paid dividends totaling $61 million during 2006. The Company repurchased 334,200 million shares for approximately $8 million during the year. During 2006, the Company adopted SFAS No. 158 which resulted in the elimination of the additional minimum liability adjustment of $181 million. SFAS No.158 requires that unamortized prior service cost and unamortized gains or losses for both the pension and postretirement plans, which totaled $133 million, be recognized as a component of other comprehensive income. The Company contributed $51 million and $17 million to the Company’s U.S. and Canadian qualified pension plans, respectively, in 2006.
Excluding the present value of operating leases, the Company’s cash, cash equivalents and short-term investments, net of debt and capital lease obligations, increased to $261 million at January 28, 2006 from $127 million at January 29, 2005. The Company reduced debt and capital lease obligations by $39 million, while increasing cash, cash equivalents and short-term investments by $95 million. Additionally, the present value of the operating leases decreased by $55 million representing the net change of lease renewals, the effect of foreign currency fluctuations primarily related to the euro and the result of the closure of 25 stores due to the hurricanes. Including the present value of operating leases, the Company’s net debt capitalization percent decreased 520 basis points in 2005. The increase in shareholders’ equity relates to net income of $264 million in 2005, $26 million related to stock plans, and a decrease of $25$65 million in the foreign exchange currency translation adjustment, primarily related to the value of the euro in relation to the U.S. dollar. The Company declared and paid dividends totaling $49 millionIn addition, during 2005.The Company repurchased approximately 1.6 million shares for $35 million during the year. During 2005,2009 the Company reduced its minimum liability forrecognized, within accumulated other comprehensive loss, amortization of prior service costs and net actuarial gains and losses, as well as an additional charge representing the Company’s pension plans by $15 million, primarily as a resultchange in the funded status of the plans’ asset performance. The Company contributed $19pension and postretirement plans, which totaled $13 million and $7 million to the Company’s U.S. and Canadian qualified pension plans, respectively, in 2005.after-tax.
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Contractual Obligations and Commitments
The following tables represent the scheduled maturities of the Company’s contractual cash obligations and other commercial commitments as of February 3, 2007:at January 30, 2010:
(1) | (1) | The amounts presented above represent the contractual maturities of the Company’s long-term debt, excluding interest. Additional information is included in the “Long-Term Debt and Obligations under Capital Leases” footnoteDebt” note under “Item 8. Consolidated Financial Statements and Supplementary Data.” |
|
| (2) | The amounts presented represent the future minimum lease payments under non-cancelable operating leases. In addition to minimum rent, certain of the Company’s leases require the payment of additional costs for insurance, maintenance, and other costs. These costs have historically represented approximately 25 to 30 percent of the minimum rent amount. These additional amounts are not included in the table of contractual commitments as the timing and/or amounts of such payments are unknown. |
| (3) | The Company’s other liabilities in the Consolidated Balance Sheet as of February 3, 2007at January 30, 2010 primarily comprise pension and postretirement benefits, deferred rent liability, income taxes, workers’ compensation and general liability reserves and various other accruals. TheseThe amounts presented in the table are comprised of the Company’s 2010 Canadian qualified plan contributions of $2 million and the liability related to the European net investment hedge of $24 million. The European net investment agreement includes a provision that may require the Company to settle this transaction in August 2010, at the option of the Company or the counterparty. This is the first of a series of annual settlement provisions until August 2015. Other than these liabilities, other amounts (including the Company’s unrecognized tax benefits of $39 million) have been excluded from the above table as the timing and/or amount of any cash payment is uncertain. The timing of the remaining amounts that are known havehas not been included as they are minimal and not useful to the presentation. Additional information is included in the “Other Liabilities” footnoteLiabilities, Financial Instruments and Risk Management,” and “Retirement Plans and Other Benefits” notes under “Item 8. Consolidated Financial Statements and Supplementary Data.” |
| | | | | | | | | | |
| | Total
Amounts
Committed | | Amount of Commitment Expiration by Period |
| Other Commercial Commitments | | Less than
1 Year | | 2 – 3
Years | | 3 – 5
Years | | After 5
Years |
| | | (in millions) |
| Unused line of credit(4) | | $ | 190 | | | $ | — | | | $ | — | | | $ | 190 | | | $ | — | |
| Standby letters of credit | | | 10 | | | | — | | | | — | | | | 10 | | | | — | |
| Purchase commitments(5) | | | 1,412 | | | | 1,412 | | | | — | | | | — | | | | — | |
| Other(6) | | | 57 | | | | 28 | | | | 27 | | | | 2 | | | | — | |
| Total commercial commitments | | $ | 1,669 | | | $ | 1,440 | | | $ | 27 | | | $ | 202 | | | $ | — | |
| (4) | Represents the unused domestic lines of credit pursuant to the Company’s $200 million revolving credit agreement. The Company’s management currently does not expect to borrow under the facility in 2010. |
| | Total | | Amount of Commitment Expiration by Period |
| | Amounts | | Less than | | 2 –3 | | 3 –5 | | After 5 |
| Other Commercial Commitments | | Committed | | 1Year | | Years | | Years | | Years |
| | (in millions) |
| Line of credit | $ | 186 | | | $ | — | | | $ | 186 | | $ | — | | $ — |
| Stand-by letters of credit | | 14 | | | | — | | | | 14 | | | — | | — |
| Purchase commitments(3) | | 1,676 | | | | 1,670 | | | | 5 | | | 1 | | — |
| Other(4) | | 53 | | | | 25 | | | | 21 | | | 7 | | — |
| Total commercial commitments | $ | 1,929 | | | $ | 1,695 | | | $ | 226 | | $ | 8 | | $ — |
| ____________________ | | | | | | | | | | | | | | | |
(3) | (5) | Represents open purchase orders, as well as minimum requiredother commitments for merchandise purchases, under merchandise contractual agreements, at February 3, 2007.January 30, 2010. The Company is obligated under the terms of purchase orders; however, the Company is generally able to renegotiate the timing and quantity of these orders with certain vendors in response to shifts in consumer preferences. |
|
(4) | | (6) | Represents minimum payments required by non-merchandise purchase agreements and minimum royalty requirements.agreements. |
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The Company does not have any off-balance sheet financing, other than operating leases entered into in the normal course of business as disclosed above, or unconsolidated special purpose entities. The Company does not participate in transactions that generate relationships with unconsolidated entities or financial partnerships, including variable interest entities. The Company’s policy prohibits the use of derivatives for which there is no underlying exposure.
In connection with the sale of various businesses and assets, the Company may be obligated for certain lease commitments transferred to third parties and pursuant to certain normal representations, warranties, or indemnifications entered into with the purchasers of such businesses or assets. Although the maximum potential amounts for such obligations cannot be readily determined, management believes that the resolution of such contingencies will not significantly affect the Company’s consolidated financial position, liquidity, or results of operations. The Company is also operating certain stores for which lease agreements are in the process of being negotiated with landlords. Although there is no contractual commitment to make these payments, it is likely that leases will be executed.
Critical Accounting Policies
Management’s responsibility for integrity and objectivity in the preparation and presentation of the Company’s financial statements requires diligent application of appropriate accounting policies. Generally, the Company’s accounting policies and methods are those specifically required by U.S. generally accepted accounting principles (“GAAP”).principles. Included in the “Summary of Significant Accounting Policies” footnotenote in “Item 8. Consolidated Financial
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Statements and Supplementary Data” is a summary of the Company’s most significant accounting policies. In some cases, management is required to calculate amounts based on estimates for matters that are inherently uncertain. The Company believes the following to be the most critical of those accounting policies that necessitate subjective judgments.
Merchandise Inventories
Merchandise inventories for the Company’s Athletic Stores are valued at the lower of cost or market using the retail inventory method. The retail inventory method (“RIM”). The RIM is commonly used by retail companies to value inventories at cost and calculate gross margins due to its practicality. Under the retail method, cost is determined by applying a cost-to-retail percentage across groupings of similar items, known as departments. The cost-to-retail percentage is applied to ending inventory at its current owned retail valuation to determine the cost of ending inventory on a department basis. The RIM is a system of averages that requires management’s estimates and assumptions regarding markups, markdowns and shrink, among others, and as such, could result in distortions of inventory amounts.
Significant judgment is required for these estimates and assumptions, as well as to differentiate between promotional and other markdowns that may be required to correctly reflect merchandise inventories at the lower of cost or market. The Company provides reserves based on current selling prices when the inventory has not been marked down to market. The failure to take permanent markdowns on a timely basis may result in an overstatement of cost under the retail inventory method. The decision to take permanent markdowns includes many factors, including the current environment, inventory levels and the age of the item. Management believes this method and its related assumptions, which have been consistently applied, to be reasonable.
Vendor Reimbursements
In the normal course of business, the Company receives allowances from its vendors for markdowns taken. Vendor allowances are recognized as a reduction in cost of sales in the period in which the markdowns are taken. The effect of vendorVendor allowances was an improvement incontributed 30 basis points to the 2009 gross margin in 2006, as a percentage of sales, of 20 basis points as compared with 2005.rate. The Company also has volume-related agreements with certain vendors, under which it receives rebates based on fixed percentages of cost purchases. These volume-related rebates are recorded in cost of sales when the product is sold and they contributed 10 basis pointswere not significant to the 20062009 gross margin rate.
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The Company receives support from some of its vendors in the form of reimbursements for cooperative advertising and catalog costs for the launch and promotion of certain products. The reimbursements are agreed upon with vendors for specific advertising campaigns and catalogs. Cooperative income, to the extent that it reimburses specific, incremental and identifiable costs incurred to date, is recorded in SG&A in the same period as the associated expenses are incurred. Reimbursements received that are in excess of specific, incremental and identifiable costs incurred to date are recognized as a reduction to the cost of merchandise and are reflected in cost of sales as the merchandise is sold. Cooperative reimbursements amounted to approximately 27 percent and 11 percent of total advertising costs in 2006 and approximately 9 percent of catalog costs, respectively, in 2006.2009.
Impairment of Long-Lived Assets, Goodwill and Other Intangibles
In accordance with SFAS No. 144, theThe Company recognizes an impairment loss when circumstances indicate that the carrying value of long-lived tangible and intangible assets with finite lives may not be recoverable. Management’s policy in determining whether an impairment indicator exists, a triggering event, comprises measurable operating performance criteria at the division level as well as qualitative measures. If an analysis is necessitated by the occurrence of a triggering event, the Company uses assumptions, which are predominately identified from the Company’s three-year strategic plans, in determining the impairment amount. TheIn the calculation of the fair value of long-lived assets, is based onthe Company compares the carrying amount of the asset with the estimated expected discounted future cash flows expected to result from the use of the asset. If the carrying amount of the asset exceeds the estimated expected undiscounted future cash flows, the Company measures the amount of the impairment by store, whichcomparing the carrying amount of the asset with its estimated fair value. The estimation of fair value is generally measured by discounting the expected future cash flows at the Company’s weighted-average cost of capital. Management believes its policy is reasonable and is consistently applied. Future expected cash flows are based upon estimates that, if not achieved, may result in significantly different results. For the year ended January 30, 2010, the Company recorded non-cash impairment charges totaling $36 million. A charge of $32 million was recorded to write-down long-lived assets such as store fixtures and leasehold improvements, at its Lady Foot Locker, Kids Foot Locker, Footaction and Champs Sports divisions for 787 stores. Additionally, the Company recorded a charge of $4 million to write off certain software development costs for the Direct-to-Customers segment as a result of management’s decision to terminate this project. For the year ended January 31, 2009, the Company recorded non-cash impairment charges totaling $67 million primarily to write-down long-lived assets, such as store fixtures and leasehold improvements, for the Company’s U.S. store operations.
The Company is required to performperforms an impairment review of its goodwill and intangible assets with indefinite lives if impairment indicators arise and, at leasta minimum, annually. We consider many factors in evaluating whether the carrying value of goodwill may not be recoverable, including declines in stock price and market capitalization in relation to the book value of the Company and macroeconomic conditions affecting retail. The Company has chosen to perform this review at the beginning of each fiscal year, and it is done in a two-step approach. The initial step requires that the carrying value of each reporting unit be compared with its estimated fair value. The second step — to evaluate goodwill of a reporting unit for impairment — is only required if the carrying value of that reporting unit
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exceeds its estimated fair value. The fair value of each of the Company’s reporting units exceeded its carrying value as of the beginning of the year. The Company used a combination of a discounted cash flow approach and market-based approach to determine the fair value of a reporting unit. The latterdetermination of discounted cash flows of the reporting units and assets and liabilities within the reporting units requires us to make significant estimates and assumptions. These estimates and assumptions primarily include, but are not limited to, the discount rate, terminal growth rates, earnings before depreciation and amortization, and capital expenditures forecasts. The market approach requires judgment and uses one or more methods to compare the reporting unit with similar businesses, business ownership interests or securities that have been sold. Due to the inherent uncertainty involved in making these estimates, actual results could differ from those estimates.
During 2006,The Company assigned discount rates ranging from 12 to 14 percent for the four reporting units. The Company evaluated the merits of each significant assumption, both individually and in the aggregate, used to determine the fair value of the reporting units, as well as the fair values of the corresponding assets and liabilities within the reporting units, and concluded they are reasonable and are consistent with prior valuations.
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Owned trademarks and tradenames that have been determined to have indefinite lives are not subject to amortization but are reviewed at least annually for potential impairment. The fair values of purchased intangible assets are estimated and compared to their carrying values. We estimate the fair value of these intangible assets based on an income approach using the relief-from-royalty method. This methodology assumes that, in lieu of ownership, a third party would be willing to pay a royalty in order to exploit the related benefits of these types of assets. This approach is dependent on a number of factors, including estimates of future growth and trends, royalty rates in the category of intellectual property, discount rates and other variables. We base our fair value estimates on assumptions we believe to be reasonable, but which are unpredictable and inherently uncertain. Actual future results may differ from those estimates. We recognize an impairment loss when the estimated fair value of the intangible asset is less than the carrying value.
The Company’s review of goodwill and other intangible assets did not result in any impairment charges for the year ended January 30, 2010 as the fair value of each of the reporting units substantially exceeds its carrying value. The Company recorded annon-cash impairment charge of $17charges totaling $169 million ($12 million after-tax) to write-down long-lived assets such as store fixtures and leasehold improvements in 69 stores infor the European operations to their estimated fair value.year ended January 31, 2009.
Share-Based Compensation
The Company estimates the fair value of options granted using the Black-Scholes option pricing model. The Company estimates the expected term of options granted using its historical exercise and post-vesting employment termination patterns, which the Company believes are representative of future behavior. Changing the expected term by one year changes the fair value by 103 to 156 percent depending if the change was an increase or decrease to the expected term. The Company estimates the expected volatility of its common stock at the grant date using a weighted-average of the Company’s historical volatility and implied volatility from traded options on the Company’s common stock. A 50 basis point change in volatility would have a 1 percent change to the fair value. The risk-free interest rate assumption is determined using the Federal Reserve nominal rates for U.S. Treasury zero-coupon bonds with maturities similar to those of the expected term of the award being valued.
The expected dividend yield is derived from the Company’s historical experience. A 50 basis point change to the dividend yield would change the fair value by approximately 54 percent. The Company records stock-based compensation expense only for those awards expected to vest using an estimated forfeiture rate based on its historical pre-vesting forfeiture data, which it believes are representative of future behavior, and periodically will revise those estimates in subsequent periods if actual forfeitures differ from those estimates.
The Black-Scholes option pricing valuation model requires the use of subjective assumptions. Changes in these assumptions can materially affect the fair value of the options. The Company may elect to use different assumptions under the Black-Scholes option pricing model in the future if there is a difference between the assumptions used in determining stock-based compensation cost and the actual factors that become known over time.
The guidance in SFAS No. 123(R) is relatively new and best practices are not well established. The application of these principles may be subject to further interpretation and refinement over time. There are significant differences among valuation models and there is a possibility that the Company will adopt different valuation models and assumptions in the future. This may result in both a lack of comparability with other companies that use different models, methods, and assumptions, and in a lack of consistency in future periods.
Pension and Postretirement Liabilities
The Company determines its obligations for pension and postretirement liabilities based upon assumptions related to discount rates, expected long-term rates of return on invested plan assets, salary increases, age, and mortality, among others. Management reviews all assumptions annually with its independent actuaries, taking into consideration existing and future economic conditions and the Company’s intentions with regard to the plans. Management believes that its estimates for 2006,2009, as disclosed in the “Retirement Plans and Other Benefits” note in “Item 8. Consolidated Financial Statements and Supplementary Data,” to be reasonable.
Long-Term Rate of Return Assumption - The expected long-term rate of return on invested pension plan assets is a component of pension expense and theexpense. The rate is based on the plans’ weighted-average target asset allocation, of 64 percent equity securities and 36 percent fixed income investments, as well as historical and future expected performance of those assets. The target asset allocation is selected to obtain an investment return that is sufficient to cover the expected benefit payments based on the timing of settlements and to reduce future contributions by the Company. The Company’s common stock represented approximately 1one percent of the total pension plans’ assets at February 3, 2007.January 30, 2010.
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The weighted-average long-term rate of return used to determine 2009 pension expense was 7.63 percent. A decrease of 50 basis points in the weighted-average expected long-term rate of return would have increased 20062009 pension expense by approximately $3 million. The actual return on plan assets in a given year may differtypically differs from the expected long-term rate of return, and the resulting gain or loss is deferred and amortized into the plans’ performanceexpense over time.
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Discount Rate - An assumed discount rate is used to measure the present value of future cash flow obligations of the plans and the interest cost component of pension expense and postretirement income. The discount rate selected to measure the present value of the Company’s U.S. benefit obligations as of February 3, 2007at January 30, 2010 was derived using a cash flow matching method whereby the Company comparesmatches the plans’ projected payment obligations by year with the corresponding yield on the Citibank Pension Discount Curve. The cash flows are then discounted to their present value and an overall discount rate is determined. The discount rate selected to measure the present value of the Company’s Canadian benefit obligations at January 30, 2010 was developed by using the plan’s bond portfolio indices, which match the benefit obligations.
The weighted-average discount rates used to determine the 2009 benefit obligations related to the Company’s pension and postretirement plans were 5.25 percent and 4.90 percent, respectively. A decrease of 50 basis points in the weighted-average discount rate would have increased the accumulated benefit obligation as of February 3, 2007 of the pension planplans at January 30, 2010 by approximately $28$26 million, andwhile the effect on the postretirement plan would not behave been significant. Such a decrease would not have significantly changed 20062009 pension expense or postretirement income.
There is limited risk to the Company for increases in healthcarehealth care costs related to the postretirement plan as, beginning in 2001, new retirees have assumed the full expected costs and then existing retirees and futurethen-existing retirees have assumed all increases in such costs.
The Company expects to record postretirement income of approximately $8$6 million and pension expense of approximately $6$23 million in 2007.2010.
Income Taxes
In accordance with GAAP, deferred tax assets are recognized for tax credit and net operating loss carryforwards, reduced by a valuation allowance, which is established when it is more likely than not that some portion or all of the deferred tax assets will not be realized. Management is required to estimate taxable income for future years by taxing jurisdiction and to use its judgment to determine whether or not to record a valuation allowance for part or all of a deferred tax asset. Estimates of taxable income are based upon the Company’s three-year strategic plans. A one percent change in the Company’s overall statutory tax rate for 20062009 would have resulted in a $3$10 million change in the carrying value of the net deferred tax asset and a corresponding charge or credit to income tax expense depending on whether such tax rate change was a decrease or an increase.
The Company has operations in multiple taxing jurisdictions and is subject to audit in these jurisdictions. Tax audits by their nature are often complex and can require several years to resolve. Accruals of tax contingencies require management to make estimates and judgments with respect to the ultimate outcome of tax audits. Actual results could vary from these estimates.
The Company expects its 20072010 effective tax rate to be approximately 37.5range from 36 to 37 percent. The actual rate will primarily depend upon the percentage of the Company’s income earned in the United States as compared with international operations.
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Recent Accounting Pronouncements
In July of 2009, the Company adopted the FASB Accounting Standards Codification (“Codification”), which establishes the Codification as the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in conformity with GAAP. The Company exited four business segments as part of its discontinuation and restructuring programs. The final discontinued segment and disposition of the restructured businesses were completed in 2001. In order to identify and calculate the associated costs to exit these businesses, management made assumptions regarding estimates of future liabilities for operating leases and other contractual agreements, the net realizable value of assets held for sale or disposalhistorical GAAP hierarchy was eliminated and the fair valueCodification became the only level of non-cash consideration received.authoritative GAAP, other than guidance issued by the SEC. The Company has settled the majority of these liabilities and the remaining activity relates to the disposition of the residual lease liabilities.
As a result of achieving divestiture accountingFASB will not issue new standards in the fourth quarterform of 2002,Statements, FASB Staff Positions or Emerging Issues Task Force Abstracts. Instead, it will issue Accounting Standards Updates (“ASUs”). ASUs will serve to update the Northern Group note was recorded at its fair value. The Company is required to reviewCodification, provide background information about the collectibility ofguidance and provide the note based upon various criteria such as the credit-worthiness of the issuer or a delay in payment of the principal or interest. Future adjustments, if any, to the carrying value of the note will be recorded pursuant to SEC Staff Accounting Bulletin Topic 5:Z:5, “Accounting and Disclosure Regarding Discontinued Operations,” which requiresbasis for conclusions on changes in the carrying value of assets received as consideration fromCodification. The Codification was effective for all financial statements issued for interim and annual periods ending after September 15, 2009. Accordingly, the disposal of a discontinued operation to be classified within continuing operations. The Company has evaluated the projected performance of the business and will continuereflected all necessary changes in this filing.
Recently issued accounting pronouncements did not, or are not believed by management to, monitor its results during the coming year. At February 3, 2007, CAD$15.5 million remains outstandinghave a material effect on the note, the fair value of which is US$11 million.Company’s present or future consolidated financial statements.
The remaining discontinued reserve balances at February 3, 2007 totaled $15 million of which $3 million is expected to be utilized within the next twelve months. The remaining repositioning and restructuring reserves totaled $4 million at February 3, 2007, whereby $1 million is expected to be utilized within the next twelve months.
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Disclosure Regarding Forward-Looking Statements
This report contains forward-looking statements within the meaning of the federal securities laws. All statements, other than statements of historical facts, which address activities, events or developments that the Company expects or anticipates will or may occur in the future, including, but not limited to, such things as future capital expenditures, expansion, strategic plans, financial objectives, dividend payments, stock repurchases, growth of the Company’s business and operations, including future cash flows, revenues and earnings, and other such matters are forward-looking statements. These forward-looking statements are based on many assumptions and factors detailed in the Company’s filings with the Securities and Exchange Commission, including the effects of currency fluctuations, customer demand, fashion trends, competitive market forces, uncertainties related to the effect of competitive products and pricing, customer acceptance of the Company’s merchandise mix and retail locations, the Company’s reliance on a few key vendors for a majority of its merchandise purchases (including a significant portion from one key vendor), pandemics and similar major health concerns, unseasonable weather, further deterioration of global financial markets, economic conditions worldwide, further deterioration of business and economic conditions, any changes in business, political and economic conditions due to the threat of future terrorist activities in the United States or in other parts of the world and related U.S. military action overseas, the ability of the Company to execute effectively its strategic plan and its business plans effectively with regard to each of its business units, and risks associated with foreign global sourcing, including political instability, changes in import regulations, and disruptions to transportation services and distribution.
Any changes in such assumptions or factors could produce significantly different results. The Company undertakes no obligation to update forward-looking statements, whether as a result of new information, future events, or otherwise.
| Item 7A. | Quantitative and Qualitative Disclosures About Market Risk |
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Information regarding interest rate risk management and foreign exchange risk management is included in the “Financial Instruments and Risk Management” footnotenote under “Item 8. Consolidated Financial Statements and Supplementary Data.”
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Item 8. Consolidated Financial Statements and Supplementary Data
MANAGEMENT’S REPORT
The integrity and objectivity of the financial statements and other financial information presented in this annual report are the responsibility of the management of the Company. The financial statements have been prepared in conformity with U.S. generally accepted accounting principles and include, when necessary, amounts based on the best estimates and judgments of management.
The Company maintains a system of internal controls designed to provide reasonable assurance, at appropriate cost, that assets are safeguarded, transactions are executed in accordance with management’s authorization and the accounting records provide a reliable basis for the preparation of the financial statements. The system of internal accounting controls is continually reviewed by management and improved and modified as necessary in response to changing business conditions. The Company also maintains an internal audit function to assist management in evaluating and formally reporting on the adequacy and effectiveness of internal accounting controls, policies and procedures.
The Company’s financial statements have been audited by KPMG LLP, the Company’s independent registered public accounting firm, whose report expresses their opinion with respect to the fairness of the presentation of these financial statements.
The Audit Committee of the Board of Directors, which comprises solely independent non-management directors who are not officers or employees of the Company, meets regularly with the Company’s management, internal auditors, legal counsel and KPMG LLP to review the activities of each group and to satisfy itself that each is properly discharging its responsibility. In addition, the Audit Committee meets on a periodic basis with KPMG LLP, without management’s presence, to discuss the audit of the financial statements as well as other auditing and financial reporting matters. The Company’s internal auditors and independent registered public accounting firm have direct access to the Audit Committee.
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MATTHEW D. SERRA,Item 8. | ROBERT W. MCHUGH, |
Chairman of the Board, | Senior Vice PresidentConsolidated Financial Statements and |
President and Chief Executive Officer | Chief Financial Officer Supplementary Data |
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April 2, 2007
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MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. The Company’s internal control over financial reporting includes those policies and procedures that: (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Management assessed the effectiveness of the Company’s internal control over financial reporting as of February 3, 2007. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework. Based on our assessment and those criteria, management believes that the Company maintained effective internal control over financial reporting as of February 3, 2007.
The Company’s independent registered public accounting firm has issued their attestation report on management’s assessment of the Company’s internal control over financial reporting. That report appears in this Annual Report on Form 10-K under the heading,Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting.
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MATTHEW D. SERRA, | ROBERT W. MCHUGH, |
Chairman of the Board, | Senior Vice President and |
President and Chief Executive Officer | Chief Financial Officer |
April 2, 2007
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholders of
Foot Locker, Inc.:
We have audited the accompanying consolidated balance sheets of Foot Locker, Inc. and subsidiaries as of February 3, 2007January 30, 2010 and January 28, 2006,31, 2009, and the related consolidated statements of operations, comprehensive income (loss), shareholders’ equity, and cash flows for each of the years in the three-year period ended February 3, 2007.January 30, 2010. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Foot Locker, Inc. and subsidiaries as of February 3, 2007January 30, 2010 and January 28, 2006,31, 2009, and the results of their operations and their cash flows for each of the years in the three-year period ended February 3, 2007,January 30, 2010, in conformity with U.S. generally accepted accounting principles.
As discussed in the notesNotes to the consolidated financial statements, effective January 29, 2006,Consolidated Financial Statements, the Company adopted Statementthe provisions of Financial Accounting Standards (“SFAS”) No. 123(R), “Share-Based Payment,” and SFAS No. 151, “Inventory Costs - An Amendment157, “Fair Value Measurements” (included in FASB ASC Topic 820, “Fair Value Measurements and Disclosures”) as of ARB No. 43, Chapter 4,” as well as changed their methodFebruary 3, 2008, for quantifying errors based on SEC Staff Accounting Bulletin No. 108, “Considering the Effectsfair value measurements of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements.” Also as discussedall financial assets and financial liabilities and for fair value measurements of nonfinancial items that are recognized or disclosed at fair value in the notes to the consolidated financial statements on a recurring basis. In addition, effective February 3,4, 2007, the Company adopted SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Post Retirement Plans – An Amendmentthe provisions of FASB StatementsInterpretation No. 87, 88, 106, and 132(R)48, “Accounting for Uncertainty in Income Taxes” (included in FASB ASC Topic 740, “Income Taxes”).”
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Foot Locker.Locker, Inc.’s internal control over financial reporting as of February 3, 2007,January 30, 2010, based on criteria established in Internal Control—Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, (COSO), and our report dated April 2, 2007March 29, 2010 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
New York, New York
March 29, 2010
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CONSOLIDATED STATEMENTS OF OPERATIONS
| | | | | | |
| | 2009 | | 2008 | | 2007 |
| | | (in millions, except per share amounts) |
| Sales | | $ | 4,854 | | | $ | 5,237 | | | $ | 5,437 | |
Costs and expenses
| | | | | | | | | | | | |
| Cost of sales | | | 3,522 | | | | 3,777 | | | | 4,017 | |
| Selling, general and administrative expenses | | | 1,099 | | | | 1,174 | | | | 1,176 | |
| Depreciation and amortization | | | 112 | | | | 130 | | | | 166 | |
| Impairment and other charges | | | 41 | | | | 259 | | | | 128 | |
| Interest expense, net | | | 10 | | | | 5 | | | | 1 | |
| | | | 4,784 | | | | 5,345 | | | | 5,488 | |
| Other income | | | (3 | ) | | | (8 | ) | | | (1 | ) |
| | | | 4,781 | | | | 5,337 | | | | 5,487 | |
| Income (loss) from continuing operations before income taxes | | | 73 | | | | (100 | ) | | | (50 | ) |
| Income tax expense (benefit) | | | 26 | | | | (21 | ) | | | (93 | ) |
| Income (loss) from continuing operations | | | 47 | | | | (79 | ) | | | 43 | |
| Income (loss) on disposal of discontinued operations, net of income tax expense (benefit) of $(1), $—, and $1, respectively | | | 1 | | | | (1 | ) | | | 2 | |
| Net income (loss) | | $ | 48 | | | $ | (80 | ) | | $ | 45 | |
Basic earnings per share:
| | | | | | | | | | | | |
| Income (loss) from continuing operations | | $ | 0.30 | | | $ | (0.52 | ) | | $ | 0.29 | |
| Income from discontinued operations | | | — | | | | — | | | | 0.01 | |
| Net income (loss) | | $ | 0.30 | | | $ | (0.52 | ) | | $ | 0.30 | |
Diluted earnings per share:
| | | | | | | | | | | | |
| Income (loss) from continuing operations | | $ | 0.30 | | | $ | (0.52 | ) | | $ | 0.28 | |
| Income from discontinued operations | | | — | | | | — | | | | 0.01 | |
| Net income (loss) | | $ | 0.30 | | | $ | (0.52 | ) | | $ | 0.29 | |
See Accompanying Notes to Consolidated Financial Statements.
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CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
| | | | | | |
| | 2009 | | 2008 | | 2007 |
| | | (in millions) |
| Net income (loss) | | $ | 48 | | | $ | (80 | ) | | $ | 45 | |
Other comprehensive income (loss), net of tax
| | | | | | | | | | | | |
Foreign currency translation adjustment:
| | | | | | | | | | | | |
| Translation adjustment arising during the period, net of tax | | | 65 | | | | (83 | ) | | | 56 | |
Cash flow hedges:
| | | | | | | | | | | | |
| Change in fair value of derivatives, net of income tax | | | (2 | ) | | | 1 | | | | 1 | |
| Pension and postretirement plan adjustments, net of income tax benefit of $7, $62, and $11 million, respectively | | | (8 | ) | | | (99 | ) | | | (20 | ) |
| Unrealized gain (loss) on available-for-sale securities | | | 3 | | | | (3 | ) | | | (2 | ) |
| Comprehensive income (loss) | | $ | 106 | | | $ | (264 | ) | | $ | 80 | |
See Accompanying Notes to Consolidated Financial Statements.
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CONSOLIDATED BALANCE SHEETS
| | | | |
| | 2009 | | 2008 |
| | | (in millions) |
ASSETS
| | | | | | | | |
Current assets
| | | | | | | | |
| Cash and cash equivalents | | $ | 582 | | | $ | 385 | |
| Short-term investments | | | 7 | | | | 23 | |
| Merchandise inventories | | | 1,037 | | | | 1,120 | |
| Other current assets | | | 146 | | | | 236 | |
| | | | 1,772 | | | | 1,764 | |
| Property and equipment, net | | | 387 | | | | 432 | |
| Deferred taxes | | | 362 | | | | 358 | |
| Goodwill | | | 145 | | | | 144 | |
| Other intangible assets, net | | | 99 | | | | 113 | |
| Other assets | | | 51 | | | | 66 | |
| | | $ | 2,816 | | | $ | 2,877 | |
LIABILITIES AND SHAREHOLDERS’ EQUITY
| | | | | | | | |
Current liabilities
| | | | | | | | |
| Accounts payable | | $ | 215 | | | $ | 187 | |
| Accrued and other liabilities | | | 218 | | | | 231 | |
| | | | 433 | | | | 418 | |
| Long-term debt | | | 138 | | | | 142 | |
| Other liabilities | | | 297 | | | | 393 | |
| Total liabilities | | | 868 | | | | 953 | |
| Shareholders’ equity | | | 1,948 | | | | 1,924 | |
| | | $ | 2,816 | | | $ | 2,877 | |
See Accompanying Notes to Consolidated Financial Statements.
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CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
| | | | | | | | | | | | |
| | 2009 | | 2008 | | 2007 |
| | | Shares | | Amount | | Shares | | Amount | | Shares | | Amount |
| | | (shares in thousands, amounts in millions) |
Common Stock and Paid-In Capital
| | | | | | | | | | | | | | | | | | | | | | | | |
Par value $0.01 per share, 500 million shares authorized
| | | | | | | | | | | | | | | | | | | | | | | | |
| Issued at beginning of year | | | 159,599 | | | $ | 691 | | | | 158,997 | | | $ | 676 | | | | 157,810 | | | $ | 653 | |
| Restricted stock issued under stock option and award plans | | | 1,004 | | | | — | | | | 245 | | | | — | | | | 513 | | | | — | |
| Forfeitures of restricted stock | | | — | | | | — | | | | — | | | | 2 | | | | — | | | | — | |
| Share-based compensation expense | | | — | | | | 12 | | | | — | | | | 9 | | | | — | | | | 10 | |
| Issued under director and employee stock plans, net of tax | | | 664 | | | | 6 | | | | 357 | | | | 4 | | | | 674 | | | | 13 | |
| Issued at end of year | | | 161,267 | | | | 709 | | | | 159,599 | | | | 691 | | | | 158,997 | | | | 676 | |
| Common stock in treasury at beginning of year | | | (4,681 | ) | | | (102 | ) | | | (4,523 | ) | | | (99 | ) | | | (2,107 | ) | | | (47 | ) |
| Forfeitures/cancellations of restricted stock | | | (10 | ) | | | — | | | | (90 | ) | | | (2 | ) | | | (25 | ) | | | — | |
| Shares of common stock used to satisfy tax withholding obligations | | | (32 | ) | | | (1 | ) | | | (65 | ) | | | (1 | ) | | | (95 | ) | | | (2 | ) |
| Stock repurchases | | | — | | | | — | | | | — | | | | — | | | | (2,283 | ) | | | (50 | ) |
| Exchange of options | | | (3 | ) | | | — | | | | (3 | ) | | | — | | | | (13 | ) | | | — | |
| Common stock in treasury at end of year | | | (4,726 | ) | | | (103 | ) | | | (4,681 | ) | | | (102 | ) | | | (4,523 | ) | | | (99 | ) |
| | | | 156,541 | | | | 606 | | | | 154,918 | | | | 589 | | | | 154,474 | | | | 577 | |
Retained Earnings
| | | | | | | | | | | | | | | | | | | | | | | | |
| Balance at beginning of year | | | | | | | 1,581 | | | | | | | | 1,754 | | | | | | | | 1,785 | |
| Cumulative effect of accounting change resulting from the adoption of guidance for uncertainty in income taxes, net of tax (see Note 1) | | | | | | | — | | | | | | | | — | | | | | | | | 1 | |
| Adjusted balance at beginning of year | | | | | | | 1,581 | | | | | | | | 1,754 | | | | | | | | 1,786 | |
| Net income (loss) | | | | | | | 48 | | | | | | | | (80 | ) | | | | | | | 45 | |
| Cash dividends declared on common stock $0.60, $0.60 and $0.50 per share, respectively | | | | | | | (94 | ) | | | | | | | (93 | ) | | | | | | | (77 | ) |
| Balance at end of year | | | | | | | 1,535 | | | | | | | | 1,581 | | | | | | | | 1,754 | |
Accumulated Other Comprehensive Loss
| | | | | | | | | | | | | | | | | | | | | | | | |
Foreign Currency Translation Adjustment
| | | | | | | | | | | | | | | | | | | | | | | | |
| Balance at beginning of year | | | | | | | 10 | | | | | | | | 93 | | | | | | | | 37 | |
| Translation adjustment arising during the year, net of tax | | | | | | | 65 | | | | | | | | (83 | ) | | | | | | | 56 | |
| Balance at end of year | | | | | | | 75 | | | | | | | | 10 | | | | | | | | 93 | |
Cash Flow Hedges
| | | | | | | | | | | | | | | | | | | | | | | | |
| Balance at beginning of year | | | | | | | 2 | | | | | | | | 1 | | | | | | | | — | |
| Change during the year, net of tax | | | | | | | (2 | ) | | | | | | | 1 | | | | | | | | 1 | |
| Balance at end of year | | | | | | | — | | | | | | | | 2 | | | | | | | | 1 | |
Pension and Postretirement Adjustments
| | | | | | | | | | | | | | | | | | | | | | | | |
| Balance at beginning of year | | | | | | | (253 | ) | | | | | | | (162 | ) | | | | | | | (133 | ) |
| Change during the year, net of tax | | | | | | | (13 | ) | | | | | | | (91 | ) | | | | | | | (29 | ) |
| Balance at end of year | | | | | | | (266 | ) | | | | | | | (253 | ) | | | | | | | (162 | ) |
Available-for-Sale Securities
| | | | | | | | | | | | | | | | | | | | | | | | |
| Balance at beginning of year | | | | | | | (5 | ) | | | | | | | (2 | ) | | | | | | | — | |
| Change during the year, without tax benefit | | | | | | | 3 | | | | | | | | (3 | ) | | | | | | | (2 | ) |
| Balance at end of year | | | | | | | (2 | ) | | | | | | | (5 | ) | | | | | | | (2 | ) |
| Total Accumulated Other Comprehensive Loss | | | | | | | (193 | ) | | | | | | | (246 | ) | | | | | | | (70 | ) |
| Total Shareholders’ Equity | | | | | | $ | 1,948 | | | | | | | $ | 1,924 | | | | | | | $ | 2,261 | |
See Accompanying Notes to Consolidated Financial Statements.
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CONSOLIDATED STATEMENTS OF CASH FLOWS
| | | | | | |
| | 2009 | | 2008 | | 2007 |
| | | (in millions) |
From Operating Activities
| | | | | | | | | | | | |
| Net income (loss) | | $ | 48 | | | $ | (80 | ) | | $ | 45 | |
Adjustments to reconcile net income (loss) to net cash provided by operating activities of continuing operations:
| | | | | | | | | | | | |
| Discontinued operations, net of tax | | | (1 | ) | | | 1 | | | | (2 | ) |
| Non-cash impairment and other charges | | | 36 | | | | 259 | | | | 124 | |
| Depreciation and amortization | | | 112 | | | | 130 | | | | 166 | |
| Share-based compensation expense | | | 12 | | | | 9 | | | | 10 | |
| Deferred income taxes | | | 2 | | | | (44 | ) | | | (129 | ) |
Change in assets and liabilities:
| | | | | | | | | | | | |
| Merchandise inventories | | | 111 | | | | 128 | | | | 55 | |
| Accounts payable and other accruals | | | (7 | ) | | | (43 | ) | | | (36 | ) |
| Qualified pension plan contributions | | | (100 | ) | | | (6 | ) | | | — | |
| Income taxes | | | 9 | | | | (7 | ) | | | 14 | |
| Gain on termination of interest rate swaps | | | 19 | | | | — | | | | — | |
| Other, net | | | 105 | | | | 36 | | | | 36 | |
| Net cash provided by operating activities of continuing operations | | | 346 | | | | 383 | | | | 283 | |
From Investing Activities
| | | | | | | | | | | | |
| Business acquisition | | | — | | | | (106 | ) | | | — | |
| Gain from lease termination | | | — | | | | 3 | | | | 1 | |
| Gain from insurance recoveries | | | 1 | | | | — | | | | 1 | |
| Reclassification of cash equivalents to short-term investments | | | — | | | | (23 | ) | | | — | |
| Purchases of short-term investments | | | — | | | | — | | | | (1,378 | ) |
| Sales of short-term investments | | | 16 | | | | — | | | | 1,620 | |
| Capital expenditures | | | (89 | ) | | | (146 | ) | | | (148 | ) |
| Proceeds from investment and note | | | — | | | | — | | | | 21 | |
| Net cash (used in) provided by investing activities of continuing operations | | | (72 | ) | | | (272 | ) | | | 117 | |
From Financing Activities
| | | | | | | | | | | | |
| Reduction in long-term debt | | | (3 | ) | | | (94 | ) | | | (7 | ) |
| Repayment of capital lease | | | — | | | | — | | | | (14 | ) |
| Dividends paid on common stock | | | (94 | ) | | | (93 | ) | | | (77 | ) |
| Issuance of common stock | | | 3 | | | | 2 | | | | 9 | |
| Purchase of treasury shares | | | — | | | | — | | | | (50 | ) |
| Tax benefit on stock compensation | | | — | | | | — | | | | 1 | |
| Net cash used in financing activities of continuing operations | | | (94 | ) | | | (185 | ) | | | (138 | ) |
| Effect of Exchange Rate Fluctuations on Cash and Cash Equivalents | | | 18 | | | | (29 | ) | | | 5 | |
| Net Cash used by Discontinued Operations | | | (1 | ) | | | — | | | | — | |
| Net Change in Cash and Cash Equivalents | | | 197 | | | | (103 | ) | | | 267 | |
| Cash and Cash Equivalents at Beginning of Year | | | 385 | | | | 488 | | | | 221 | |
| Cash and Cash Equivalents at End of Year | | $ | 582 | | | $ | 385 | | | $ | 488 | |
Cash Paid During the Year:
| | | | | | | | | | | | |
| Interest | | $ | 12 | | | $ | 11 | | | $ | 18 | |
| Income taxes | | $ | 19 | | | $ | 64 | | | $ | 52 | |
See Accompanying Notes to Consolidated Financial Statements.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
| 1. | Summary of Significant Accounting Policies |
Basis of Presentation
The consolidated financial statements include the accounts of Foot Locker, Inc. and its domestic and international subsidiaries (the “Company”), all of which are wholly owned. All significant intercompany amounts have been eliminated. The preparation of financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”) requires management to make estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results may differ from those estimates.
In July of 2009, the Company adopted the FASB Accounting Standards Codification (“ASC” and collectively, the “Codification”), which establishes the Codification as the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in conformity with GAAP. The historical GAAP hierarchy was eliminated and the Codification became the only level of authoritative GAAP, other than guidance issued by the SEC. The FASB will not issue new standards in the form of Statements, FASB Staff Positions or Emerging Issues Task Force Abstracts. Instead, it will issue Accounting Standards Updates (“ASUs”). ASUs will serve to update the Codification, provide background information about the guidance and provide the basis for conclusions on changes in the Codification. The Codification was effective for all financial statements issued for interim and annual periods ending after September 15, 2009. Accordingly, the Company has reflected all necessary changes in this filing.
Reporting Year
The reporting period for the Company is the Saturday closest to the last day in January. Fiscal years 2009, 2008 and 2007 represent the 52 week periods ending January 30, 2010, January 31, 2009 and February 2, 2008, respectively. References to years in this annual report relate to fiscal years rather than calendar years.
Revenue Recognition
Revenue from retail stores is recognized at the point of sale when the product is delivered to customers. Internet and catalog sales revenue is recognized upon estimated receipt by the customer. Sales include shipping and handling fees for all periods presented. Sales include merchandise, net of returns, and exclude taxes. The Company provides for estimated returns based on return history and sales levels. Revenue from layaway sales is recognized when the customer receives the product, rather than when the initial deposit is paid.
Gift Cards
The Company sells gift cards to its customers, which do not have expiration dates. Revenue from gift card sales is recorded when the gift cards are redeemed or when the likelihood of the gift card being redeemed by the customer is remote and there is no legal obligation to remit the value of unredeemed gift cards to the relevant jurisdictions. The Company has determined its gift card breakage rate based upon historical redemption patterns. Historical experience indicates that after 12 months the likelihood of redemption is deemed to be remote. Gift card breakage income is included in selling, general and administrative expenses and totaled $4 million, $5 million, and $4 million in 2009, 2008, and 2007, respectively. Unredeemed gift cards are recorded as a current liability.
Statement of Cash Flows
The Company has selected to present the operations of the discontinued businesses as one line in the Consolidated Statements of Cash Flows. For all the periods presented this caption includes only operating activities.
Store Pre-Opening and Closing Costs
Store pre-opening costs are charged to expense as incurred. In the event a store is closed before its lease has expired, the estimated post-closing lease exit costs, less the sublease rental income, is provided for once the store ceases to be used.
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Advertising Costs and Sales Promotion
Advertising and sales promotion costs are expensed at the time the advertising or promotion takes place, net of reimbursements for cooperative advertising. Advertising expenses also include advertising costs as required by some of the Company’s mall-based leases. Cooperative advertising reimbursements earned for the launch and promotion of certain products agreed upon with vendors is recorded in the same period as the associated expenses are incurred. The Company accounts for reimbursements received in excess of expenses incurred related to specific, incremental, identifiable advertising, as a reduction to the cost of merchandise, which is reflected in cost of sales as the merchandise is sold.
Advertising costs, which are included as a component of selling, general and administrative expenses were as follows:
| | | | | | |
| | 2009 | | 2008 | | 2007 |
| | | (in millions) |
| Advertising expenses | | $ | 94.0 | | | $ | 106.8 | | | $ | 105.9 | |
| Cooperative advertising reimbursements | | | (25.2 | ) | | | (40.2 | ) | | | (34.8 | ) |
| Net advertising expense | | $ | 68.8 | | | $ | 66.6 | | | $ | 71.1 | |
Catalog Costs
Catalog costs, which primarily comprise paper, printing, and postage, are capitalized and amortized over the expected customer response period related to each catalog, which is generally 90 days. Cooperative reimbursements earned for the promotion of certain products are agreed upon with vendors and are recorded in the same period as the associated catalog expenses are amortized. Prepaid catalog costs totaled $3.9 million and $3.1 million at January 30, 2010 and January 31, 2009, respectively.
Catalog costs, which are included as a component of selling, general and administrative expenses, were as follows:
| | | | | | |
| | 2009 | | 2008 | | 2007 |
| | | (in millions) |
| Catalog costs | | $ | 48.4 | | | $ | 48.0 | | | $ | 45.6 | |
| Cooperative reimbursements | | | (4.3 | ) | | | (4.1 | ) | | | (3.8 | ) |
| Net catalog expense | | $ | 44.1 | | | $ | 43.9 | | | $ | 41.8 | |
Earnings Per Share
The Company accounts for and discloses net earnings (loss) per share using the treasury stock method. The Company’s basic earnings per share is computed by dividing the Company’s reported net income (loss) for the period by the weighted-average number of common shares outstanding at the end of the period. The Company’s restricted stock awards, which contain non-forfeitable rights to dividends, are considered participating securities and are included in the calculation of basic earnings per share. Diluted earnings per share reflects the weighted-average number of common shares outstanding during the period used in the basic earnings per share computation plus dilutive common stock equivalents.
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The computation of basic and diluted earnings per share is as follows:
| | | | | | |
| | 2009 | | 2008 | | 2007 |
| | | (in millions) |
| Net income (loss) from continuing operations | | $ | 47 | | | $ | (79 | ) | | $ | 43 | |
| Weighted-average common shares outstanding | | | 156.0 | | | | 154.0 | | | | 154.0 | |
| Basic Earnings per share from continuing operations | | $ | 0.30 | | | $ | (0.52 | ) | | $ | 0.29 | |
| Weighted-average common shares outstanding | | | 156.0 | | | | 154.0 | | | | 154.0 | |
| Dilutive effect of potential common shares | | | 0.3 | | | | — | | | | 1.6 | |
Weighted-average common shares outstanding
assuming dilution | | | 156.3 | | | | 154.0 | | | | 155.6 | |
| Diluted earnings per share from continuing operations | | $ | 0.30 | | | $ | (0.52 | ) | | $ | 0.28 | |
Potential common shares include the dilutive effect of stock options and restricted stock units. Options to purchase 6.3 million, 4.8 million, and 3.4 million shares of common stock at January 30, 2010, January 31, 2009, and February 2, 2008, respectively, were not included in the computations because the exercise price of the options was greater than the average market price of the common shares and, therefore, the effect of their inclusion would be antidilutive. Additionally, due to a loss reported for the year ended January 31, 2009, options and awards of 1.2 million shares of common stock were excluded from the calculation of diluted earnings per share as the effect would be antidilutive.
Share-Based Compensation
The Company recognizes compensation expense in the financial statements for share-based awards based on the grant date fair value of those awards. Additionally, stock-based compensation expense includes an estimate for pre-vesting forfeitures and is recognized over the requisite service periods of the awards. See Note 21, “Share-Based Compensation,” for information on the assumptions the Company used to calculate the fair value of share-based compensation.
Upon exercise of stock options, issuance of restricted stock or issuance of shares under the employee stock purchase plan, the Company will issue authorized but unissued common stock or use common stock held in treasury. The Company may make repurchases of its common stock from time to time, subject to legal and contractual restrictions, market conditions and other factors.
Cash and Cash Equivalents
The Company considers all highly liquid investments with original maturities of three months or less, including money market funds, to be cash equivalents. Amounts due from third party credit card processors for the settlement of debit and credit card transactions are included as cash equivalents as they are generally collected within three business days. Cash equivalents at January 30, 2010 and January 31, 2009 were $501 million and $331 million, respectively.
Investments
The Company’s short-term investment and auction rate security are classified as available-for-sale. Changes in the fair value of available-for-sale securities are reported as a component of accumulated other comprehensive loss in the Consolidated Statements of Shareholders’ Equity and are not reflected in the Consolidated Statements of Operations until a sale transaction occurs or when declines in fair value are deemed to be other-than-temporary. The Company routinely reviews available-for-sale securities for other-than-temporary declines in fair value below the cost basis, and when events or changes in circumstances indicate the carrying value of a security may not be recoverable, the security is written down to fair value. The Company’s short-term investment was $7 million and $23 million at January 30, 2010 and January 31, 2009, respectively. The Company’s auction rate security was $5 million and $2 million at January 30, 2010 and January 31, 2009, respectively. See Note 19, “Fair Value Measurements,” for further discussion of these investments.
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Merchandise Inventories and Cost of Sales
Merchandise inventories for the Company’s Athletic Stores are valued at the lower of cost or market using the retail inventory method. Cost for retail stores is determined on the last-in, first-out (“LIFO”) basis for domestic inventories and on the first-in, first-out (“FIFO”) basis for international inventories. The retail inventory method is commonly used by retail companies to value inventories at cost and calculate gross margins due to its practicality. Under the retail inventory method, cost is determined by applying a cost-to-retail percentage across groupings of similar items, known as departments. The cost-to-retail percentage is applied to ending inventory at its current owned retail valuation to determine the cost of ending inventory on a department basis. The Company provides reserves based on current selling prices when the inventory has not been marked down to market. Merchandise inventories of the Direct-to-Customers business are valued at the lower of cost or market using weighted-average cost, which approximates FIFO. Transportation, distribution center, and sourcing costs are capitalized in merchandise inventories. The Company expenses the freight associated with transfers between its store locations in the period incurred. The Company maintains an accrual for shrinkage based on historical rates.
Cost of sales is comprised of the cost of merchandise, occupancy, buyers’ compensation and shipping and handling costs. The cost of merchandise is recorded net of amounts received from vendors for damaged product returns, markdown allowances and volume rebates, as well as cooperative advertising reimbursements received in excess of specific, incremental advertising expenses. Occupancy includes the amortization of amounts received from landlords for tenant improvements.
Property and Equipment
Property and equipment are recorded at cost, less accumulated depreciation and amortization. Significant additions and improvements to property and equipment are capitalized. Maintenance and repairs are charged to current operations as incurred. Major renewals or replacements that substantially extend the useful life of an asset are capitalized and depreciated. Owned property and equipment are depreciated on a straight-line basis over the estimated useful lives of the assets: maximum of 50 years for buildings and 3 to 10 years for furniture, fixtures and equipment. Property and equipment under capital leases and improvements to leased premises are generally amortized on a straight-line basis over the shorter of the estimated useful life of the asset or the remaining lease term. Capitalized software reflects certain costs related to software developed for internal use that are capitalized and amortized. After substantial completion of a project, the costs are amortized on a straight-line basis over a 2 to 7 year period. Capitalized software, net of accumulated amortization, is included as a component of property and equipment and was $24 million and $23 million at January 30, 2010 and January 31, 2009, respectively.
Recoverability of Long-Lived Assets
The Company recognizes impairment losses whenever events or changes in circumstances indicate that the carrying amounts of long-lived tangible and intangible assets with finite lives may not be recoverable. Management’s policy in determining whether an impairment indicator exists, a triggering event, comprises measurable operating performance criteria at the division level, as well as qualitative measures. The Company considers historical performance and future estimated results, which are predominately identified from the Company’s three-year strategic plans, in its evaluation of potential store-level impairment and then compares the carrying amount of the asset with the estimated future cash flows expected to result from the use of the asset. If the carrying amount of the asset exceeds the estimated expected undiscounted future cash flows, the Company measures the amount of the impairment by comparing the carrying amount of the asset with its estimated fair value. The estimation of fair value is measured by discounting expected future cash flows at the Company’s weighted-average cost of capital. The Company estimates fair value based on the best information available using estimates, judgments and projections as considered necessary.
Goodwill and Other Intangible Assets
The Company reviews goodwill and intangible assets with indefinite lives for impairment annually during the first quarter of its fiscal year or more frequently if impairment indicators arise. The fair value of each reporting unit is determined using a combination of market and discounted cash flow approaches.
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Derivative Financial Instruments
All derivative financial instruments are recorded in the Company’s Consolidated Balance Sheets at their fair values. Changes in fair values of derivatives are recorded each period in earnings, other comprehensive gain or loss, or as a basis adjustment to the underlying hedged item, depending on whether a derivative is designated and is effective as part of a hedge transaction. The effective portion of the gain or loss on the hedging derivative instrument is reported as a component of other comprehensive income/loss or as a basis adjustment to the underlying hedged item and reclassified to earnings in the period in which the hedged item affects earnings.
The effective portion of the gain or loss on hedges of foreign net investments is generally not reclassified to earnings unless the net investment is disposed of. To the extent derivatives do not qualify as hedges, or are ineffective, their changes in fair value are recorded in earnings immediately, which may subject the Company to increased earnings volatility. The changes in the fair value of the Company’s hedges of net investments in various foreign subsidiaries are computed using the spot method.
Fair Value
The Company adopted the provisions as prescribed by ASC 820, “Fair Value Measurements and Disclosures,” for the year ended January 31, 2009. The Company categorizes its financial instruments into a three-level fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). If the inputs used to measure fair value fall within different levels of the hierarchy, the category level is based on the lowest priority level input that is significant to the fair value measurement of the instrument. Fair value is determined based upon the exit price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants exclusive of any transaction costs.
The Company’s financial assets recorded at fair value are categorized as follows:
Level 1 – Quoted prices for identical instruments in active markets.
Level 2 – Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs or significant value-drivers are observable in active markets.
Level 3 – Model-derived valuations in which one or more significant inputs or significant value-drivers are unobservable.
Income Taxes
The Company determines its deferred tax provision under the liability method, whereby deferred tax assets and liabilities are recognized for the expected tax consequences of temporary differences between the tax basis of assets and liabilities and their reported amounts using presently enacted tax rates. Deferred tax assets are recognized for tax credits and net operating loss carryforwards, reduced by a valuation allowance, which is established when it is more likely than not that some portion or all of the deferred tax assets will not be realized. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
A taxing authority may challenge positions that the Company adopted in its income tax filings. Accordingly, the Company may apply different tax treatments for transactions in filing its income tax returns than for income tax financial reporting. The Company regularly assesses its tax positions for such transactions and records reserves for those differences when considered necessary.
Provision for U.S. income taxes on undistributed earnings of foreign subsidiaries is made only on those amounts in excess of the funds considered to be permanently reinvested.
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On February 4, 2007, the Company adopted authoritative guidance for the Accounting for Uncertainty in Income Taxes, as prescribed by ASC 740, “Income Taxes.” The guidance clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements and prescribes a recognition threshold and measurement standard for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. Upon the adoption of the guidance, the Company recognized a $1 million increase to retained earnings to reflect the change of its liability for its unrecognized income tax benefits. The Company recognizes interest and penalties related to unrecognized tax benefits in income tax expense.
Pension and Postretirement Obligations
The discount rate selected to measure the present value of the Company’s U.S. benefit obligations at January 30, 2010 was derived using a cash flow matching method whereby the Company matches the plans’ projected payment obligations by year with the corresponding yield on the Citibank Pension Discount Curve. The cash flows are then discounted to their present value and an overall discount rate is determined. The discount rate selected to measure the present value of the Company’s Canadian benefit obligations at January 30, 2010 was developed by using the plan’s bond portfolio indices, which match the benefit obligations.
Insurance Liabilities
The Company is primarily self-insured for health care, workers’ compensation and general liability costs. Accordingly, provisions are made for the Company’s actuarially determined estimates of discounted future claim costs for such risks, for the aggregate of claims reported and claims incurred but not yet reported. Self-insured liabilities totaled $15 million and $16 million at January 30, 2010 and January 31, 2009, respectively. The Company discounts its workers’ compensation and general liability using a risk-free interest rate. Imputed interest expense related to these liabilities was not significant for 2009 and 2008 and was $1 million in 2007.
Accounting for Leases
The Company recognizes rent expense for operating leases as of the possession date for store leases or the commencement of the agreement for a non-store lease. Rental expense, inclusive of rent holidays, concessions and tenant allowances are recognized over the lease term on a straight-line basis. Contingent payments based upon sales and future increases determined by inflation-related indices cannot be estimated at the inception of the lease and accordingly, are charged to operations as incurred.
Foreign Currency Translation
The functional currency of the Company’s international operations is the applicable local currency. The translation of the applicable foreign currency into U.S. dollars is performed for balance sheet accounts using current exchange rates in effect at the balance sheet date and for revenue and expense accounts using the weighted-average rates of exchange prevailing during the year. The unearned gains and losses resulting from such translation are included as a separate component of accumulated other comprehensive loss within shareholders’ equity.
Recent Accounting Pronouncements Not Previously Discussed Herein
Recently issued accounting pronouncements did not, or are not believed by management to, have a material effect on the Company’s present or future consolidated financial statements.
The Company has determined that its reportable segments are those that are based on its method of internal reporting. As of January 30, 2010, the Company has two reportable segments, Athletic Stores and Direct-to-Customers. The Company acquired CCS during the fourth quarter of 2008, and its operations are presented within the Direct-to-Customers segment. The Company also operated the Family Footwear segment, which included the retail format under the Footquarters brand name through the second quarter of 2007. During the third quarter, the Company converted the Footquarters stores, which were the only stores reported under the Family Footwear segment, to Foot Locker and Champs Sports outlet stores. The Company has concluded that the Footquarters store closings are not discontinued operations.
The accounting policies of both segments are the same as those described in the “Summary of Significant Accounting Policies” note. The Company evaluates performance based on several factors, of which the primary financial measure is division results. Division profit (loss) reflects income (loss) from continuing operations before income taxes, corporate expense, non-operating income, and net interest expense.
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Sales
| | | | | | |
| | 2009 | | 2008 | | 2007 |
| | | (in millions) |
| Athletic Stores | | $ | 4,448 | | | $ | 4,847 | | | $ | 5,071 | |
| Direct-to-Customers | | | 406 | | | | 390 | | | | 364 | |
| Family Footwear | | | — | | | | — | | | | 2 | |
| Total sales | | $ | 4,854 | | | $ | 5,237 | | | $ | 5,437 | |
Operating Results
| | | | | | |
| | 2009 | | 2008 | | 2007 |
| | | (in millions) |
| Athletic Stores(1) | | $ | 114 | | | $ | (59 | ) | | $ | (27 | ) |
| Direct-to-Customers(2) | | | 32 | | | | 43 | | | | 40 | |
| Family Footwear(3) | | | — | | | | — | | | | (6 | ) |
| | | | 146 | | | | (16 | ) | | | 7 | |
| Restructuring income(4) | | | 1 | | | | — | | | | 2 | |
| Division profit (loss) | | | 147 | | | | (16 | ) | | | 9 | |
| Corporate expense(5) | | | (67 | ) | | | (87 | ) | | | (59 | ) |
| Operating profit (loss) | | | 80 | | | | (103 | ) | | | (50 | ) |
| Other income(6) | | | 3 | | | | 8 | | | | 1 | |
| Interest expense, net | | | 10 | | | | 5 | | | | 1 | |
| Income (loss) from continuing operations before income taxes | | $ | 73 | | | $ | (100 | ) | | $ | (50 | ) |
| (1) | The year ended January 30, 2010 includes non-cash impairment charges totaling $32 million, which were recorded to write-down long-lived assets such as store fixtures and leasehold improvements at the Company’s Lady Foot Locker, Kids Foot Locker, Footaction, and Champs Sports divisions. The year ended January 31, 2009 includes a $241 million charge representing long-lived store asset impairment, goodwill and other intangibles impairment and store closing costs related to the Company’s U.S. operations. The year ended February 2, 2008 includes a $128 million charge representing impairment and store closing costs related to the Company’s U.S. operations. |
| (2) | Included in the results for the year ended January 30, 2010 is a non-cash impairment charge of $4 million to write off software development costs. |
| (3) | During the first quarter of 2007, the Company launched a new family footwear concept, Footquarters. The concept’s results did not meet the Company’s expectations and, therefore, the Company decided not to invest further in this business. These stores were converted to the Company’s other formats. Included in the operating loss of $6 million was $2 million of costs associated with the removal of signage and the write-off of unusable fixtures. |
| (4) | During 2009, the Company adjusted its 1999 restructuring reserves to reflect a favorable lease termination. During 2007, the Company adjusted its 1993 Repositioning and 1991 Restructuring reserve by $2 million primarily due to favorable lease terminations. |
| (5) | During the fourth quarter of 2009, the Company restructured its organization by consolidating the Lady Foot Locker, Foot Locker U.S., Kids Foot Locker and Footaction businesses in addition to reducing corporate staff resulting in a $5 million charge. Included in corporate expense for the year ended January 31, 2009 is a $3 million other-than-temporary impairment charge related to the investment in the Reserve International Liquidity Fund. Additionally, for the year ended January 31, 2009 the Company recorded a $15 million impairment charge on the Northern Group note receivable. |
| (6) | Other income includes non-operating items, such as gains from insurance recoveries, gains on the repurchase and retirement of bonds, royalty income, the changes in fair value, premiums paid and realized gains associated with foreign currency option contracts, described more fully in Note 4, “Other Income.” |
| | | | | | | | | | | | | | | | | | |
| | Depreciation and
Amortization | | Capital Expenditures | | Total Assets |
| | | 2009 | | 2008 | | 2007 | | 2009 | | 2008 | | 2007 | | 2009 | | 2008 | | 2007 |
| | | (in millions) |
| Athletic Stores | | $ | 90 | | | $ | 111 | | | $ | 146 | | | $ | 70 | | | $ | 122 | | | $ | 125 | | | $ | 1,873 | | | $ | 1,879 | | | $ | 2,300 | |
| Direct-to-Customers | | | 9 | | | | 6 | | | | 6 | | | | 5 | | | | 6 | | | | 7 | | | | 291 | | | | 297 | | | | 197 | |
| | | | 99 | | | | 117 | | | | 152 | | | | 75 | | | | 128 | | | | 132 | | | | 2,164 | | | | 2,176 | | | | 2,497 | |
| Corporate | | | 13 | | | | 13 | | | | 14 | | | | 14 | | | | 18 | | | | 16 | | | | 652 | | | | 701 | | | | 746 | |
| Total Company | | $ | 112 | | | $ | 130 | | | $ | 166 | | | $ | 89 | | | $ | 146 | | | $ | 148 | | | $ | 2,816 | | | $ | 2,877 | | | $ | 3,243 | |
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Sales and long-lived asset information by geographic area as of and for the fiscal years ended January 30, 2010, January 31, 2009, and February 2, 2008 are presented below. Sales are attributed to the country in which the sales originate, which is where the legal subsidiary is domiciled. Long-lived assets reflect property and equipment. The Company’s sales in Italy, Canada, and France represent approximately 24, 17, and 14 percent, respectively, of the International category’s sales for the period ended January 30, 2010. No other individual country included in the International category is significant.
Sales
| | | | | | |
| | 2009 | | 2008 | | 2007 |
| | | (in millions) |
| United States | | $ | 3,425 | | | $ | 3,768 | | | $ | 3,991 | |
| International | | | 1,429 | | | | 1,469 | | | | 1,446 | |
| Total sales | | $ | 4,854 | | | $ | 5,237 | | | $ | 5,437 | |
Long-Lived Assets
| | | | | | |
| | 2009 | | 2008 | | 2007 |
| | | (in millions) |
| United States | | $ | 266 | | | $ | 311 | | | $ | 368 | |
| International | | | 121 | | | | 121 | | | | 153 | |
| Total long-lived assets | | $ | 387 | | | $ | 432 | | | $ | 521 | |
| 3. | Impairment and Other Charges |
| | | | | | |
| | 2009 | | 2008 | | 2007 |
| | | (in millions) |
| Impairment of assets | | $ | 36 | | | $ | 67 | | | $ | 124 | |
| Reorganization costs | | | 5 | | | | — | | | | — | |
| Store closing program | | | — | | | | 5 | | | | 4 | |
| Impairment of goodwill and other intangible assets | | | — | | | | 169 | | | | — | |
| Money market impairment | | | — | | | | 3 | | | | — | |
| Northern Group note impairment | | | — | | | | 15 | | | | — | |
| Total impairment and other charges | | $ | 41 | | | $ | 259 | | | $ | 128 | |
Impairment of Assets
During the year ended January 30, 2010, the Company recorded non-cash impairment charges totaling $36 million. A charge of $32 million was recorded to write-down long-lived assets such as store fixtures and leasehold improvements at its Lady Foot Locker, Kids Foot Locker, Footaction and Champs Sports divisions for 787 stores. Additionally, the Company recorded a charge of $4 million to write off certain software development costs for the Direct-to-Customers segment as a result of management’s assessmentdecision to terminate this project. During 2008, the Company evaluated the long-lived assets of its U.S. retail store divisions, comprising Foot Locker U.S., Kids Foot Locker, Footaction and Champs Sports, for impairment and recorded non-cash impairment charges of $67 million primarily to write-down long-lived assets such as store fixtures and leasehold improvements for 868 stores. During 2007, the Company evaluated the long-lived assets of its U.S. retail store divisions for impairment and recorded non-cash impairment charges of $124 million primarily to write-down long-lived assets such as store fixtures and leasehold improvements for 1,461 stores.
Reorganization Costs
On January 8, 2010, the Company announced that it would change its organizational structure by consolidating the management team that oversees its Lady Foot Locker business with the team that currently manages the Foot Locker U.S., Kids Foot Locker and Footaction businesses. As a result of this divisional reorganization, as well as certain corporate staff reductions taken to improve corporate efficiency, the Company recorded a charge of $5 million. This charge was comprised primarily of severance costs to eliminate approximately 120 positions.
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Store Closing Program
As part of the Company’s store closing program announced in 2007, the Company recognized exit costs of $5 million for the year ended January 31, 2009, comprising primarily lease termination costs for 21 stores. In 2007, the Company recognized $4 million of exit costs related to 33 stores, which closed during 2007, comprising primarily lease termination costs. Store closings may constitute discontinued operations if migration of customers and cash flows are not expected. The Company has concluded that no store closings have met the criteria for discontinued operations treatment.
Impairment of Goodwill and Other Intangible Assets
The Company performs its annual goodwill impairment test as of the beginning of each year. However, during the fourth quarter of 2008, as a result of the significant decline in the Company’s common stock and market capitalization in relation to the book value, the Company determined that a triggering event had occurred and performed an interim goodwill impairment test. Based on this testing, the Company determined that the fair values were less than the carrying values of the Foot Locker, Kids Foot Locker and Footaction reporting unit and the Champs Sports reporting unit. Accordingly, the Company performed further analysis to determine the extent of the goodwill impairment and concluded that the carrying value of these two reporting units was fully impaired, resulting in a non-cash impairment charge of $167 million. There were no goodwill impairment charges in 2009 or 2007.
Intangible assets that are determined to have finite lives are amortized over their useful lives and are measured for impairment only when events or circumstances indicate that the carrying value may be impaired. Intangible assets with indefinite lives are tested for impairment if impairment indicators arise and, at a minimum, annually. As a result of the impairment review related to long-lived assets and goodwill, the Company performed a review of its other intangible assets and recorded impairment charges in 2008 totaling $2 million related to trademarks of Footaction in the U.S. and Foot Locker in the Republic of Ireland, reflecting decreases in projected revenues. There were no other intangible asset impairment charges in 2009 or 2007.
Money Market Impairment
On September 16, 2008, the Company requested redemption of its shares in the Reserve International Liquidity Fund, Ltd., a money market fund (the “Fund”), totaling $75 million. At the time the redemption request was made, the Company was informed by the Reserve Management Company, the Fund’s investment advisor, that the Company’s redemption trades would be honored at a $1.00 per share net asset value. Litigation, to which the Company is not a party, exists that involves how the remaining assets of the Fund should be distributed; therefore, there is a risk that the Company could receive less than the $1.00 per share net asset value. As a result, during the third quarter of 2008, the Company recognized an impairment loss of $3 million to reflect a decline in fair value that is other-than-temporary. This charge was recorded with no tax benefit. The impairment was related to the underlying securities of Lehman Brothers Holdings Inc. held in the Fund. The Company has received $65 million of its original investment in the Fund as of January 30, 2010; however, the Company has not received information as to when the remaining amount of its redemption request will be paid.
Northern Group Note Impairment
On January 23, 2001, the Company announced that it was exiting its Northern Group segment. During the second quarter of 2001, the Company completed the liquidation of the 324 stores in the United States. On September 28, 2001, the Company completed the stock transfer of the 370 Northern Group stores in Canada through one of its wholly owned subsidiaries for approximately CAD$59 million, which was paid in the form of a note. Over the last several years, the note has been amended and payments have been received; however, the interest and payment terms remained unchanged. The CAD$15.5 million note was required to be repaid upon the occurrence of “payment events,” as defined in the purchase agreement, but no later than September 28, 2008. During the first quarter of 2008, the principal owners of the Northern Group requested an extension on the repayment of the note. The Company determined, based on the Northern Group’s current financial condition and projected performance, that repayment of the note pursuant to the original terms of the purchase agreement was not likely. Accordingly, a non-cash impairment charge of $15 million was recorded during the first quarter of 2008. This charge was recorded with no tax benefit. The tax benefit is a capital loss that can only be used to offset capital gains. The Company does not anticipate recognizing sufficient capital gains to utilize these losses. Therefore, the Company determined that a full valuation allowance was required.
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Another wholly owned subsidiary of the Company was the assignor of the store leases involved in the Northern Group transaction and, therefore, retains potential liability for such leases. As the assignor of the Northern Canada leases, the Company remained secondarily liable under these leases. At January 30, 2010, the Company estimates that its gross contingent lease liability is CAD$1 million. The Company currently estimates the expected value of the lease liability to be insignificant. The Company believes that, because it is secondarily liable on the leases, it is unlikely that it would be required to make such contingent payments.
Other income was $3 million, $8 million and $1 million for 2009, 2008 and 2007, respectively. For the year ended January 30, 2010, other income includes $4 million related to gains from insurance recoveries, gains on the purchase and retirement of bonds, and royalty income partially offset by $1 million of foreign currency option contract premiums. Other income in 2008 primarily reflects a $4 million net gain related to the Company’s foreign currency options contracts and a $3 million gain on lease terminations related to two lease interests in Europe. For 2007, other income includes a $1 million gain related to a final settlement with the Company’s insurance carriers of a claim related to a store damaged by fire in 2006. Additionally, the Company sold two of its lease interests in Europe for a gain of $1 million. These gains were offset primarily by premiums paid for foreign currency option contracts.
| 5. | Merchandise Inventories |
| | | | |
| | 2009 | | 2008 |
| | | (in millions) |
| LIFO inventories | | $ | 682 | | | $ | 788 | |
| FIFO inventories | | | 355 | | | | 332 | |
| Total merchandise inventories | | $ | 1,037 | | | $ | 1,120 | |
The value of the Company’s LIFO inventories, as calculated on a LIFO basis, approximates their value as calculated on a FIFO basis.
| | | | |
| | 2009 | | 2008 |
| | | (in millions) |
| Net receivables | | $ | 37 | | | $ | 53 | |
| Prepaid expenses and other current assets | | | 33 | | | | 33 | |
| Prepaid rent | | | 28 | | | | 62 | |
| Prepaid income taxes | | | 25 | | | | 47 | |
| Income tax receivable | | | 5 | | | | 7 | |
| Fair value of derivative contracts | | | 1 | | | | 5 | |
| Deferred taxes | | | 17 | | | | 29 | |
| | | $ | 146 | | | $ | 236 | |
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| 7. | Property and Equipment, Net |
| | | | |
| | 2009 | | 2008 |
| | | (in millions) |
| Land | | $ | 3 | | | $ | 3 | |
Buildings:
| | | | | | | | |
| Owned | | | 31 | | | | 31 | |
Furniture, fixtures and equipment:
| | | | | | | | |
| Owned | | | 792 | | | | 1,018 | |
| | | | 826 | | | | 1,052 | |
| Less: accumulated depreciation | | | (641 | ) | | | (829 | ) |
| | | | 185 | | | | 223 | |
Alterations to leased and owned buildings
| | | | | | | | |
| Cost | | | 701 | | | | 724 | |
| Less: accumulated amortization | | | (499 | ) | | | (515 | ) |
| | | | 202 | | | | 209 | |
| | | $ | 387 | | | $ | 432 | |
| | | | | | |
| | Athletic Stores | | Direct-to-
Customers | | Total |
| | | (in millions) |
| Goodwill at February 2, 2008 | | $ | 186 | | | $ | 80 | | | $ | 266 | |
| Acquisition of CCS | | | — | | | | 47 | | | | 47 | |
| Foreign currency translation adjustment | | | (2 | ) | | | — | | | | (2 | ) |
| Impairment charge | | | (167 | ) | | | — | | | | (167 | ) |
| Goodwill at January 31, 2009 | | | 17 | | | | 127 | | | | 144 | |
| Foreign currency translation adjustment | | | 1 | | | | — | | | | 1 | |
| Goodwill at January 30, 2010 | | $ | 18 | | | $ | 127 | | | $ | 145 | |
| 9. | Other Intangible Assets, Net |
| | | | | | | | | | | | | | |
| | January 30, 2010 | | January 31, 2009 |
| (in millions) | | Gross
value | | Accum.
amort. | | Net
Value
(1) | | Wtd. Avg.
Useful
Life in
Years (2) | | Gross
value | | Accum.
amort. | | Net
Value
(1) |
Finite life intangible assets:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Lease acquisition costs | | $ | 184 | | | $ | (143 | ) | | $ | 41 | | | | 12.1 | | | $ | 173 | | | $ | (124 | ) | | $ | 49 | |
| Trademark | | | 20 | | | | (6 | ) | | | 14 | | | | 20.0 | | | | 20 | | | | (5 | ) | | | 15 | |
| Loyalty program | | | 1 | | | | (1 | ) | | | — | | | | — | | | | 1 | | | | (1 | ) | | | — | |
| Favorable leases | | | 9 | | | | (8 | ) | | | 1 | | | | 4.1 | | | | 9 | | | | (7 | ) | | | 2 | |
| CCS customer relationships | | | 21 | | | | (5 | ) | | | 16 | | | | 5.0 | | | | 21 | | | | (1 | ) | | | 20 | |
| Total finite life intangible assets | | | 235 | | | | (163 | ) | | | 72 | | | | 11.8 | | | | 224 | | | | (138 | ) | | | 86 | |
Intangible assets not subject to amortization:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Republic of Ireland trademark | | | 2 | | | | — | | | | 2 | | | | | | | | 2 | | | | — | | | | 2 | |
| CCS tradename | | | 25 | | | | — | | | | 25 | | | | | | | | 25 | | | | — | | | | 25 | |
| Total finite life intangible assets | | | 27 | | | | — | | | | 27 | | | | | | | | 27 | | | | — | | | | 27 | |
| Total other intangible assets | | $ | 262 | | | $ | (163 | ) | | $ | 99 | | | | | | | $ | 251 | | | $ | (138 | ) | | $ | 113 | |
| (1) | Includes the effect of foreign currency translation, which represents an increase of $3 million in 2009 and a reduction of $8 million in 2008, primarily related to the movements of the euro in relation to the U.S. dollar. Additionally, the net value at January 31, 2009 includes a $2 million impairment charge related to the Footaction trademark and the Republic of Ireland trademark, described more fully in Note 3. |
| (2) | The weighted-average useful life disclosed excludes those assets that are fully amortized. |
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Lease acquisition costs represent amounts that are required to secure prime lease locations and other lease rights, primarily in Europe. Included in finite life intangibles are the customer relationship intangible associated with the purchase of CCS, trademark for the Footaction name, favorable leases associated with acquisitions and amounts paid to obtain names of members of the Footaction loyalty program. The CCS customer relationship intangible is amortized on a straight-line basis over 5 years, which represents the pattern in which the economic benefits are expected to be realized.
Amortization expense for the intangibles subject to amortization was $19 million, $18 million, and $19 million for 2009, 2008, and 2007, respectively. Annual estimated amortization expense for finite life intangible assets is expected to approximate $18 million for 2010, $16 million for 2011, $14 million for 2012, $9 million for 2013 and $3 million for 2014.
| | | | |
| | 2009 | | 2008 |
| | | (in millions) |
| Prepaid income taxes | | $ | 6 | | | $ | 6 | |
| Auction rate security | | | 5 | | | | 2 | |
| Deferred tax costs | | | 5 | | | | 7 | |
| Income tax asset | | | 2 | | | | 2 | |
| Fair value of derivative contracts | | | — | | | | 19 | |
| Other | | | 33 | | | | 30 | |
| | | $ | 51 | | | $ | 66 | |
| 11. | Accrued and Other Liabilities |
| | | | |
| | 2009 | | 2008 |
| | | (in millions) |
| Other payroll and payroll related costs, excluding taxes | | $ | 46 | | | $ | 50 | |
| Taxes other than income taxes | | | 41 | | | | 36 | |
| Customer deposits(1) | | | 29 | | | | 32 | |
| Property and equipment | | | 13 | | | | 13 | |
| Income taxes | | | 10 | | | | — | |
| Incentive bonuses | | | 9 | | | | 23 | |
| Income taxes payable | | | 7 | | | | 4 | |
| Current deferred tax liabilities | | | 5 | | | | 10 | |
| Pension and postretirement benefits | | | 5 | | | | 4 | |
| Sales return reserve | | | 3 | | | | 4 | |
| Reserve for discontinued operations | | | 2 | | | | 2 | |
| Other operating costs | | | 48 | | | | 53 | |
| | | $ | 218 | | | $ | 231 | |
| (1) | Customer deposits include unredeemed gift cards and certificates, merchandise credits, and deferred revenue related to undelivered merchandise, including layaway sales. |
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| 12. | Revolving Credit Facility |
On March 20, 2009, the Company entered into a credit agreement (the “2009 Credit Agreement”) with its banks, providing for a $200 million asset-based revolving credit facility maturing on March 20, 2013, which replaced the Company’s prior credit agreement. The 2009 Credit Agreement also provides for an incremental facility of up to $100 million under certain circumstances. The 2009 Credit Agreement provides for a security interest in certain of the Company’s domestic assets, including certain inventory assets. The Company is not required to comply with any financial covenants as long as there are no outstanding borrowings. If the Company is borrowing, then it may not make Restricted Payments, such as dividends or share repurchases, unless there is at least $50 million of Excess Availability (as defined in the 2009 Credit Agreement), and the Company’s projected fixed charge coverage ratio, which is a Non-GAAP financial ratio pursuant to the 2009 Credit Agreement designed as a measure of the Company’s ability to meet current and future obligations (Consolidated EBITDA less capital expenditures less cash taxes divided by Debt Service Charges and Restricted Payments), is at least 1.1 to 1.0. The Company’s management does not currently expect to borrow under the facility in 2010.
At January 30, 2010, the Company had unused domestic lines of credit of $190 million pursuant to its $200 million revolving credit agreement, of which $10 million was committed to support standby letters of credit. The letters of credit are primarily used for insurance programs.
Deferred financing fees are amortized over the life of the facility on a straight-line basis, which is comparable to the interest method. The unamortized balance at January 30, 2010 is $6.6 million. Interest is based on the LIBOR rate in effect at the time of the borrowing plus a 3.25 to 3.75 percent applicable margin, as defined in the 2009 Credit Agreement. The quarterly facility fees paid on the unused portion ranged from 0.40 percent to 0.75 percent for 2009 and 2008. There were no short-term borrowings during 2009 or 2008. The amounts paid prior to March 20, 2009 relate to the predecessor credit agreement. Interest expense, including facility fees, related to the revolving credit facility was $3 million and $2 million in 2009 and 2008, respectively.
The Company’s long-term debt reflects the Company’s 8.50 percent debentures payable in 2022. The Company has historically employed various interest rate swaps to minimize its exposure to interest rate fluctuations. During the first quarter of 2009, the Company terminated the interest rate swaps for a gain of $19 million. The gain is being amortized as part of interest expense over the remaining term of the debt, using the effective-yield method. This amortization totaled $1 million in 2009.
The Company’s long term debt was $138 million and $142 million for the years ended January 30, 2010 and January 31, 2009, respectively. During 2009, the Company purchased and retired $3 million of its 8.50 percent debentures. Interest expense related to long-term debt, including the effect of the interest rate swaps and the amortization of the associated debt issuance costs, was $9 million in each of 2009 and 2008, and $18 million in 2007.
The Company is obligated under operating leases for almost all of its store properties. Some of the store leases contain renewal options with varying terms and conditions. Management expects that in the normal course of business, expiring leases will generally be renewed or, upon making a decision to relocate, replaced by leases on other premises. Operating lease periods generally range from 5 to 10 years. Certain leases provide for additional rent payments based on a percentage of store sales. Most of the Company’s leases require the payment of certain executory costs such as insurance, maintenance, and other costs in addition to the future minimum lease payments. These costs totaled $138 million, $147 million, and $151 million in 2009, 2008 and 2007, respectively. Included in the amounts below, are non-store expenses that totaled $15 million in both 2009 and 2008 and $16 million in 2007.
| | | | | | |
| | 2009 | | 2008 | | 2007 |
| | | (in millions) |
| Minimum rent | | $ | 514 | | | $ | 527 | | | $ | 521 | |
| Contingent rent based on sales | | | 14 | | | | 14 | | | | 17 | |
| Sublease income | | | (2 | ) | | | (2 | ) | | | (1 | ) |
| | | $ | 526 | | | $ | 539 | | | $ | 537 | |
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Future minimum lease payments under non-cancelable operating leases, net of future non-cancelable operating sublease payments, are:
| | |
| | (in millions) |
| 2010 | | $ | 487 | |
| 2011 | | | 441 | |
| 2012 | | | 380 | |
| 2013 | | | 312 | |
| 2014 | | | 261 | |
| Thereafter | | | 669 | |
| Total operating lease commitments | | $ | 2,550 | |
| | | | |
| | 2009 | | 2008 |
| | | (in millions) |
| Pension benefits | | $ | 101 | | | $ | 183 | |
| Straight-line rent liability | | | 101 | | | | 98 | |
| Income taxes | | | 29 | | | | 30 | |
| Fair value of derivatives | | | 24 | | | | 24 | |
| Workers’ compensation and general liability reserves | | | 12 | | | | 13 | |
| Postretirement benefits | | | 11 | | | | 11 | |
| Reserve for discontinued operations | | | 8 | | | | 10 | |
| Deferred taxes | | | — | | | | 12 | |
| Other | | | 11 | | | | 12 | |
| | | $ | 297 | | | $ | 393 | |
| 16. | Discontinued Operations |
In 1997, the Company exited its Domestic General Merchandise segment. In 1998, the Company exited both its International General Merchandise and Specialty Footwear segments. In 2001, the Company discontinued its Northern Group segment. The remaining reserve balances at January 30, 2010 primarily represent lease obligations, of which $2 million is expected to be utilized within twelve months and the remaining $8 million thereafter. The balances at January 31, 2009 totaled $12 million, of which $2 million was classified as current and $10 million was classified as non current. The majority of the reserve balance relates to the Domestic General Merchandise segment as the leases extend many years.
Following are the domestic and international components of pre-tax income (loss) from continuing operations:
| | | | | | |
| | 2009 | | 2008 | | 2007 |
| | | (in millions) |
| Domestic | | $ | (23 | ) | | $ | (174 | ) | | $ | (131 | ) |
| International | | | 96 | | | | 74 | | | | 81 | |
| Total pre-tax income (loss) | | $ | 73 | | | $ | (100 | ) | | $ | (50 | ) |
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The income tax provision (benefit) consists of the following:
| | | | | | |
| | 2009 | | 2008 | | 2007 |
| | | (in millions) |
Current:
| | | | | | | | | | | | |
| Federal | | $ | (6 | ) | | $ | 2 | | | $ | (3 | ) |
| State and local | | | — | | | | 3 | | | | (4 | ) |
| International | | | 30 | | | | 18 | | | | 43 | |
| Total current tax provision | | | 24 | | | | 23 | | | | 36 | |
Deferred:
| | | | | | | | | | | | |
| Federal | | | (3 | ) | | | (42 | ) | | | (52 | ) |
| State and local | | | — | | | | (6 | ) | | | 1 | |
| International | | | 5 | | | | 4 | | | | (78 | ) |
| Total deferred tax provision (benefit) | | | 2 | | | | (44 | ) | | | (129 | ) |
| Total income tax provision (benefit) | | $ | 26 | | | $ | (21 | ) | | $ | (93 | ) |
Provision has been made in the accompanying Consolidated Statements of Operations for additional income taxes applicable to dividends received or expected to be received from international subsidiaries. The amount of unremitted earnings of international subsidiaries for which no such tax is provided and which is considered to be permanently reinvested in the subsidiaries totaled $599 million and $511 million at January 30, 2010, and January 31, 2009, respectively. Determination of the amount of the deferred tax liability, if any, related to permanently reinvested earnings is not practicable.
A reconciliation of the significant differences between the federal statutory income tax rate and the effective income tax rate on pre-tax income (loss) from continuing operations is as follows:
| | | | | | |
| | 2009 | | 2008 | | 2007 |
| Federal statutory income tax rate | | | 35.0 | % | | | (35.0 | )% | | | (35.0 | )% |
| State and local income taxes, net of federal tax benefit | | | 0.2 | | | | (6.6 | ) | | | (11.0 | ) |
| International income taxed at varying rates | | | 1.3 | | | | (2.1 | ) | | | 7.5 | |
| Foreign tax credits | | | (7.4 | ) | | | (5.3 | ) | | | (53.1 | ) |
| Increase (decrease) in valuation allowance | | | — | | | | 0.2 | | | | (120.0 | ) |
| Domestic/foreign tax settlements | | | (2.8 | ) | | | (2.2 | ) | | | — | |
| Tax exempt obligations | | | — | | | | — | | | | (3.7 | ) |
| Federal tax credits | | | (2.0 | ) | | | (1.2 | ) | | | (1.6 | ) |
| Foreign dividends and gross-up | | | — | | | | — | | | | 25.4 | |
| Non-deductible impairment charges | | | — | | | | 26.9 | | | | — | |
| Canadian tax rate changes | | | 6.0 | | | | 0.4 | | | | — | |
| Other, net | | | 5.7 | | | | 4.1 | | | | 4.5 | |
| Effective income tax rate | | | 36.0 | % | | | (20.8 | )% | | | (187.0 | )% |
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Items that gave rise to significant portions of the deferred tax accounts are as follows:
| | | | |
| | 2009 | | 2008 |
| | | (in millions) |
Deferred tax assets:
| | | | | | | | |
| Tax loss/credit carryforwards and capital loss | | $ | 106 | | | $ | 37 | |
| Employee benefits | | | 66 | | | | 102 | |
| Reserve for discontinued operations | | | 4 | | | | 5 | |
| Repositioning and restructuring reserves | | | 1 | | | | 1 | |
| Property and equipment | | | 177 | | | | 184 | |
| Allowance for returns and doubtful accounts | | | 1 | | | | 1 | |
| Straight-line rent | | | 27 | | | | 25 | |
| Goodwill | | | 23 | | | | 25 | |
| Other | | | 32 | | | | 28 | |
| Total deferred tax assets | | | 437 | | | | 408 | |
| Valuation allowance | | | (12 | ) | | | (13 | ) |
| Total deferred tax assets, net | | | 425 | | | | 395 | |
Deferred tax liabilities:
| | | | | | | | |
| Inventories | | | 46 | | | | 22 | |
| Other | | | 5 | | | | 8 | |
| Total deferred tax liabilities | | | 51 | | | | 30 | |
| Net deferred tax asset | | $ | 374 | | | $ | 365 | |
Balance Sheet caption reported in:
| | | | | | | | |
| Deferred taxes | | $ | 362 | | | $ | 358 | |
| Other current assets | | | 17 | | | | 29 | |
| Other current liabilities | | | (5 | ) | | | (10 | ) |
| Other liabilities | | | — | | | | (12 | ) |
| | | $ | 374 | | | $ | 365 | |
The Company operates in multiple taxing jurisdictions and is subject to audit. Audits can involve complex issues that may require an extended period of time to resolve. A taxing authority may challenge positions that the Company has adopted in its income tax filings. Accordingly, the Company may apply different tax treatments for transactions in filing its income tax returns than for income tax financial reporting. The Company regularly assesses its tax positions for such transactions and records reserves for those differences.
The Company’s U.S. Federal income tax filings have been examined by the Internal Revenue Service (the “IRS”) through 2008. The Company is participating in the IRS’s Compliance Assurance Process (“CAP”) for 2009, which is expected to conclude during 2010. The Company has started the CAP for 2010. Due to the recent utilization of net operating loss carryforwards, the Company is subject to state and local tax examinations effectively including years from 1996 to the present. To date, no adjustments have been proposed in any audits that will have a material effect on the Company’s financial position or results of operations.
As of January 30, 2010, the Company has a valuation allowance of $12 million to reduce its deferred tax assets to an amount that is more likely than not to be realized. The valuation allowance primarily relates to the deferred tax assets arising from a capital loss associated with the 2008 impairment of the Northern Group note receivable, state tax loss carryforwards, and state tax credits. A full valuation allowance is required for the capital loss because the Company does not anticipate recognizing sufficient capital gains to utilize this loss. The valuation allowance for state tax loss carryforwards decreased principally due to anticipated expirations of those losses.
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Based upon the level of historical taxable income and projections for future taxable income, which are based upon the Company’s three-year strategic plans, over the periods in which the temporary differences are anticipated to reverse, management believes it is more likely than not that the Company will realize the benefits of these deductible differences, net of the valuation allowances at January 30, 2010. However, the amount of the deferred tax asset considered realizable could be adjusted in the future if estimates of taxable income are revised.
At January 30, 2010, the Company has a current year net operating loss with a potential benefit of $38 million, which may be carried back up to five years or carried forward twenty years; and has federal tax credit carryforwards totaling $36 million that expire between 2017 and 2029. The Company also has state operating loss carryforwards with a potential tax benefit of $22 million that expire between 2010 and 2029. The Company will have, when recognized, a capital loss with a potential benefit of $5 million arising from a note receivable. This loss will carryforward for 5 years after recognition. The Company has U.S. state and Canadian provincial credit carryforwards that total $3 million, expiring between 2010 and 2022. The Company has international operating loss carryforwards with a potential tax benefit of $2 million, expiring between 2010 and 2028.
The Company had $58 million of gross unrecognized tax benefits and $55 million of net unrecognized tax benefits, as of February 1, 2009. The Company has classified certain income tax liabilities as current or noncurrent based on management’s estimate of when these liabilities will be settled. Interest expense and penalties related to unrecognized tax benefits are classified as income tax expense. The Company recognized $1 million of interest expense in each of 2009, 2008, and 2007. The total amount of accrued interest and penalties was $5 million in 2009 and $4 million in 2008.
The following table summarizes the activity related to unrecognized tax benefits:
| | |
| (in millions) | | |
| Balance as of February 1, 2009 | | $ | 58 | |
| Foreign currency translation adjustments | | | 6 | |
| Increases related to current year tax positions | | | 4 | |
| Increases related to prior period tax positions | | | 4 | |
| Decreases related to prior period tax positions | | | (2 | ) |
| Settlements | | | — | |
| Lapse of statute of limitations | | | — | |
| Balance as of January 30, 2010 | | $ | 70 | |
Of the unrecognized tax benefits, $68 million would, if recognized, affect the Company’s annual effective tax rate. It is reasonably possible that the liability associated with the Company’s unrecognized tax benefits will increase or decrease within the next twelve months. These changes may be the result of foreign currency fluctuations, ongoing audits or the expiration of statutes of limitations. Settlements could increase earnings in an amount ranging from $0 to $5 million based on current estimates. Audit outcomes and the timing of audit settlements are subject to significant uncertainty. Although management believes that adequate provision has been made for such issues, the ultimate resolution of these issues could have an adverse effect on the earnings of the Company. Conversely, if these issues are resolved favorably in the future, the related provision would be reduced, generating a positive effect on earnings. Due to the uncertainty of amounts and in accordance with its accounting policies, the Company has not recorded any potential impact of these settlements.
| 18. | Financial Instruments and Risk Management |
The Company operates internationally and utilizes certain derivative financial instruments to mitigate its foreign currency exposures, primarily related to third party and intercompany forecasted transactions. As a result of the use of derivative instruments, the Company is exposed to the risk that counterparties will fail to meet their contractual obligations. To mitigate the counterparty credit risk, the Company has a policy of entering into contracts only with major financial institutions selected based upon their credit ratings and other financial factors. The Company monitors the creditworthiness of counterparties throughout the duration of the derivative instrument. Additional information is contained within Note 19, “Fair Value Measurements.”
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Derivative Holdings Designated as Hedges
For a derivative to qualify as a hedge at inception and throughout the hedged period, the Company formally documents the nature of the hedged items and the relationships between the hedging instruments and the hedged items, as well as its risk-management objectives, strategies for undertaking the various hedge transactions, and the methods of assessing hedge effectiveness and hedge ineffectiveness. In addition, for hedges of forecasted transactions, the significant characteristics and expected terms of a forecasted transaction must be specifically identified, and it must be probable that each forecasted transaction would occur. If it were deemed probable that the forecasted transaction would not occur, the gain or loss would be recognized in earnings immediately. No such gains or losses were recognized in earnings for any of the periods presented. Derivative financial instruments qualifying for hedge accounting must maintain a specified level of effectiveness between the hedging instrument and the item being hedged, both at inception and throughout the hedged period, which management evaluates periodically.
Cash Flow Hedges
The primary currencies to which the Company is exposed are the euro, the British pound, the Canadian dollar, and the Australian dollar. For option and forward foreign exchange contracts designated as cash flow hedges of the purchase of inventory, the effective portion of gains and losses is deferred as a component of accumulated other comprehensive loss (“AOCL”) and is recognized as a component of cost of sales when the related inventory is sold. The change in AOCL related to such contracts was a decrease of $3 million for the year ended January 30, 2010 and a $1 million increase in AOCL for the year ended January 31, 2009. Cost of sales was reduced by approximately $2 million for both 2009 and 2008 as a result of settling these derivative contracts. The ineffective portion of gains and losses related to cash flow hedges recorded to earnings was not significant for any of the periods presented. When using a forward contract as a hedging instrument, the Company excludes the time value from the assessment of effectiveness. At each year-end, the Company had not hedged forecasted transactions for more than the next twelve months, and the Company expects all derivative-related amounts reported in accumulated other comprehensive loss to be reclassified to earnings within twelve months.
Net Investment Hedges
The Company has numerous investments in foreign subsidiaries, and the net assets of those subsidiaries are exposed to foreign exchange-rate volatility. In 2005, the Company hedged a portion of its net investment in its European subsidiaries by entering into a 10-year cross currency swap, effectively creating a €100 million long-term liability and a $122 million long-term asset. During the third quarter of 2008, the Company terminated this hedge by amending its existing cross currency swap and entering simultaneously into a new cross currency swap, thereby fixing the amount owed to the counterparty in 2015 at $24 million. In 2006, the Company hedged a portion of its net investment in its Canadian subsidiaries. During the fourth quarter of 2008, the Company terminated this hedge and received approximately $3 million.
The Company had designated these hedging instruments as hedges of the net investments in foreign subsidiaries, and used the spot rate method of accounting to value changes of the hedging instrument attributable to currency rate fluctuations. As such, adjustments in the fair market value of the hedging instrument due to changes in the spot rate were recorded in other comprehensive income and offset changes in the euro-denominated net investment. Amounts recorded to foreign currency translation within accumulated other comprehensive loss will remain there until the net investment is disposed of.
The amount recorded within the foreign currency translation adjustment included in accumulated other comprehensive loss on the Company’s Consolidated Balance Sheet decreased shareholders’ equity by $15 million, $15 million and $20 million, net of tax at January 30, 2010, January 31, 2009 and February 2, 2008, respectively. The effect on the Consolidated Statements of Operations related to the net investment hedges was not significant for the year ended January 30, 2010, represented $3 million of expense for 2008, and represented $1 million of income for 2007.
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Derivative Holdings Designated as Non-Hedges
The Company mitigates the effect of fluctuating foreign exchange rates on the reporting of foreign currency denominated earnings by entering into a variety of derivative instruments, including option currency contracts. Changes in the fair value of these foreign currency option contracts, which are designated as non-hedges, are recorded in earnings immediately within other income. The realized gains, premiums paid and changes in the fair market value recorded in the Consolidated Statements of Operations was not significant and was $4 million of income for the years ended January 30, 2010 and January 31, 2009, respectively, and was not significant for the year ended February 2, 2008. The notional value of the option currency contract outstanding at January 30, 2010 was $8 million.
The Company also enters into forward foreign exchange contracts to hedge foreign-currency denominated merchandise purchases and intercompany transactions. Net changes in the fair value of foreign exchange derivative financial instruments designated as non-hedges were substantially offset by the changes in value of the underlying transactions, which were recorded in selling, general and administrative expenses. The amount recorded for all the periods presented was not significant.
The Company enters into monthly diesel fuel forward and option contracts to mitigate a portion of the Company’s freight expense due to the variability caused by fuel surcharges imposed by our third-party freight carriers. The notional value of the contracts outstanding at January 30, 2010 was $4 million and these contracts extend through November 2010. Changes in the fair value of these contracts are recorded in earnings immediately. The effect was not significant for any of the periods presented.
As discussed above, the Company terminated its European net investment hedge during the third quarter of 2008. During the remaining term of the agreement, the Company will remit to its counterparty interest payments based on one-month U.S. LIBOR rates on the $24 million liability. The agreement includes a provision that may require the Company to settle this transaction in August 2010, at the option of the Company or the counterparty.
Fair Value of Derivative Contracts
The following represents the fair value of the Company’s derivative contracts. Many of the Company’s agreements allow for a netting arrangement. The following is presented on a gross basis, by type of contract:
| | | | | | | | |
| | 2009 | | 2008 |
| (in millions) | | Balance Sheet Caption | | Fair Value | | Balance Sheet Caption | | Fair Value |
Hedging Instruments:
| | | | | | | | | | | | | | | | |
| Forward foreign exchange contracts | | | Current assets | | | $ | — | | | | Current assets | | | $ | 3 | |
| Interest rate swaps | | | Non current assets | | | | — | | | | Non current assets | | | | 19 | |
| Total | | | | | | $ | — | | | | | | | $ | 22 | |
Non Hedging Instruments:
| | | | | | | | | | | | | | | | |
| Forward foreign exchange contracts | | | Current assets | | | $ | 1 | | | | Current assets | | | $ | 2 | |
| European cross currency swap | | | Non current liability | | | | (24 | ) | | | Non current liability | | | | (24 | ) |
| Fuel forwards and options contracts | | | Non current liability | | | | — | | | | Non current liability | | | | (1 | ) |
| Total | | | | | | $ | (23 | ) | | | | | | $ | (23 | ) |
Foreign Currency Exchange Rates
The table below presents the notional amounts and weighted-average exchange rates of foreign exchange forward contracts outstanding at January 30, 2010.
| | | | |
| | Contract Value
(U.S. in millions) | | Weighted-Average
Exchange Rate |
Inventory
| | | | | | | | |
| Buy €/Sell British £ | | $ | 30 | | | | .8664 | |
| Buy US/Sell € | | | 9 | | | | .6864 | |
Intercompany
| | | | | | | | |
| Buy €/Sell British £ | | $ | 21 | | | | .8674 | |
| Buy US/Sell CAD$ | | | 7 | | | | 1.0376 | |
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Interest Rate Risk Management
The Company historically has employed various interest rate swaps to minimize its exposure to interest rate fluctuations. On March 20, 2009, the Company terminated its interest rate swaps for a gain of $19 million. This gain will be amortized as part of interest expense over the remaining term of the debt using the effective-yield method. The amount amortized during 2009 was $1 million.
Business Risk
The retailing business is highly competitive. Price, quality, selection of merchandise, reputation, store location, advertising and customer service are important competitive factors in the Company’s business. The Company operates in 21 countries and purchased approximately 82 percent of its merchandise in 2009 from its top 5 vendors. In 2009, the Company purchased approximately 68 percent of its athletic merchandise from one major vendor and approximately 8 percent from another major vendor. Each of our operating divisions is highly dependent on Nike; they individually purchase 46 to 85 percent of their merchandise from Nike. The Company generally considers all vendor relations to be satisfactory.
Included in the Company’s Consolidated Balance Sheet at January 30, 2010, are the net assets of the Company’s European operations, which total $658 million and which are located in 17 countries, 11 of which have adopted the euro as their functional currency.
Fair Value of Financial Instruments
The carrying value and estimated fair value of long-term debt was $138 million and $127 million, respectively, at January 30, 2010 and $142 million and $120 million, respectively, at January 31, 2009. The carrying values of cash and cash equivalents and other current receivables and payables approximate their fair value due to the short-term nature of these assets and liabilities.
| 19. | Fair Value Measurements |
The following table provides a summary of the recognized assets and liabilities that are measured at fair value on a recurring basis:
| | | | | | | | |
| | As of January 30, 2010 |
| (in millions) | | Level 1 | | Level 2 | | Level 3 | | Total |
Assets
| | | | | | | | | | | | | | | | |
| Short-term investment | | $ | — | | | $ | — | | | $ | 7 | | | $ | 7 | |
| Auction rate security | | | — | | | | 5 | | | | — | | | | 5 | |
| Forward foreign exchange contracts | | | — | | | | 1 | | | | — | | | | 1 | |
| Total Assets | | $ | — | | | $ | 6 | | | $ | 7 | | | $ | 13 | |
Liabilities
| | | | | | | | | | | | | | | | |
| European net investment hedge | | | — | | | | 24 | | | | — | | | | 24 | |
| Total Liabilities | | $ | — | | | $ | 24 | | | $ | — | | | $ | 24 | |
| | | | | | | | |
| | As of January 31, 2009 |
| (in millions) | | Level 1 | | Level 2 | | Level 3 | | Total |
Assets
| | | | | | | | | | | | | | | | |
| Short-term investment | | $ | — | | | $ | — | | | $ | 23 | | | $ | 23 | |
| Auction rate security | | | — | | | | 2 | | | | — | | | | 2 | |
| Forward foreign exchange contracts | | | — | | | | 5 | | | | — | | | | 5 | |
| Interest rate swaps | | | — | | | | 19 | | | | — | | | | 19 | |
| Total Assets | | $ | — | | | $ | 26 | | | $ | 23 | | | $ | 49 | |
Liabilities
| | | | | | | | | | | | | | | | |
| Forward foreign exchange contracts | | | — | | | | 1 | | | | — | | | | 1 | |
| European net investment hedge | | | — | | | | 24 | | | | — | | | | 24 | |
| Total Liabilities | | $ | — | | | $ | 25 | | | $ | — | | | $ | 25 | |
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The Company’s Level 3 asset represents the Company’s investment in the Reserve International Liquidity Fund, Ltd. (the “Fund”), a money market fund classified as a short-term investment on the Company’s Consolidated Balance Sheets. The Company assesses the fair value of its investment in the Fund, which includes an impairment evaluation, on a quarterly basis, through a review of the underlying securities within the Fund. For the year ended January 31, 2009, the Company recorded an other-than-temporary impairment charge of $3 million, incorporating the valuation at zero for the Lehman Brothers debt securities. The Company did not record any additional other-than-temporary impairments on the fund for the year ended January 30, 2010. Changes in market conditions and the method and timing of the liquidation process of the Fund could result in further adjustments to the fair value and classification of this investment in future periods. The Fund was not in a continuous unrealized loss position for greater than twelve months at January 30, 2010.
At January 30, 2010, the Company held a preferred stock auction rate security with a face value of $7 million, which has experienced failed auctions due to the liquidity issues experienced in the global credit and capital markets. The security continues to earn and pay interest based on the stated terms. The Company classifies the security as long-term available-for-sale and reports the security at fair value as a component of other assets on the Company’s Consolidated Balance Sheets. The Company evaluates the security for other-than-temporary impairments at each reporting period. The security is considered temporarily impaired at January 30, 2010 with a cumulative unrealized loss of $2 million reflected in accumulated other comprehensive loss in the Company’s Consolidated Statement of Comprehensive Loss. The Company has the intent and the ability to hold the security until future auctions are successful.
The Company’s derivative financial instruments are valued using observable market-based inputs to industry valuation models. These valuation models require a variety of inputs, including contractual terms, market prices, yield curves, and measures of volatility obtained from various market sources.
The following table is a reconciliation of financial assets and liabilities measured at fair value on a recurring basis classified as Level 3, for the year ended January 30, 2010:
| | |
| (in millions) | | Level 3 |
| Balance at January 31, 2009 | | $ | 23 | |
| Redemptions received from the Fund | | | (16 | ) |
| Balance at January 30, 2010 | | $ | 7 | |
The following table provides a summary of the Company’s recognized assets that are measured at fair value on a non-recurring basis for the year ended January 30, 2010:
| | | | | | |
| (in millions) | | Level 1 | | Level 2 | | Level 3 |
Assets
| | | | | | | | | | | | |
| Long-lived assets held and used | | $ | — | | | $ | — | | | $ | 71 | |
For the year ended January 30, 2010, long-lived assets held and used with a carrying amount of $107 million were written down to their fair value of $71 million, resulting in an impairment charge of $36 million, which was included in earnings for the period. See Note 3, “Impairment and Other Charges,” for further discussion.
| 20. | Retirement Plans and Other Benefits |
Pension and Other Postretirement Plans
The Company has defined benefit pension plans covering most of its North American employees, which are funded in accordance with the provisions of the laws where the plans are in effect. In addition to providing pension benefits, the Company sponsors postretirement medical and life insurance plans, which are available to most of its retired U.S. employees. These plans are contributory and are not funded. The measurement date of the assets and liabilities is the last day of the fiscal year.
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The following tables set forth the plans’ changes in benefit obligations and plan assets, funded status and amounts recognized in the Consolidated Balance Sheets, measured at January 30, 2010 and January 31, 2009:
| | | | | | | | |
| | Pension
Benefits | | Postretirement
Benefits |
| | | 2009 | | 2008 | | 2009 | | 2008 |
| | | (in millions) |
Change in benefit obligation
| | | | | | | | | | | | | | | | |
| Benefit obligation at beginning of year | | $ | 604 | | | $ | 649 | | | $ | 12 | | | $ | 10 | |
| Service cost | | | 11 | | | | 10 | | | | — | | | | — | |
| Interest cost | | | 36 | | | | 36 | | | | 1 | | | | 1 | |
| Plan participants’ contributions | | | — | | | | — | | | | 3 | | | | 4 | |
| Actuarial loss (gain) | | | 49 | | | | (15 | ) | | | — | | | | (2 | ) |
| Foreign currency translation adjustments | | | 12 | | | | (18 | ) | | | — | | | | — | |
| Plan amendment | | | — | | | | — | | | | 1 | | | | 3 | |
| Benefits paid | | | (58 | ) | | | (58 | ) | | | (4 | ) | | | (4 | ) |
| Benefit obligation at end of year | | $ | 654 | | | $ | 604 | | | $ | 13 | | | $ | 12 | |
Change in plan assets
| | | | | | | | | | | | | | | | |
| Fair value of plan assets at beginning of year | | $ | 418 | | | $ | 611 | | | | | | | | | |
| Actual return on plan assets | | | 76 | | | | (127 | ) | | | | | | | | |
| Employer contributions | | | 103 | | | | 8 | | | | | | | | | |
| Foreign currency translation adjustments | | | 11 | | | | (16 | ) | | | | | | | | |
| Benefits paid | | | (58 | ) | | | (58 | ) | | | | | | | | |
| Fair value of plan assets at end of year | | $ | 550 | | | $ | 418 | | | | | | | | | |
| Funded status | | $ | (104 | ) | | $ | (186 | ) | | $ | (13 | ) | | $ | (12 | ) |
Balance Sheet caption reported in:
| | | | | | | | | | | | | | | | |
| Accrued and other liabilities | | | (3 | ) | | | (3 | ) | | | (2 | ) | | | (1 | ) |
| Other liabilities | | | (101 | ) | | | (183 | ) | | | (11 | ) | | | (11 | ) |
| | | $ | (104 | ) | | $ | (186 | ) | | $ | (13 | ) | | $ | (12 | ) |
Amounts recognized in accumulated other comprehensive loss consists of:
| | | | | | | | |
| | Pension
Benefits | | Postretirement
Benefits |
| | | 2009 | | 2008 | | 2009 | | 2008 |
| | | (in millions) |
| Net loss (gain) | | $ | 457 | | | $ | 448 | | | $ | (35 | ) | | $ | (41 | ) |
| Prior service cost (credit) | | | 1 | | | | 2 | | | | (1 | ) | | | (3 | ) |
| | | $ | 458 | | | $ | 450 | | | $ | (36 | ) | | $ | (44 | ) |
As of January 31, 2009, the accumulated benefit obligation exceeded plan assets for all plans, whereas, as of January 30, 2010, the Canadian qualified pension plan’s assets equaled its accumulated benefit obligation. Information for pension plans with an accumulated benefit obligation in excess of plan assets is as follows:
| | | | |
| | 2009 | | 2008 |
| | | (in millions) |
| Projected benefit obligation | | $ | 569 | | | $ | 604 | |
| Accumulated benefit obligation | | | 569 | | | | 603 | |
| Fair value of plan assets | | | 465 | | | | 418 | |
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Beginning with 2001, new retirees were charged the expected full cost of the medical plan and then-existing retirees will incur 100 percent of the expected future increases in medical plan costs. Any changes in the health care cost trend rates assumed would not affect the accumulated benefit obligation or net benefit income, since retirees will incur 100 percent of such expected future increase. In addition, the Company maintains a Supplemental Executive Retirement Plan (“SERP”), which is an unfunded plan that includes provisions for the continuation of medical and dental insurance benefits to certain executive officers and certain other key employees of the Company (“SERP Medical Plan”). The SERP Medical Plan’s accumulated projected benefit obligation at January 30, 2010 was approximately $5 million. A one hundred basis point change in the health care cost trend rates assumed would increase or decrease the accumulated projected benefit obligation by approximately $1 million.
The expected long-term rate of return on invested plan assets is based on the plans’ weighted-average target asset allocation, as well as historical and future expected performance of those assets. The target asset allocation is selected to obtain an investment return that is sufficient to cover the expected benefit payments and to reduce future contributions by the Company.
Plan Assets
During 2009, the Company changed the target composition of its U.S. plan assets from 65 percent equity and 35 percent fixed income securities to 50 percent equity and 50 percent fixed income. On January 29, 2010, the Company contributed $60 million to the U.S. plan. This contribution was allocated to fixed income securities as the Company migrated to its new target composition. The Company may alter the targets from time to time depending on market conditions and the funding requirements of the pension plan. This change will reduce future volatility with regard to the funded status of the plan. This change will, however, result in higher pension expense due to the lower long-term rate of return associated with fixed income securities. Due to market conditions and other factors, actual asset allocations may vary from the target allocation outlined above. The Company believes that plan assets are invested in a prudent manner with an objective of providing a total return that, over the long term, provides sufficient assets to fund benefit obligations, taking into account the Company’s expected contributions and the level of risk deemed appropriate. The Company’s investment strategy seeks to utilize asset classes with differing rates of return, volatility, and correlation in order to reduce risk by providing diversification relative to equities. Diversification within asset classes is also utilized to ensure that there are no significant concentrations of risk in plan assets and to reduce the effect that the return on any single investment may have on the entire portfolio.
In late January 2008, the Company modified the actual asset allocation for its Canadian pension plan. Effective with the beginning of 2008, the target allocation for the Canadian plan is 95 percent debt securities and 5 percent equity. The Company believes that plan assets are invested in a prudent manner with the same overall objective and investment strategy as noted above for the U.S. pension plan. The bond portfolio is comprised of government and corporate bonds chosen to match the duration of the pension plan’s benefit payment obligations. This change will reduce future volatility with regard to the funded status of the plan. This change has resulted in higher pension expense due to the lower long-term rate of return associated with fixed-income securities.
Valuation of Investments
Significant portions of plan assets are invested in commingled trust funds. These funds are valued at the net asset value of units held by the plan at year end. Stocks traded on U.S. security exchanges are valued at closing market prices on the measurement date.
Investments in real estate are carried at their estimated fair value based on information supplied by independent appraisers whereby each property is independently appraised and adjusted accordingly at least once within a five-year period. The Company’s management reviews the fair value of each property during the intervening years to determine whether an impairment has occurred since receiving the latest independent appraisal and that no change is required to the fair value.
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The fair values of the Company’s U.S. pension plan assets at January 30, 2010 are as follows:
| | | | | | | | |
| (in millions) | | Level 1 | | Level 2 | | Level 3 | | Total |
| Cash and cash equivalents | | $ | — | | | $ | 5 | | | $ | — | | | $ | 5 | |
Equity securities:
| | | | | | | | | | | | | | | | |
| U.S. large-cap(a) | | | — | | | | 110 | | | | — | | | | 110 | |
| U.S. mid-cap(a) | | | — | | | | 36 | | | | — | | | | 36 | |
| International(b) | | | — | | | | 62 | | | | — | | | | 62 | |
| Corporate stock(c) | | | 17 | | | | — | | | | — | | | | 17 | |
Fixed income securities:
| | | | | | | | | | | | | | | | |
| Long duration corporate and government bonds(d) | | | — | | | | 200 | | | | — | | | | 200 | |
| Intermediate duration corporate and government bonds(e) | | | — | | | | 27 | | | | — | | | | 27 | |
Other types of investments:
| | | | | | | | | | | | | | | | |
| Real estate | | | — | | | | — | | | | 7 | | | | 7 | |
| Insurance contracts | | | — | | | | 1 | | | | — | | | | 1 | |
| Total assets at fair value | | $ | 17 | | | $ | 441 | | | $ | 7 | | | $ | 465 | |
| (a) | These categories consist of various managed funds that invest primarily in common stocks, as well as other equity securities and a combination of other funds. |
| (b) | This category comprises two managed funds that invest primarily in international common stocks, as well as other equity securities and a combination of other funds. |
| (c) | This category consists of common and preferred stock issued by U.S. and non-U.S. corporations, including $4 million invested in the Company’s common stock. |
| (d) | This category consists of various fixed income funds that invest primarily in long-term bonds, as well as a combination of other funds, that together are designed to exceed the performance of related long-term market indices. |
| (e) | This category consists of a fixed income fund that invests primarily in intermediate duration bonds, as well as a combination of other funds, that together are designed to track the performance of the Barclays Capital U.S. Intermediate Credit Index. |
The fair values of the Company’s Canadian pension plan assets at January 30, 2010 are as follows:
| | | | | | | | |
| (in millions) | | Level 1 | | Level 2 | | Level 3 | | Total |
Equity securities:
| | | | | | | | | | | | | | | | |
| Canadian equity securities(a) | | $ | — | | | $ | 7 | | | $ | — | | | $ | 7 | |
Debt securities:
| | | | | | | | | | | | | | | | |
| Cash matched bonds(b) | | | — | | | | 78 | | | | — | | | | 78 | |
| Total assets at fair value | | $ | — | | | $ | 85 | | | $ | — | | | $ | 85 | |
| (a) | This category comprises a mutual fund that invests in a diverse portfolio of Canadian equity securities, and convertible bonds. |
| (b) | This category consists of fixed income securities, including strips and coupons, issued or guaranteed by the Government of Canada, provinces or municipalities of Canada including their agencies and crown corporations, as well as corporate bonds. |
No Level 3 assets were held by the Canadian pension plan during 2009, and there was no activity within the U.S. pension plan’s real estate investments classified as Level 3 for the year ended January 30, 2010.
During 2009 the Company made contributions of $97 million and $3 million to its U.S. and Canadian plans, respectively. In accordance with the Pension Protection Act, the Company contributed to its U.S. pension plan amounts in excess of the minimum requirements. The Company contributed approximately $2 million to its Canadian pension plan in February 2010. The Company continuously evaluates the amount and timing of any future contributions. Additional contributions will depend on the plan asset performance for the balance of the year and statutory or regulatory changes that may occur, if any.
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Estimated future benefit payments for each of the next five years and the five years thereafter are as follows:
| | | | |
| | Pension
Benefits | | Postretirement
Benefits |
| | | (in millions) |
| 2010 | | $ | 70 | | | $ | 2 | |
| 2011 | | | 61 | | | | 1 | |
| 2012 | | | 59 | | | | 1 | |
| 2013 | | | 57 | | | | 1 | |
| 2014 | | | 55 | | | | 1 | |
| 2015–2019 | | | 253 | | | | 4 | |
In February 2007, the Company and its U.S. pension plan, the Foot Locker Retirement Plan, were named as defendants in a class action in federal court in New York. The Complaint alleged that the Company’s pension plan violated the Employee Retirement Income Security Act of 1974, including, without limitation, its age discrimination and notice provisions, as a result of the Company’s conversion of its defined benefit plan to a defined benefit pension plan with a cash balance feature in 1996. The Company is defending the action vigorously.
Savings Plans
The Company has two qualified savings plans, a 401(k) Plan that is available to employees whose primary place of employment is the U.S., and an 1165 (e) Plan that is available to employees whose primary place of employment is in Puerto Rico. Both plans require that the employees have attained at least the age of twenty-one and have completed one year of service consisting of at least 1,000 hours. The savings plans allow eligible employees to contribute up to 40 percent and $9,000 as of January 1, 2010, for the U.S. and Puerto Rico plans, respectively, of their compensation on a pre-tax basis. The Company matches 25 percent of the first 4 percent of the employees’ contributions with Company stock and such matching Company contributions are vested incrementally over 5 years for both plans. The charge to operations for the Company’s matching contribution was $2.7 million, $2.2 million, and $1.8 million in 2009, 2008, and 2007, respectively.
| 21. | Share-Based Compensation |
Stock Options
On May 30, 2007, the Company’s shareholders approved the Company’s 2007 Stock Incentive Plan (the “2007 Stock Plan”). Upon approval of the 2007 Stock Plan, the Company stated it would no longer grant stock awards under the 2003 Stock Option and Award Plan (the “2003 Stock Option Plan”), the 1998 Stock Option and Award Plan (the “1998 Plan”), and the 2002 Foot Locker Directors’ Stock Plan (the “2002 Directors’ Plan”), although awards previously made under those plans and outstanding on May 30, 2007 continue in effect governed by the provisions of those plans.
Under the 2007 Stock Plan, stock options, restricted stock, stock appreciation rights (SARs), or other stock-based awards may be granted to officers and other employees of the Company, including its subsidiaries and operating divisions worldwide. Nonemployee directors are also eligible to receive awards under this plan. Options for employees become exercisable in substantially equal annual installments over a three-year period, beginning with the first anniversary of the date of grant of the option, unless a shorter or longer duration is established at the time of the option grant. Options for nonemployee directors become exercisable one year from the date of grant. The maximum number of shares of stock reserved for all awards under the 2007 Stock Plan is 6,000,000. The number of shares reserved for issuance as restricted stock and other stock-based awards cannot exceed 1,500,000 shares. The options terminate up to ten years from the date of grant.
Under the Company’s 2003 Stock Option Plan and the 1998 Plan, options to purchase shares of common stock were granted to officers and other employees at not less than the market price on the date of grant. Under these plans, the Company was authorized to grant to officers and other employees, including those at the subsidiary level, stock options, SARs, restricted stock or other stock-based awards. Generally, one-third of each stock option grant becomes exercisable on each of the first three anniversary dates of the date of grant. The options terminate up to ten years from the date of grant.
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The 2002 Directors’ Plan replaced both the Directors’ Stock Plan, which was adopted in 1996, and the Directors’ Stock Option Plan, which was adopted in 2000. No further grants or awards may be made under either of the prior plans. Options granted prior to 2003 have a three-year vesting schedule. Options granted beginning in 2003 become exercisable one year from the date of grant.
In addition, options to purchase shares of common stock remain outstanding under the Company’s 1995 Stock Option and Award Plan (the “1995 Plan”). The 1995 Plan is substantially the same as the 1998 Plan. As of March 8, 2005 no further awards may be made under the 1995 Plan.
Employee Stock Purchase Plan
Under the Company’s 2003 Employee Stock Purchase Plan (the “2003 Employee Stock Purchase Plan”), participating employees are able to contribute up to 10 percent of their annual compensation through payroll deductions to acquire shares of the Company’s common stock at 85 percent of the lower market price on one of two specified dates in each plan year. Under the 2003 Employee Stock Purchase Plan, 3,000,000 shares of common stock are authorized for purchase beginning June 2005. Of the 3,000,000 shares of common stock authorized for purchase under this plan, 604 participating employees purchased 125,992 shares in 2009, and 587 participating employees purchased 96,800 shares in 2008. To date, a total of 663,717 shares have been purchased under this plan.
Total compensation expense related to the Company’s share based compensation plans was $12.1 million, $8.6 million and $10.4 million for 2009, 2008 and 2007 respectively. The total related tax benefit for 2009 and 2008 was not significant and was $1.0 million for 2007.
Valuation Model and Assumptions
The Company uses a Black-Scholes option-pricing model to estimate the fair value of share-based awards. The Black-Scholes option-pricing model incorporates various and highly subjective assumptions, including expected term and expected volatility.
The Company estimates the expected term of share-based awards granted using the Company’s historical exercise and post-vesting employment termination patterns, which it believes are representative of future behavior. The expected term for the Company’s employee stock purchase plan valuation is based on the length of each purchase period as measured at the beginning of the offering period, which is one year. The Company estimates the expected volatility of its common stock at the grant date using a weighted-average of the Company’s historical volatility and implied volatility from traded options on the Company’s common stock. The Company believes that the combination of historical volatility and implied volatility provides a better estimate of future stock price volatility. The risk-free interest rate assumption is determined using the Federal Reserve nominal rates for U.S. Treasury zero-coupon bonds with maturities similar to those of the expected term of the award being valued. The expected dividend yield is derived from the Company’s historical experience. The Company estimates pre-vesting option forfeitures at the time of grant and periodically revises those estimates in subsequent periods if actual forfeitures differ from those estimates. The Company records stock-based compensation expense only for those awards expected to vest using an estimated forfeiture rate based on its historical pre-vesting forfeiture data. The following table shows the Company’s assumptions used to compute the share-based compensation expense:
| | | | | | | | | | | | |
| | Stock Option Plans | | Stock Purchase Plan |
| | | 2009 | | 2008 | | 2007 | | 2009 | | 2008 | | 2007 |
| Weighted-average risk free rate of interest | | | 1.93 | % | | | 2.43 | % | | | 4.43 | % | | | 1.74 | % | | | 4.16 | % | | | 5.00 | % |
| Expected volatility | | | 53 | % | | | 37 | % | | | 28 | % | | | 39 | % | | | 27 | % | | | 22 | % |
| Weighted-average expected award life | | | 4.6 years | | | | 4.6 years | | | | 4.2 years | | | | 1.0 year | | | | 1.0 year | | | | 1.0 year | |
| Dividend yield | | | 6.0 | % | | | 5.1 | % | | | 2.3 | % | | | 4.4 | % | | | 2.8 | % | | | 2.0 | % |
| Weighted-average fair value | | $ | 2.89 | | | $ | 2.49 | | | $ | 5.28 | | | $ | 4.17 | | | $ | 7.80 | | | $ | 4.96 | |
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The information set forth in the following table covers options granted under the Company’s stock option plans:
| | | | | | | | | | | | |
| | 2009 | | 2008 | | 2007 |
| | | Number
of
Shares | | Weighted-
Average
Exercise
Price | | Number
of
Shares | | Weighted-
Average
Exercise
Price | | Number
of
Shares | | Weighted-
Average
Exercise
Price |
| | | (in thousands, except prices per share) |
| Options outstanding at beginning of year | | | 6,080 | | | $ | 18.64 | | | | 5,977 | | | $ | 19.57 | | | | 6,048 | | | $ | 19.15 | |
| Granted | | | 1,521 | | | $ | 10.02 | | | | 588 | | | $ | 11.73 | | | | 778 | | | $ | 22.38 | |
| Exercised | | | (181 | ) | | $ | 8.76 | | | | (81 | ) | | $ | 9.76 | | | | (474 | ) | | $ | 15.29 | |
| Expired or cancelled | | | (418 | ) | | $ | 21.03 | | | | (404 | ) | | $ | 24.12 | | | | (375 | ) | | $ | 23.99 | |
| Options outstanding at end of year | | | 7,002 | | | $ | 16.88 | | | | 6,080 | | | $ | 18.64 | | | | 5,977 | | | $ | 19.57 | |
| Options exercisable at end of year | | | 5,084 | | | $ | 18.85 | | | | 4,812 | | | $ | 18.89 | | | | 4,530 | | | $ | 18.27 | |
| Options available for future grant at end of year | | | 2,214 | | | | | | | | 4,890 | | | | | | | | 5,804 | | | | | |
The total intrinsic value of options exercised (the difference between the market price of the Company’s common stock on the exercise date and the price paid by the optionee to exercise the option) for 2009, 2008 and 2007 was $0.4 million, $0.2 million and $2.7 million, respectively. The aggregate intrinsic value for stock options outstanding and for stock options exercisable (the difference between the Company’s closing stock price on the last trading day of the period and the exercise price of the options, multiplied by the number of in-the-money stock options) as of January 30, 2010 was $2.4 million and $0.7 million, respectively. The Company received $1.6 million in cash from option exercises for the year ended January 30, 2010. The tax benefit realized by the Company on stock option exercises for the year ended January 30, 2010 was not significant. Compensation expense related to the Company’s stock options and employee stock purchase plan was $3.8 million, $3.5 million and $4.5 million for 2009, 2008, and 2007, respectively.
The following table summarizes information about stock options outstanding and exercisable at January 30, 2010:
| | | | | | | | | | |
| | Options Outstanding | | Options Exercisable |
| Range of Exercise Prices | | Number
Outstanding | | Weighted-
Average
Remaining
Contractual
Life | | Weighted-
Average
Exercise
Price | | Number
Exercisable | | Weighted-
Average
Exercise
Price |
| | | (in thousands, except prices per share) |
| $9.51 to $10.10 | | | 1,486 | | | | 9.25 | | | $ | 10.00 | | | | 145 | | | $ | 9.95 | |
| $10.22 to $11.91 | | | 1,682 | | | | 4.08 | | | $ | 11.29 | | | | 1,340 | | | $ | 11.25 | |
| $12.30 to $23.42 | | | 1,868 | | | | 4.16 | | | $ | 18.09 | | | | 1,634 | | | $ | 17.61 | |
| $23.59 to $27.01 | | | 1,483 | | | | 5.02 | | | $ | 24.95 | | | | 1,482 | | | $ | 24.95 | |
| $27.10 to $28.50 | | | 483 | | | | 4.87 | | | $ | 28.08 | | | | 483 | | | $ | 28.08 | |
| $9.51 to $28.50 | | | 7,002 | | | | 5.45 | | | $ | 16.88 | | | | 5,084 | | | $ | 18.85 | |
Changes in the Company’s nonvested options at January 30, 2010 are summarized as follows:
| | | | |
| | Number of
Shares | | Weighted-
Average Grant
Date Fair Value
per Share |
| | | (in thousands) |
| Nonvested at February 1, 2009 | | | 1,268 | | | $ | 17.71 | |
| Granted | | | 1,521 | | | | 10.02 | |
| Vested | | | (453 | ) | | | 14.36 | |
| Expired or Cancelled | | | (418 | ) | | | 21.03 | |
| Nonvested at January 30, 2010 | | | 1,918 | | | | 11.67 | |
TABLE OF CONTENTS
The weighted-average grant date fair value per share for options granted during 2009, 2008, and 2007 was $10.02, $11.73 and $22.38, respectively. As of January 30, 2010, there was $2.0 million of total unrecognized compensation cost, net of estimated forfeitures, related to nonvested stock options, which is expected to be recognized over a remaining weighted-average period of approximately 1 year.
Restricted Stock and Units
Restricted shares of the Company’s common stock may be awarded to certain officers and key employees of the Company. For executives outside of the United States the Company issues restricted stock units. The Company also issues restricted stock units to its non-employee directors. Each restricted stock unit represents the right to receive one share of the Company’s common stock provided that the vesting conditions are satisfied. In 2009, 2008 and 2007, there were 227,000, 87,500 and 90,000 restricted stock units outstanding, respectively. Compensation expense is recognized using the fair market value at the date of grant and is amortized over the vesting period, provided the recipient continues to be employed by the Company. These awards fully vest after the passage of time, generally three years. Restricted stock is considered outstanding at the time of grant, as the holders of restricted stock are entitled to receive dividends and have voting rights.
Restricted share and unit activity for the years ended January 30, 2010, January 31, 2009, and February 2, 2008 is summarized as follows:
| | | | | | |
| | Number of Shares and Units |
| | | 2009 | | 2008 | | 2007 |
| | | (in thousands) |
| Outstanding at beginning of year | | | 844 | | | | 810 | | | | 537 | |
| Granted | | | 1,115 | | | | 243 | | | | 583 | |
| Vested | | | (279 | ) | | | (109 | ) | | | (285 | ) |
| Cancelled or forfeited | | | — | | | | (100 | ) | | | (25 | ) |
| Outstanding at end of year | | | 1,680 | | | | 844 | | | | 810 | |
| Aggregate value (in millions) | | $ | 22.6 | | | $ | 16.7 | | | $ | 19.0 | |
| Weighted-average remaining contractual life | | | 1.50 years | | | | 1.28 years | | | | 1.77 years | |
The weighted-average grant-date fair value per share was $9.90, $11.79 and $22.95 for 2009, 2008, and 2007, respectively. The total fair value of awards for which restrictions lapsed was $5.2 million, $2.7 million and $7.3 million for 2009, 2008 and 2007 respectively. At January 30, 2010, there was $8.0 million of total unrecognized compensation cost net of estimated forfeitures, related to nonvested restricted stock awards. The Company recorded compensation expense related to restricted shares, net of estimated forfeitures, of $8.3 million, $5.1 million and $5.6 million for 2009, 2008 and 2007, respectively.
Legal proceedings pending against the Company or its consolidated subsidiaries consist of ordinary, routine litigation, including administrative proceedings, incidental to the business of the Company or businesses that have been sold or disposed of by the Company in past years. These legal proceedings include commercial, intellectual property, customer, and labor-and-employment-related claims.
Certain of the Company’s subsidiaries are defendants in a number of lawsuits filed in state and federal courts containing various class action allegations under state wage and hour laws, including allegations concerning classification of employees as exempt or nonexempt, unpaid overtime, meal and rest breaks, and uniforms. InPereira v. Foot Locker (United States District Court, E.D. Pennsylvania), one of the class actions, plaintiff alleged that the Company permitted unpaid off-the-clock hours in violation of the Fair Labor Standards Act. In September 2009, the court conditionally certified a nationwide collective action.
Management does not believe that the outcome of any such proceedings would have a material adverse effect on the Company’s consolidated financial position, liquidity, or results of operations, taken as a whole.
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In connection with the sale of various businesses and assets, the Company may be obligated for certain lease commitments transferred to third parties and pursuant to certain normal representations, warranties, or indemnifications entered into with the purchasers of such businesses or assets. Although the maximum potential amounts for such obligations cannot be readily determined, management believes that the resolution of such contingencies will not have a material effect on the Company’s consolidated financial position, liquidity, or results of operations. The Company is also operating certain stores and making rental payments for which lease agreements are in the process of being negotiated with landlords. Although there is no contractual commitment to make these payments, it is likely that a lease will be executed.
The Company does not have any off-balance sheet financing, other than operating leases entered into in the normal course of business and disclosed above, or unconsolidated special purpose entities. The Company does not participate in transactions that generate relationships with unconsolidated entities or financial partnerships, including variable interest entities.
| 24. | Shareholder Information and Market Prices (Unaudited) |
Foot Locker, Inc. common stock is listed on The New York Stock Exchange as well as on the boerse-stuttgart stock exchange in Germany and the Elektronische Borse Schweiz (EBS) stock exchange in Switzerland. In addition, the stock is traded on the Cincinnati stock exchange. At January 30, 2010, the Company had 20,480 shareholders of record owning 156,540,788 common shares. During 2009 and 2008, the Company declared dividends of $0.15 per share during each of the quarters.
The following table sets forth, for the period indicated, the intra-day high and low sales prices for the Company’s common stock:
| | | | | | | | |
| | 2009 | | 2008 |
| | | High | | Low | | High | | Low |
Common Stock
| | | | | | | | |
Quarter
| | | | | | | | | | | | | | | | |
| 1stQ | | $ | 12.29 | | | $ | 7.09 | | | $ | 13.90 | | | $ | 10.39 | |
| 2ndQ | | | 12.95 | | | | 9.38 | | | | 15.43 | | | | 11.40 | |
| 3rdQ | | | 12.31 | | | | 9.91 | | | | 18.19 | | | | 10.12 | |
| 4thQ | | | 12.55 | | | | 9.46 | | | | 14.79 | | | | 3.65 | |
TABLE OF CONTENTS
| 25. | Quarterly Results (Unaudited) |
| | | | | | | | | | |
| | 1st Q | | 2nd Q | | 3rd Q | | 4th Q | | Year |
| | (in millions, except per share amounts) |
Sales
| | | | | | | | | | | | | | | | | | | | |
| 2009 | | $ | 1,216 | | | | 1,099 | | | | 1,214 | | | | 1,325 | | | | 4,854 | |
| 2008 | | | 1,309 | | | | 1,302 | | | | 1,309 | | | | 1,317 | | | | 5,237 | |
Gross margin(a)
| | | | | | | | | | | | | | | | | | | | |
| 2009 | | $ | 356 | | | | 280 | | | | 329 | | | | 367 | (b) | | | 1,332 | |
| 2008 | | | 366 | | | | 361 | | | | 355 | | | | 378 | | | | 1,460 | |
Operating profit (loss)(c)
| | | | | | | | | | | | | | | | | | | | |
| 2009 | | $ | 50 | | | | — | | | | (10 | ) | | | 40 | | | | 80 | |
| 2008 | | | 16 | | | | 28 | | | | 33 | | | | (180 | )(d) | | | (103 | ) |
Income (loss) from continuing operations
| | | | | | | | | | | | | | | | | | | | |
| 2009 | | $ | 31 | | | | (1 | ) | | | (6 | ) | | | 23 | (e) | | | 47 | |
| 2008 | | | 3 | | | | 18 | | | | 24 | | | | (124 | ) | | | (79 | ) |
Net income (loss)
| |
| 2009 | | $ | 31 | | | | — | | | | (6 | ) | | | 23 | | | | 48 | |
| 2008 | | | 3 | | | | 18 | | | | 24 | | | | (125 | ) | | | (80 | ) |
Basic earnings (loss) per share:
| | | | | | | | | | | | | | | | | | | | |
2009
| | | | | | | | | | | | | | | | | | | | |
| Income (loss) from continuing operations | | $ | 0.20 | | | | — | | | | (0.04 | ) | | | 0.14 | | | | 0.30 | |
| Income from discontinued operations | | | — | | | | — | | | | — | | | | — | | | | — | |
| Net income (loss) | | | 0.20 | | | | — | | | | (0.04 | ) | | | 0.14 | | | | 0.30 | |
2008
| | | | | | | | | | | | | | | | | | | | |
| Income (loss) from continuing operations | | $ | 0.02 | | | | 0.11 | | | | 0.16 | | | | (0.81 | ) | | | (0.52 | ) |
| Income from discontinued operations | | | — | | | | — | | | | — | | | | — | | | | — | |
| Net income (loss) | | | 0.02 | | | | 0.11 | | | | 0.16 | | | | (0.81 | ) | | | (0.52 | ) |
Diluted earnings (loss) per share:
| |
2009
| | | | | | | | | | | | | | | | | | | | |
| Income (loss) from continuing operations | | $ | 0.20 | | | | — | | | | (0.04 | ) | | | 0.14 | | | | 0.30 | |
| Income from discontinued operations | | | — | | | | — | | | | — | | | | — | | | | — | |
| Net income (loss) | | | 0.20 | | | | — | | | | (0.04 | ) | | | 0.14 | | | | 0.30 | |
2008
| | | | | | | | | | | | | | | | | | | | |
| Income (loss) from continuing operations | | $ | 0.02 | | | | 0.11 | | | | 0.16 | | | | (0.81 | ) | | | (0.52 | ) |
| Income from discontinued operations | | | — | | | | — | | | | — | | | | — | | | | — | |
| Net income (loss) | | | 0.02 | | | | 0.11 | | | | 0.16 | | | | (0.81 | ) | | | (0.52 | ) |
| (a) | Gross margin represents sales less cost of sales. |
| (b) | Included in the results for the fourth quarter of 2009 is an inventory reserve charge of $14 million for certain aged apparel. |
| (c) | Operating profit (loss) represents income (loss) from continuing operations before income taxes, interest expense, net and non-operating income. |
| (d) | During the fourth quarter of 2008, the Company recorded $236 million in impairment charges representing $67 million of store long-lived assets and $169 million of goodwill and other intangibles. |
| (e) | During the fourth quarter of 2009, the Company recorded a charge of $4 million to reflect the write-down of certain Canadian deferred tax assets as a result of certain Canadian provincial rate reductions enacted during the quarter. |
TABLE OF CONTENTS
FIVE-YEAR SUMMARY OF SELECTED FINANCIAL DATA
The selected financial data below should be read in conjunction with the Consolidated Financial Statements and the Notes thereto and other information contained elsewhere in this report.
| | | | | | | | | | |
| | 2009 | | 2008 | | 2007 | | 2006(1) | | 2005 |
($ in millions, except per share amounts)
| | | | | | | | | | | | | | | | | | | | |
Summary of Continuing Operations
| | | | | | | | | | | | | | | | | | | | |
| Sales | | $ | 4,854 | | | | 5,237 | | | | 5,437 | | | | 5,750 | | | | 5,653 | |
| Gross margin | | | 1,332 | | | | 1,460 | | | | 1,420 | | | | 1,736 | | | | 1,709 | |
| Selling, general and administrative expenses | | | 1,099 | | | | 1,174 | | | | 1,176 | | | | 1,163 | | | | 1,129 | |
| Impairment and other charges | | | 41 | | | | 259 | | | | 128 | | | | 17 | | | | — | |
| Depreciation and amortization | | | 112 | | | | 130 | | | | 166 | | | | 175 | | | | 171 | |
| Interest expense, net | | | 10 | | | | 5 | | | | 1 | | | | 3 | | | | 10 | |
| Other income | | | (3 | ) | | | (8 | ) | | | (1 | ) | | | (14 | ) | | | (6 | ) |
| Income (loss) from continuing operations | | | 47 | | | | (79 | ) | | | 43 | | | | 247 | | | | 263 | |
| Cumulative effect of accounting change(2) | | | — | | | | — | | | | — | | | | 1 | | | | — | |
| Basic earnings per share from continuing operations | | | 0.30 | | | | (0.52 | ) | | | 0.29 | | | | 1.59 | | | | 1.70 | |
| Basic earnings per share from cumulative effect of accounting change | | | — | | | | — | | | | — | | | | 0.01 | | | | — | |
| Diluted earnings per share from continuing operations | | | 0.30 | | | | (0.52 | ) | | | 0.28 | | | | 1.58 | | | | 1.67 | |
| Diluted earnings per share from cumulative effect of accounting change | | | — | | | | — | | | | — | | | | — | | | | — | |
| Common stock dividends declared per share | | | 0.60 | | | | 0.60 | | | | 0.50 | | | | 0.40 | | | | 0.32 | |
| Weighted-average common shares outstanding (in millions) | | | 156.0 | | | | 154.0 | | | | 154.0 | | | | 155.0 | | | | 155.1 | |
| Weighted-average common shares outstanding assuming dilution (in millions) | | | 156.3 | | | | 154.0 | | | | 155.6 | | | | 156.8 | | | | 157.6 | |
Financial Condition
| | | | | | | | | | | | | | | | | | | | |
| Cash, cash equivalents and short-term investments | | $ | 589 | | | | 408 | | | | 493 | | | | 470 | | | | 587 | |
| Merchandise inventories | | | 1,037 | | | | 1,120 | | | | 1,281 | | | | 1,303 | | | | 1,254 | |
| Property and equipment, net | | | 387 | | | | 432 | | | | 521 | | | | 654 | | | | 675 | |
| Total assets | | | 2,816 | | | | 2,877 | | | | 3,243 | | | | 3,249 | | | | 3,312 | |
| Long-term debt and obligations under capital leases | | | 138 | | | | 142 | | | | 221 | | | | 234 | | | | 326 | |
| Total shareholders’ equity | | | 1,948 | | | | 1,924 | | | | 2,261 | | | | 2,295 | | | | 2,027 | |
Financial Ratios
| | | | | | | | | | | | | | | | | | | | |
| Return on equity (ROE) | | | 2.4 | % | | | (3.8 | ) | | | 1.6 | | | | 11.5 | | | | 13.6 | |
| Operating (loss) profit margin | | | 1.6 | % | | | (2.0 | ) | | | (0.9 | ) | | | 6.6 | | | | 7.2 | |
| Income (loss) from continuing operations as a percentage of sales | | | 1.0 | % | | | (1.5 | ) | | | 0.8 | | | | 4.3 | | | | 4.7 | |
| Net debt capitalization percent(3) | | | 43.0 | % | | | 46.7 | | | | 45.1 | | | | 44.4 | | | | 45.2 | |
| Current ratio | | | 4.1 | | | | 4.2 | | | | 4.0 | | | | 3.9 | | | | 2.8 | |
Other Data
| | | | | | | | | | | | | | | | | | | | |
| Capital expenditures | | $ | 89 | | | | 146 | | | | 148 | | | | 165 | | | | 155 | |
| Number of stores at year end | | | 3,500 | | | | 3,641 | | | | 3,785 | | | | 3,942 | | | | 3,921 | |
| Total selling square footage at year end (in millions) | | | 7.74 | | | | 8.09 | | | | 8.50 | | | | 8.74 | | | | 8.71 | |
| Total gross square footage at year end (in millions) | | | 12.96 | | | | 13.50 | | | | 14.12 | | | | 14.55 | | | | 14.48 | |
| (1) | 2006 represents the 53 weeks ended February 3, 2007. |
| (2) | 2006 relates to the adoption of authoritative accounting guidance for share-based compensation. |
| (3) | Represents total debt, net of cash, cash equivalents and short-term investments and includes the effect of interest rate swaps. The effect of interest rate swaps increased/(decreased) debt by $18 million, $19 million, $4 million, $(4) million, and $(1) million, at January 30, 2010, January 31, 2009, February 2, 2008, February 3, 2007, and January 28, 2006, respectively. |
TABLE OF CONTENTS
| Item 9. | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure |
There were no disagreements between the Company and its independent registered public accounting firm on matters of accounting principles or practices.
| Item 9A. | Controls and Procedures |
| (a) | Evaluation of Disclosure Controls and Procedures. |
The Company’s management performed an evaluation under the supervision and with the participation of the Company’s Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), and completed an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as that term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of January 30, 2010. Based on that evaluation, the Company’s CEO and CFO concluded that the Company’s disclosure controls and procedures were effective to ensure that information relating to the Company that is required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC rules and form, and is accumulated and communicated to management, including the CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.
| (b) | Management’s Annual Report on Internal Control over Financial Reporting. |
The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting (as that term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f)). The Company’s internal control system over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. Because of inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
As of January 31, 2009, management identified a material weakness pertaining to our internal control over financial reporting. Management developed a remediation plan to strengthen our internal control over financial reporting relating to accounting for income taxes. A remediation plan was implemented during 2009 to remediate the material weakness, which included the following actions:
We improved the documentation of the income tax provision process and instituted a more formalized review process.
We accelerated the timing of certain tax preparation and review activities during the financial statement closing.
We automated many parts of the income tax provision process thereby eliminating various manual spreadsheets. Additionally, we implemented a software tool to assist in the calculation of the consolidated income tax provision.
We hired various tax professionals who are experienced in accounting for income taxes.
To evaluate the effectiveness of the Company’s internal control over financial reporting, the Company uses the framework in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO Framework”). Using the COSO Framework, the Company’s management, including the CEO and CFO, evaluated the Company’s internal control over financial reporting and concluded that the Company’s internal control over financial reporting was effective as of January 30, 2010.
KPMG LLP, the independent registered public accounting firm that audits the Company’s consolidated financial statements included in this annual report, has issued an attestation report on the Company’s effectiveness of internal control over financial reporting, which is included in Item 9A(d).
| (c) | Changes in Internal Control over Financial Reporting. |
During the Company’s last fiscal quarter there were no changes in internal control over financial reporting that materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
| (d) | Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting |
/s/ KPMG LLP
New York, New York
April 2, 2007
24
REPORTTABLE OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON
INTERNAL CONTROL OVER FINANCIAL REPORTINGCONTENTS
The Board of Directors and Shareholders of
Foot Locker, Inc.:
We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that Foot Locker, Inc. maintained effective’s internal control over financial reporting as of February 3, 2007,January 30, 2010, based on criteria established in Internal Control—Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Foot Locker, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting.reporting, included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting (Item 9A(b)). Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment,assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control andbased on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assessment that Foot Locker, Inc. maintained effective internal control over financial reporting as of February 3, 2007, is fairly stated, in all material respects, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, Foot Locker, Inc. maintained, in all material respects, effective internal control over financial reporting as of February 3, 2007,January 30, 2010, based on the criteria established inInternal Control—Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).Commission.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Foot Locker, Inc. and subsidiaries as of February 3, 2007January 30, 2010 and January 28, 2006,31, 2009, and the related consolidated statements of operations, shareholders’ equity and comprehensive income shareholders’ equity,(loss), and cash flows for each of the years in the three-year period ended February 3, 2007,January 30, 2010, and our report dated April 2, 2007March 29, 2010, expressed an unqualified opinion on thosethese consolidated financial statements.
/s/ KPMG LLP
New York, New York
April 2, 2007March 29, 2010
25
CONSOLIDATED STATEMENTSTABLE OF OPERATIONSCONTENTS
| 2006 | | | 2005 | | | 2004 |
| (in millions, except per share amounts) |
| Sales | $ | 5,750 | | | $ | 5,653 | | | $ | 5,355 |
| Costs and expenses | | | | | | | | | | |
| Cost of sales | | 4,014 | | | | 3,944 | | | | 3,722 |
| Selling, general and administrative expenses | | 1,163 | | | | 1,129 | | | | 1,090 |
| Depreciation and amortization | | 175 | | | | 171 | | | | 154 |
| Impairment charge | | 17 | | | | — | | | | — |
| Interest expense, net | | 3 | | | | 10 | | | | 15 |
| | 5,372 | | | | 5,254 | | | | 4,981 |
| Other income | | (14 | ) | | | (6 | ) | | | — |
| | 5,358 | | | | 5,248 | | | | 4,981 |
| Income from continuing operations before income taxes | | 392 | | | | 405 | | | | 374 |
| Income tax expense | | 145 | | | | 142 | | | | 119 |
| Income from continuing operations | | 247 | | | | 263 | | | | 255 |
| Income on disposal of discontinued operations, | | | | | | | | | | |
| net of income tax benefit of $1, $3, and $37, respectively | | 3 | | | | 1 | | | | 38 |
| Cumulative effect of accounting change, | | | | | | | | | | |
| net of income tax benefit of $ — | | 1 | | | | — | | | | — |
| Net income | $ | 251 | | | $ | 264 | | | $ | 293 |
| Basic earnings per share: | | | | | | | | | | |
| Income from continuing operations | $ | 1.59 | | | $ | 1.70 | | | $ | 1.69 |
| Income from discontinued operations | | 0.02 | | | | 0.01 | | | | 0.25 |
| Cumulative effect of accounting change | | 0.01 | | | | — | | | | — |
| Net income | $ | 1.62 | | | $ | 1.71 | | | $ | 1.94 |
| Diluted earnings per share: | | | | | | | | | | |
| Income from continuing operations | $ | 1.58 | | | $ | 1.67 | | | $ | 1.64 |
| Income from discontinued operations | | 0.02 | | | | 0.01 | | | | 0.24 |
| Cumulative effect of accounting change | | — | | | | — | | | | — |
| Net income | $ | 1.60 | | | $ | 1.68 | | | $ | 1.88 |
See Accompanying Notes to Consolidated Financial Statements.
26
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
| 2006 | | | 2005 | | | 2004 | |
| (in millions) |
| Net income | $ | 251 | | | $ | 264 | | | $ | 293 | |
| Other comprehensive income, net of tax | | | | | | | | | | | |
| Foreign currency translation adjustment: | | | | | | | | | | | |
| Translation adjustment arising during the period, net of tax | | 27 | | | | (25 | ) | | | 19 | |
| Cash flow hedges: | | | | | | | | | | | |
| Change in fair value of derivatives, net of income tax | | — | | | | 2 | | | | (1 | ) |
| Reclassification adjustments, net of income tax | | — | | | | (1 | ) | | | 1 | |
| Net change in cash flow hedges | | — | | | | 1 | | | | — | |
| Minimum pension liability adjustment: | | | | | | | | | | | |
| Minimum pension liability adjustment, net of deferred tax expense | | | | | | | | | | | |
| (benefit) of $120, $10 and $(9) million, respectively | | 181 | | | | 15 | | | | (14 | ) |
| Comprehensive income | $ | 459 | | | $ | 255 | | | $ | 298 | |
See Accompanying Notes to Consolidated Financial Statements.
27
CONSOLIDATED BALANCE SHEETS
| 2006 | | 2005 |
| (in millions) |
| ASSETS | | | | | |
| | | | | | |
| Current assets | | | | | |
| Cash and cash equivalents | $ | 221 | | $ | 289 |
| Short-term investments | | 249 | | | 298 |
| Total cash, cash equivalents and short-term investments | | 470 | | | 587 |
| Merchandise inventories | | 1,303 | | | 1,254 |
| Other current assets | | 261 | | | 173 |
| | 2,034 | | | 2,014 |
| Property and equipment, net | | 654 | | | 675 |
| Deferred taxes | | 109 | | | 147 |
| Goodwill | | 264 | | | 263 |
| Intangible assets, net | | 105 | | | 117 |
| Other assets | | 83 | | | 96 |
| $ | 3,249 | | $ | 3,312 |
| LIABILITIES AND SHAREHOLDERS’ EQUITY | | | | | |
| | | | | | |
| Current liabilities | | | | | |
| Accounts payable | $ | 256 | | $ | 361 |
| Accrued and other liabilities | | 246 | | | 305 |
| Current portion of long-term debt and obligations under capital leases | | 14 | | | 51 |
| | 516 | | | 717 |
| Long-term debt and obligations under capital leases | | 220 | | | 275 |
| Other liabilities | | 218 | | | 293 |
| Total liabilities | | 954 | | | 1,285 |
| Shareholders’ equity | | 2,295 | | | 2,027 |
| $ | 3,249 | | $ | 3,312 |
See Accompanying Notes to Consolidated Financial Statements.
28
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
| 2006 | | 2005 | | 2004 |
| Shares | | Amount | | Shares | | Amount | | Shares | | Amount |
| (shares in thousands, amounts in millions) |
| Common Stock and Paid-In Capital | | | | | | | | | | | | | | | | | | | | |
| Par value $0.01 per share, 500 million shares authorized | | | | | | | | | | | | | | | | | | | | |
| Issued at beginning of year | 157,280 | | | $ | 635 | | | 156,155 | | | $ | 608 | | | 144,009 | | | $ | 411 | |
| Restricted stock issued under stock option and award plans | — | | | | (3 | ) | | 225 | | | | — | | | 400 | | | | — | |
| Forfeitures of restricted stock | — | | | | — | | | — | | | | 2 | | | — | | | | 2 | |
| Share-based compensation expense | — | | | | 10 | | | — | | | | 6 | | | — | | | | 8 | |
| Conversion of convertible debt | — | | | | — | | | — | | | | — | | | 9,490 | | | | 150 | |
| Reclassification of convertible debt issuance costs | — | | | | — | | | — | | | | — | | | — | | | | (3 | ) |
| Issued under director and employee stock plans, net of tax | 530 | | | | 11 | | | 900 | | | | 19 | | | 2,256 | | | | 40 | |
| Issued at end of year | 157,810 | | | | 653 | | | 157,280 | | | | 635 | | | 156,155 | | | | 608 | |
| Common stock in treasury at beginning of year | (1,776 | ) | | | (38 | ) | | (64 | ) | | | (2 | ) | | (57 | ) | | | (1 | ) |
| Reissued under employee stock plans | 122 | | | | 3 | | | 90 | | | | 2 | | | 260 | | | | 5 | |
| Restricted stock issued under stock option and award plans | 157 | | | | 3 | | | — | | | | — | | | — | | | | — | |
| Forfeitures/cancellations of restricted stock | (30 | ) | | | (1 | ) | | (135 | ) | | | (2 | ) | | (100 | ) | | | (2 | ) |
| Shares of common stock used to satisfy tax | | | | | | | | | | | | | | | | | | | | |
| withholding obligations | (241 | ) | | | (6 | ) | | (49 | ) | | | (1 | ) | | (137 | ) | | | (3 | ) |
| Stock repurchases | (334 | ) | | | (8 | ) | | (1,590 | ) | | | (35 | ) | | — | | | | — | |
| Exchange of options | (5 | ) | | | — | | | (28 | ) | | | — | | | (30 | ) | | | (1 | ) |
| Common stock in treasury at end of year | (2,107 | ) | | | (47 | ) | | (1,776 | ) | | | (38 | ) | | (64 | ) | | | (2 | ) |
| 155,703 | | | | 606 | | | 155,504 | | | | 597 | | | 156,091 | | | | 606 | |
| Retained Earnings | | | | | | | | | | | | | | | | | | | | |
| Balance at beginning of year | | | | | 1,601 | | | | | | | 1,386 | | | | | | | 1,132 | |
| Cumulative effect of adjustments resulting from | | | | | | | | | | | | | | | | | | | | |
| the adoption of SAB 108, net of tax (see note 2) | | | | | (6 | ) | | | | | | — | | | | | | | — | |
| Adjusted balance at beginning of year | | | | | 1,595 | | | | | | | 1,386 | | | | | | | 1,132 | |
| Net income | | | | | 251 | | | | | | | 264 | | | | | | | 293 | |
| Cash dividends declared on common stock | | | | | | | | | | | | | | | | | | | | |
| $0.40, $0.32 and $0.26 per share, respectively | | | | | (61 | ) | | | | | | (49 | ) | | | | | | (39 | ) |
| Balance at end of year | | | | | 1,785 | | | | | | | 1,601 | | | | | | | 1,386 | |
| Accumulated Other Comprehensive Loss | | | | | | | | | | | | | | | | | | | | |
| Foreign Currency Translation Adjustment | | | | | | | | | | | | | | | | | | | | |
| Balance at beginning of year | | | | | 10 | | | | | | | 35 | | | | | | | 16 | |
| Translation adjustment arising during the period, net of tax | | | | | 27 | | | | | | | (25 | ) | | | | | | 19 | |
| Balance at end of year | | | | | 37 | | | | | | | 10 | | | | | | | 35 | |
| Cash Flow Hedges | | | | | | | | | | | | | | | | | | | | |
| Balance at beginning of year | | | | | — | | | | | | | (1 | ) | | | | | | (1 | ) |
| Change during year, net of tax | | | | | — | | | | | | | 1 | | | | | | | — | |
| Balance at end of year | | | | | — | | | | | | | — | | | | | | | (1 | ) |
| Minimum Pension Liability Adjustment | | | | | | | | | | | | | | | | | | | | |
| Balance at beginning of year | | | | | (181 | ) | | | | | | (196 | ) | | | | | | (182 | ) |
| Change during year, net of tax | | | | | 181 | | | | | | | 15 | | | | | | | (14 | ) |
| Balance at end of year | | | | | — | | | | | | | (181 | ) | | | | | | (196 | ) |
| Adjustment related to initial application of | | | | | | | | | | | | | | | | | | | | |
| SFAS No. 158, net of tax (see note 21) | | | | | (133 | ) | | | | | | — | | | | | | | — | |
| Total Accumulated Other Comprehensive Loss | | | | | (96 | ) | | | | | | (171 | ) | | | | | | (162 | ) |
| Total Shareholders’ Equity | | | | $ | 2,295 | | | | | | $ | 2,027 | | | | | | $ | 1,830 | |
See Accompanying Notes to Consolidated Financial Statements.
29
CONSOLIDATED STATEMENTS OF CASH FLOWS
| 2006 | | 2005 | | 2004 |
| (in millions) |
| From Operating Activities | | | | | | | | | | | |
| Net income | $ | 251 | | | $ | 264 | | | $ | 293 | |
| Adjustments to reconcile net income to net cash provided by operating | | | | | | | | | | | |
| activities of continuing operations: | | | | | | | | | | | |
| Income on disposal of discontinued operations, net of tax | | (3 | ) | | | (1 | ) | | | (38 | ) |
| Impairment charge | | 17 | | | | — | | | | — | |
| Cumulative effect of accounting change, net of tax | | (1 | ) | | | — | | | | — | |
| Depreciation and amortization | | 175 | | | | 171 | | | | 154 | |
| Share-based compensation expense | | 10 | | | | 6 | | | | 8 | |
| Deferred income taxes | | 21 | | | | 24 | | | | 50 | |
| Change in assets and liabilities: | | | | | | | | | | | |
| Merchandise inventories | | (38 | ) | | | (111 | ) | | | (183 | ) |
| Accounts payable and other accruals | | (103 | ) | | | 14 | | | | 157 | |
| Qualified pension plan contributions | | (68 | ) | | | (26 | ) | | | (106 | ) |
| Income taxes | | (3 | ) | | | (8 | ) | | | — | |
| Other, net | | (69 | ) | | | 16 | | | | (63 | ) |
| Net cash provided by operating activities of continuing operations | | 189 | | | | 349 | | | | 272 | |
| From Investing Activities | | | | | | | | | | | |
| Acquisitions | | — | | | | 1 | | | | (242 | ) |
| Gain from lease termination | | 4 | | | | — | | | | — | |
| Gain from insurance recoveries | | 4 | | | | 3 | | | | — | |
| Purchases of short-term investments | | (1,992 | ) | | | (2,798 | ) | | | (2,884 | ) |
| Sales of short-term investments | | 2,041 | | | | 2,767 | | | | 2,875 | |
| Capital expenditures | | (165 | ) | | | (155 | ) | | | (156 | ) |
| Net cash used in investing activities of continuing operations | | (108 | ) | | | (182 | ) | | | (407 | ) |
| From Financing Activities | | | | | | | | | | | |
| Debt issuance costs | | — | | | | — | | | | (2 | ) |
| (Reduction) increase in long-term debt | | (86 | ) | | | (35 | ) | | | 175 | |
| Repayment of capital lease | | (1 | ) | | | — | | | | — | |
| Dividends paid on common stock | | (61 | ) | | | (49 | ) | | | (39 | ) |
| Issuance of common stock | | 9 | | | | 12 | | | | 28 | |
| Treasury stock reissued under employee stock plans | | 3 | | | | 2 | | | | 5 | |
| Purchase of treasury shares | | (8 | ) | | | (35 | ) | | | — | |
| Tax benefit on stock compensation | | 2 | | | | — | | | | — | |
| Net cash (used in) provided by financing activities of continuing operations | | (142 | ) | | | (105 | ) | | | 167 | |
| Net Cash (Used In) Provided by operating activities of Discontinued Operations | | (8 | ) | | | — | | | | 1 | |
| Effect of Exchange Rate Fluctuations on Cash and Cash Equivalents | | 1 | | | | 2 | | | | 2 | |
| Net Change in Cash and Cash Equivalents | | (68 | ) | | | 64 | | | | 35 | |
| Cash and Cash Equivalents at Beginning of Year | | 289 | | | | 225 | | | | 190 | |
| Cash and Cash Equivalents at End of Year | $ | 221 | | | $ | 289 | | | $ | 225 | |
| Cash Paid During the Year: | | | | | | | | | | | |
| Interest | $ | 20 | | | $ | 21 | | | $ | 23 | |
| Income taxes | $ | 133 | | | $ | 93 | | | $ | 121 | |
| Non-cash Financing Activities: | | | | | | | | | | | |
| Common stock issued upon conversion of convertible debt | $ | — | | | $ | — | | | $ | 150 | |
| Debt issuance costs reclassified to equity upon conversion of convertible debt | $ | — | | | $ | — | | | $ | 3 | |
See Accompanying Notes to Consolidated Financial Statements.
30
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1 Summary of Significant Accounting Policies
Basis of Presentation
The consolidated financial statements include the accounts of Foot Locker, Inc. and its domestic and international subsidiaries (the “Company”), all of which are wholly owned. All significant intercompany amounts have been eliminated. The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results may differ from those estimates.
Reporting Year
The 2006 fiscal year end for the Company is the Saturday closest to the last day in January. Fiscal year 2006 represents the 53 weeks ending February 3, 2007. Fiscal year 2005 and 2004 represented the 52 weeks ended January 28, 2006 and January 29, 2005, respectively. References to years in this annual report relate to fiscal years rather than calendar years.
Revenue Recognition
Revenue from retail stores is recognized at the point of sale when the product is delivered to customers. Internet and catalog sales revenue is recognized upon estimated receipt by the customer. Sales include shipping and handling fees for all periods presented. Sales include merchandise, net of returns and exclude all taxes. The Company provides for estimated returns based on return history and sales levels. The Company recognizes revenue, including gift card sales and layaway sales, in accordance with SEC Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements,” as amended by SAB No. 104, “Revenue Recognition.” Revenue from layaway sales is recognized when the customer receives the product, rather than when the initial deposit is paid.
Gift Cards
The Company sells gift cards to its customers; the cards do not have expiration dates. Revenue from gift card sales is recorded when the gift cards are redeemed or when the likelihood of the gift card being redeemed by the customer is remote and there is no legal obligation to remit the value of unredeemed gift cards to the relevant jurisdictions. The Company has determined its gift card breakage rate based upon historical redemption patterns. Historical experience indicates that after 12 months the likelihood of redemption is deemed to be remote. Gift card breakage income is included in selling, general and administrative expenses and totaled $7 million in 2006 and $2 million, for both 2005 and 2004. Unredeemed gift cards are recorded as a current liability.
Statement of Cash Flows
The Company has selected to present the operations of the discontinued business as one line in the Consolidated Statements of Cash Flows. For all the periods presented this caption includes only operating activities.
Store Pre-Opening and Closing Costs
Store pre-opening costs are charged to expense as incurred. In the event a store is closed before its lease has expired, the estimated post-closing lease exit costs, less the sublease rental income, is provided for once the store ceases to be used, in accordance with SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.”
Advertising Costs and Sales Promotion
Advertising and sales promotion costs are expensed at the time the advertising or promotion takes place, net of reimbursements for cooperative advertising. Cooperative advertising reimbursements earned for the launch and promotion of certain products is agreed upon with vendors and is recorded in the same period as the associated
31
expense is incurred. In accordance with EITF 02-16, “Accounting by a Reseller for Cash Consideration from a Vendor,” the Company accounts for reimbursements received in excess of expenses incurred related to specific, incremental advertising, as a reduction to the cost of merchandise and is reflected in cost of sales as the merchandise is sold.
Advertising costs, which are included as a component of selling, general and administrative expenses, net of reimbursements for cooperative advertising, were as follows:
| 2006 | | | 2005 | | | 2004 | |
| (in millions) |
| Advertising expenses | $ | 92.5 | | | $ | 99.0 | | | $ | 102.5 | |
| Cooperative advertising reimbursements | | (23.0 | ) | | | (21.2 | ) | | | (24.8 | ) |
| Net advertising expense | $ | 69.5 | | | $ | 77.8 | | | $ | 77.7 | |
Catalog Costs
Catalog costs, which primarily comprise paper, printing, and postage, are capitalized and amortized over the expected customer response period to each catalog, generally 90 days. Cooperative reimbursements earned for the promotion of certain products is agreed upon with vendors and is recorded in the same period as the associated catalog expenses are amortized. Prepaid catalog costs totaled $3.9 million and $3.0 million at February 3, 2007 and January 28, 2006, respectively.
Catalog costs, which are included as a component of selling, general and administrative expenses, net of reimbursements for cooperative reimbursements, were as follows:
| 2006 | | | 2005 | | | 2004 | |
| (in millions) |
| Catalog costs | $ | 47.0 | | | $ | 48.2 | | | $ | 50.3 | |
| Cooperative reimbursements | | (3.5 | ) | | | (3.0 | ) | | | (2.9 | ) |
| Net catalog expense | $ | 43.5 | | | $ | 45.2 | | | $ | 47.4 | |
Earnings Per Share
Basic earnings per share is computed as net income divided by the weighted-average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur from common shares issuable through share-based compensation including stock options and the conversion of convertible long-term debt. The following table reconciles the numerator and denominator used to compute basic and diluted earnings per share for continuing operations.
| 2006 | | 2005 | | 2004 |
| (in millions) |
| Income from continuing operations | $ | 247 | | $ | 263 | | $ | 255 |
| Effect of Dilution: | | | | | | | | |
| Convertible debt(1) | | — | | | — | | | 2 |
| Income from continuing operations assuming dilution | $ | 247 | | $ | 263 | | $ | 257 |
| Weighted-average common shares outstanding | | 155.0 | | | 155.1 | | | 150.9 |
| Effect of Dilution: | | | | | | | | |
| Stock options and awards | | 1.8 | | | 2.5 | | | 3.0 |
| Convertible debt(1) | | — | | | — | | | 3.2 |
| Weighted-average common shares outstanding | | | | | | | | |
| assuming dilution | | 156.8 | | | 157.6 | | | 157.1 |
____________________
(1) | Item 9B. | In 2001, the Company issued $150 million of subordinated convertible notes due 2008. Effective June 4, 2004, all of the convertible subordinated notes were cancelled and approximately 9.5 million new shares of the Company’s common stock were issued.Other Information |
32None.
Options to purchase 2.8 million, 2.2 million and 1.5 million shares of common stock as of February 3, 2007, January 28, 2006, and January 29, 2005, respectively, were not included in the computations because the exercise price of the options was greater than the average market price of the common shares and, therefore, the effect of their inclusion would be antidilutive.
Share-Based Compensation
Effective January 29, 2006, the Company adopted the provisions of Statement of Financial Accounting Standards No. 123(R), “Share-Based Payment,” and related interpretations, (“SFAS No. 123(R)”) to account for stock-based compensation using the modified prospective transition method and, therefore, will not restate its prior period results. SFAS No. 123(R) supersedes Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” (“APB No. 25”), and revises guidance in SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”). Among other things, SFAS No. 123(R) requires that compensation expense be recognized in the financial statements for share-based awards based on the grant date fair value of those awards. The modified prospective transition method applies to unvested stock options, restricted shares and stock appreciation rights and issuances under the employee stock purchase plan outstanding as of January 29, 2006 based on the grant-date fair value estimated in accordance with the pro forma provisions of SFAS No. 123, and any new share-based awards granted subsequent to January 29, 2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS No. 123(R). Additionally, stock-based compensation expense includes an estimate for pre-vesting forfeitures and is recognized over the requisite service periods of the awards over the vesting term.
Prior to January 29, 2006, the Company accounted for these stock-based compensation plans in accordance with APB No. 25 and related interpretations. This method did not result in compensation cost for stock options and shares purchased under employee stock purchase plans. No compensation expense for employee stock options was recorded, as all stock options granted under the stock option plans had an exercise price that was not less than the quoted market price at the date of grant. Compensation expense was also not recorded for employee purchases of stock under the employee stock purchase plans as it was considered non-compensatory under APB No. 25. Prior to the Company’s adoption of SFAS No. 123(R), as required under the disclosure provisions of SFAS No. 123, as amended, the Company provided pro forma net income and earnings per common share for each period as if it had applied the fair value method to measure stock-based compensation expense.
The Company has recorded an additional $6 million of stock-based compensation expense, net of estimated forfeitures, during 2006 as a result of its adoption of SFAS No. 123(R). During 2006, the Company recorded a cumulative effect of a change in accounting of $1 million to reflect estimated forfeitures for prior periods related to the Company’s nonvested restricted stock awards. Prior to the adoption of SFAS No. 123(R), the Company recognized compensation cost of restricted stock awards over the vesting term based upon the fair value of the Company’s common stock at the date of grant. Forfeitures were recorded as they occurred, however under SFAS No. 123(R) an estimate of forfeitures is required to be included over the vesting term. Under SFAS No. 123(R), the Company will continue to recognize compensation expense over the vesting term, net of estimated forfeitures. See Note 22 for information on the assumptions the Company used to calculate the fair value of stock-based compensation.
SFAS No. 123(R) requires the benefits associated with tax deductions in excess of recognized compensation cost to be reported as a financing cash flow rather than as an operating cash flow as previously required. For 2006, the Company recorded an excess tax benefit of $2 million as a financing cash flow as required by the standard.
Upon exercise of stock options, issuance of restricted stock or issuance of shares under the employee stock purchase plan, the Company will issue authorized but unissued common stock or use common stock held in treasury. The Company may make repurchases of its common stock from time to time, subject to legal and contractual restrictions, market conditions and other factors.
33
The following table illustrates the effect on net income and earnings per common share as if the Company had applied the fair value method to measure stock-based compensation, as required under the disclosure provisions of SFAS No. 123:
| | 2005 | | | 2004 | |
| Net income: | | | | | | | |
| As reported | $ | 264 | | | $ | 293 | |
| Compensation expense included in reported net income, | | | | | | | |
| net of income tax benefit | | 4 | | | | 5 | |
| Total compensation expense under fair value method for | | | | | | | |
| all awards, net of income tax benefit | | (9 | ) | | | (13 | ) |
| Pro forma | $ | 259 | | | $ | 285 | |
| Basic earnings per share: | | | | | | | |
| As reported | $ | 1.71 | | | $ | 1.94 | |
| Pro forma | $ | 1.67 | | | $ | 1.89 | |
| Diluted earnings per share: | | | | | | | |
| As reported | $ | 1.68 | | | $ | 1.88 | |
| Pro forma | $ | 1.64 | | | $ | 1.83 | |
Cash and Cash Equivalents
The Company considers all highly liquid investments with original maturities of three months or less, including commercial paper and money market funds, to be cash equivalents. Amounts due from third party credit card processors for the settlement of debit and credit cards transactions are included as cash equivalents as they are generally collected within three business days. Cash equivalents at February 3, 2007 and January 28, 2006 were $208 million and $237 million, respectively.
Short-Term Investments
The Company accounts for its short-term investments in accordance with SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” At February 3, 2007, all of the Company’s investments were classified as available for sale, and accordingly are reported at fair value. Short-term investments comprise auction rate securities. Auction rate securities are perpetual preferred or long-dated securities whose dividend/coupon resets periodically through a Dutch auction process. A Dutch auction is a competitive bidding process designed to determine a rate for the next term, such that all sellers sell at par and all buyers buy at par. Accordingly, there were no realized or unrealized gains or losses for any of the periods presented.
Merchandise Inventories and Cost of Sales
Merchandise inventories for the Company’s Athletic Stores are valued at the lower of cost or market using the retail inventory method. Cost for retail stores is determined on the last-in, first-out (LIFO) basis for domestic inventories and on the first-in, first-out (FIFO) basis for international inventories. Merchandise inventories of the Direct-to-Customers business are valued at the lower of cost or market using weighted-average cost, which approximates FIFO. Transportation, distribution center and sourcing costs are capitalized in merchandise inventories. In 2006, the Company adopted SFAS No. 151, “Inventory Costs- An Amendment of ARB 43, Chapter 4.” This standard amends the guidance to clarify that abnormal amounts of idle facility expense, freight, handling costs, and wasted materials (spoilage) should be recognized as current-period charges. With the adoption of this standard the Company no longer capitalized the freight associated with transfers between its store locations.
Cost of sales is comprised of the cost of merchandise, occupancy, buyers’ compensation and shipping and handling costs. The cost of merchandise is recorded net of amounts received from vendors for damaged product returns, markdown allowances and volume rebates, as well as cooperative advertising reimbursements received in excess of specific, incremental advertising expenses. Occupancy reflects the amortization of amounts received from landlords for tenant improvements.
34
Property and Equipment
Property and equipment are recorded at cost, less accumulated depreciation and amortization. Significant additions and improvements to property and equipment are capitalized. Maintenance and repairs are charged to current operations as incurred. Major renewals or replacements that substantially extend the useful life of an asset are capitalized and depreciated. Owned property and equipment is depreciated on a straight-line basis over the estimated useful lives of the assets: maximum of 50 years for buildings and 3 to 10 years for furniture, fixtures and equipment. Property and equipment under capital leases and improvements to leased premises are generally amortized on a straight-line basis over the shorter of the estimated useful life of the asset or the remaining lease term. Capitalized software reflects certain costs related to software developed for internal use that are capitalized and amortized. After substantial completion of the project, the costs are amortized on a straight-line basis over a 2 to 7 year period. Capitalized software, net of accumulated amortization, is included in property and equipment and was $29 million at February 3, 2007 and $39 million at January 28, 2006.
Recoverability of Long-Lived Assets
In accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS No. 144”), an impairment loss is recognized whenever events or changes in circumstances indicate that the carrying amounts of long-lived tangible and intangible assets with finite lives may not be recoverable. Assets are grouped and evaluated at the lowest level for which there are identifiable cash flows that are largely independent of the cash flows of other groups of assets. The Company has identified this lowest level to be individual stores. The Company considers historical performance and future estimated results in its evaluation of potential impairment and then compares the carrying amount of the asset with the estimated future cash flows expected to result from the use of the asset. If the carrying amount of the asset exceeds estimated expected undiscounted future cash flows, the Company measures the amount of the impairment by comparing the carrying amount of the asset with its estimated fair value. The estimation of fair value is generally measured by discounting expected future cash flows at the Company’s weighted-average cost of capital. The Company estimates fair value based on the best information available using estimates, judgments and projections as considered necessary.
During 2006, the Company recorded an impairment charge of $17 million ($12 million after-tax) to write-down long-lived assets such as store fixtures and leasehold improvements in 69 stores in the European operations to their estimated fair value.
Goodwill and Intangible Assets
The Company accounts for goodwill and other intangibles in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” which requires that goodwill and intangible assets with indefinite lives be reviewed for impairment if impairment indicators arise and, at a minimum, annually.
The Company performs its annual impairment review as of the beginning of each fiscal year. The fair value of each reporting unit is evaluated as of the beginning of each year, determined using a combination of market and discounted cash flow approaches, exceeded the carrying value of each respective reporting unit. Separable intangible assets that are deemed to have finite lives will continue to be amortized over their estimated useful lives. Intangible assets with finite lives primarily reflect lease acquisition costs and are amortized over the lease term.
Derivative Financial Instruments
All derivative financial instruments are recorded in the Consolidated Balance Sheets at their fair values. Changes in fair values of derivatives are recorded each period in earnings, other comprehensive gain or loss or as a basis adjustment to the underlying hedged item, depending on whether a derivative is designated and effective as part of a hedge transaction. The effective portion of the gain or loss on the hedging derivative instrument is reported as a component of other comprehensive income/loss or as a basis adjustment to the underlying hedged item and reclassified to earnings in the period in which the hedged item affects earnings.
35
The effective portion of the gain or loss on hedges of foreign net investments is generally not reclassified to earnings unless the net investment is disposed of. To the extent derivatives do not qualify as hedges, or are ineffective, their changes in fair value are recorded in earnings immediately, which may subject the Company to increased earnings volatility. The changes in the fair value of the Company’s hedges of net investments in various foreign subsidiaries is computed using the spot method.
Fair Value of Financial Instruments
The fair value of financial instruments is determined by reference to various market data and other valuation techniques as appropriate. The carrying value of cash and cash equivalents, short-term investments, and other current receivables and payables approximates fair value due to the short-term nature of these assets and liabilities. Quoted market prices of the same or similar instruments are used to determine fair value of long-term debt and forward foreign exchange contracts. Discounted cash flows are used to determine the fair value of long-term investments and notes receivable if quoted market prices on these instruments are unavailable.
Income Taxes
The Company determines its deferred tax provision under the liability method, whereby deferred tax assets and liabilities are recognized for the expected tax consequences of temporary differences between the tax bases of assets and liabilities and their reported amounts using presently enacted tax rates. Deferred tax assets are recognized for tax credits and net operating loss carryforwards, reduced by a valuation allowance, which is established when it is more likely than not that some portion or all of the deferred tax assets will not be realized. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
A taxing authority may challenge positions that the Company adopted in its income tax filings. Accordingly, the Company may apply different tax treatments for transactions in filing its income tax returns than for income tax financial reporting. The Company regularly assesses its tax position for such transactions and records reserves for those differences when considered necessary.
Provision for U.S. income taxes on undistributed earnings of foreign subsidiaries is made only on those amounts in excess of the funds considered to be permanently reinvested.
Pension and Postretirement Obligations
The discount rate selected to measure the present value of the Company’s benefit obligations as of February 3, 2007 was derived using a cash flow matching method whereby the Company compares the plans’ projected payment obligations by year with the corresponding yield on the Citibank Pension Discount Curve. The cash flows are then discounted to their present value and an overall discount rate is determined.
Insurance Liabilities
The Company is primarily self-insured for health care, workers’ compensation and general liability costs. Accordingly, provisions are made for the Company’s actuarially determined estimates of discounted future claim costs for such risks for the aggregate of claims reported and claims incurred but not yet reported. Self-insured liabilities totaled $16 million at February 3, 2007 and January 28, 2006. The Company discounts its workers’ compensation and general liability using a risk-free interest rate. Imputed interest expense related to these liabilities was $1 million in each of 2006, 2005 and 2004.
Accounting for Leases
The Company recognizes rent expense for operating leases as of the possession date for store leases or the commencement of the agreement for a non-store lease. Rental expense, inclusive of rent holidays, concessions and tenant allowances are recognized over the lease term on a straight-line basis. Contingent payments based upon sales and future increases determined by inflation related indices cannot be estimated at the inception of the lease and accordingly, are charged to operations as incurred.
36
Foreign Currency Translation
The functional currency of the Company’s international operations is the applicable local currency. The translation of the applicable foreign currency into U.S. dollars is performed for balance sheet accounts using current exchange rates in effect at the balance sheet date and for revenue and expense accounts using the weighted-average rates of exchange prevailing during the year. The unearned gains and losses resulting from such translation are included as a separate component of accumulated other comprehensive loss within shareholders’ equity.
Reclassifications
Certain balances in prior years have been reclassified to conform to the presentation adopted in the current year.
Recent Accounting Pronouncements Not Previously Discussed Herein
In March 2006, the EITF reached a consensus on EITF Issue No. 06-3, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That is, Gross versus Net Presentation)” that entities may adopt a policy of presenting taxes in the income statement on either a gross or net basis. Gross or net presentation may be elected for each different type of tax, but similar taxes should be presented consistently. Taxes within the scope of this EITF would include taxes that are imposed on a revenue transaction between a seller and a customer, for example, sales taxes, use taxes, value-added taxes, and some types of excise taxes. EITF 06-3 will not impact the method for recording these sales taxes in the Company’s consolidated financial statements as the Company has historically presented sales excluding all taxes.
In July 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - An interpretation of FASB Statement No. 109” (“FIN 48”), which clarifies the accounting and disclosure requirements for uncertainty in tax positions. This Interpretation requires financial statement recognition of the impact of a tax position if that position is more likely than not of being sustained on audit based on the technical merits of the position. Additionally, FIN 48 provides guidance on measurement, derecognition, classification, accounting in interim periods, and disclosure requirements for uncertain tax positions. The provisions of FIN 48 will be effective as of the beginning of 2007, with the cumulative effect of the change in accounting principle, if any, recorded as an adjustment to opening retained earnings. The Company is currently evaluating the effect of FIN 48. However, the Company does not expect the adoption of this interpretation will significantly affect the Company’s financial position or results of operations.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” (“SFAS No. 157”). This statement provides a single definition of fair value, a framework for measuring fair value, and expanded disclosures concerning fair value. Previously, different definitions of fair value were contained in various accounting pronouncements creating inconsistencies in measurement and disclosures. SFAS No. 157 applies under those previously issued pronouncements that prescribe fair value as the relevant measure of value, except SFAS No. 123(R) and related interpretations and pronouncements that require or permit measurement similar to fair value but are not intended to measure fair value. This pronouncement is effective for fiscal years beginning after November 15, 2007. The Company does not believe that this standard will significantly affect the Company’s financial position or results of operations.
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities—Including an Amendment of FASB Statement No. 115." This statement permits, but does not require, entities to measure many financial instruments at fair value. The objective is to provide entities with an opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. The Company does not believe that this standard will significantly affect the Company's financial position or results of operations.
2 Staff Accounting Bulletin No. 108
In September 2006, the SEC issued Staff Accounting Bulletin No. 108 (“SAB 108”) “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements,” that provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. There are two widely recognized methods for quantifying the effects of financial statement misstatements: the “rollover” or income statement method and the “iron curtain” or balance sheet method. The SEC staff believes that registrants should quantify errors using both a balance sheet and an income
37
statement approach (“dual method”) and evaluate whether either approach results in quantifying a misstatement that, when all relevant quantitative and qualitative factors are considered, is material. The Company had historically evaluated uncorrected misstatements using the “rollover” method. SAB 108 permits companies to apply its provisions initially by either (i) restating prior financial statements as if the provisions had always been applied or (ii) recording the cumulative effect of initially applying SAB 108 as adjustments to the carrying value of assets and liabilities as of the beginning of 2006 with an offsetting adjustment recorded to the opening balance of shareholders’ equity.
The Company believes its prior period assessments of uncorrected misstatements and the conclusions reached regarding its quantitative and qualitative assessments of materiality of such items, both individually and in the aggregate, were appropriate. These items did not significantly affect 2005 or 2004 as these items originated in earlier periods. In accordance with SAB 108, the Company has adjusted its opening retained earnings for 2006 for the items described below.
PART III
| | |
| | Adjustment |
| | at Jan. 29, |
(in millions) | | 2006 |
Accrued liabilities(1) | | $ | 3.4 | |
Revenue recognition(2) | | | 2.8 | |
Inventory valuation(3) | | | 4.2 | |
| | | 10.4 | |
Provision for income taxes | | | 4.1 | |
Decrease to shareholders’ equity | | $ | 6.3 | |
____________________
(1) | | Accrued liabilities – The Company understated its accrued liabilities for certain items, such as telecommunications, utilities and property taxes in years prior to 2003. These items originated when the Company was accruing for these items on a calendar year rather than a fiscal year basis. |
|
(2) | | Revenue recognition – The Company had historically recorded revenue from its catalog and Internet operations when the product was shipped to the customer, rather than upon the actual receipt of the product by the customer. |
|
(3) | | Inventory valuation – The Company did not properly recognize the permanent reduction of the retail value of its inventory upon the transfer to clearance stores. The Company provided a reserve for the value of this inventory that had not been marked down to current selling prices. |
In addition, the Company had historically included its lease acquisition costs of $8 million in 2005 and $17 million in 2004 within the investing section of the Statement of Cash Flows. In 2005, the Company classified the premiums paid and proceeds received ($3 million, net) associated with its option currency contracts as an investing activity. The Company has determined that these activities would be more appropriately classified as an operating activity. Accordingly, the Company reclassified $5 million and $17 million for 2005 and 2004, respectively, to operating activities.
3 Segment Information
The Company has determined that its reportable segments are those that are based on its method of internal reporting. As of February 3, 2007, the Company has two reportable segments, Athletic Stores, which sells athletic footwear and apparel through its various retail stores, and Direct-to-Customers, which includes the Company’s catalogs and Internet business.
The accounting policies of both segments are the same as those described in the “Summary of Significant Accounting Policies.” The Company evaluates performance based on several factors, of which the primary financial measure is division results. Division profit reflects income from continuing operations before income taxes, corporate expense, non-operating income, and net interest expense.
| Sales |
| | | 2006 | | 2005 | | 2004 |
| | | (in millions) |
| Athletic Stores | | $ | 5,370 | | $ | 5,272 | | $ | 4,989 |
| Direct-to-Customers | | | 380 | | | 381 | | | 366 |
| Total sales | | $ | 5,750 | | $ | 5,653 | | $ | 5,355 |
38
| Operating Results |
| | |
| | 2006 | | 2005 | | 2004 | |
| | (in millions) | |
| Athletic Stores | $ | 405 | | $ | 419 | | $ | 420 | |
| Direct-to-Customers | | 45 | | | 48 | | | 45 | |
| | | 450 | | | 467 | | | 465 | |
| Restructuring charges(1) | | (1 | ) | | — | | | (2 | ) |
| Division profit | | 449 | | | 467 | | | 463 | |
| Corporate expense(2) | | (68 | ) | | (58 | ) | | (74 | ) |
| Operating profit | | 381 | | | 409 | | | 389 | |
| Other income(3) | | 14 | | | 6 | | | — | |
| Interest expense, net | | 3 | | | 10 | | | 15 | |
| Income from continuing operations before income taxes | $ | 392 | | $ | 405 | | $ | 374 | |
____________________
(1) | | The restructuring charge in 2006 represents a revision to the original estimate of the lease liability associated with the guarantee of The San Francisco Music Box distribution center. During 2004, the Company recorded a restructuring charge of $2 million related to the dispositions of non-core businesses. These charges were classified within selling, general and administrative expenses in the Consolidated Statements of Operations. |
|
(2) | | 2004 includes integration costs of $5 million related to the acquisitions of Footaction and the 11 stores in the Republic of Ireland. |
|
(3) | | 2006 includes $4 million gain on lease terminations; $8 million of insurance proceeds related to the 2005 hurricane; and $2 million gain on debt repurchase. |
|
| | 2005 includes a $3 million gain from insurance recoveries associated with Hurricane Katrina. Additionally, $3 million represents a net gain on foreign currency option contracts that were entered into by the Company to mitigate the effect of fluctuating foreign exchange rates on the reporting of euro dominated earnings. |
|
| | | Depreciation and | | | | |
| | | Amortization | | Capital Expenditures | | Total Assets |
| | | 2006 | | 2005 | | 2004 | | 2006 | | 2005 | | 2004 | | 2006 | | 2005 | | 2004 |
| | | (in millions) |
| Athletic Stores | | $ | 147 | | $ | 141 | | $ | 126 | | $ | 135 | | $ | 137 | | $ | 139 | | $ | 2,374 | | $ | 2,322 | | $ | 2,335 |
| Direct-to-Customers | | | 6 | | | 6 | | | 5 | | | 4 | | | 6 | | | 8 | | | 195 | | | 196 | | | 190 |
| | | | 153 | | | 147 | | | 131 | | | 139 | | | 143 | | | 147 | | | 2,569 | | | 2,518 | | | 2,525 |
| Corporate | | | 22 | | | 24 | | | 23 | | | 26 | | | 12 | | | 9 | | | 680 | | | 794 | | | 711 |
| Discontinued operations | | | — | | | — | | | — | | | — | | | — | | | — | | | — | | | — | | | 1 |
| Total Company | | $ | 175 | | $ | 171 | | $ | 154 | | $ | 165 | | $ | 155 | | $ | 156 | | $ | 3,249 | | $ | 3,312 | | $ | 3,237 |
Sales and long-lived asset information by geographic area as of and for the fiscal years ended February 3, 2007, January 28, 2006 and January 29, 2005 are presented below. Sales are attributed to the country in which the sales originate, which is where the legal subsidiary is domiciled. Long-lived assets reflect property and equipment. The Company’s sales in Italy and France represent approximately 36, 39 and 40 percent of the International category’s sales for the three-year period ended February 3, 2007. No other individual country included in the International category is significant.
| Sales |
| |
| | | 2006 | | 2005 | | 2004 |
| | | (in millions) |
| United States | | $ | 4,356 | | $ | 4,257 | | $ | 3,982 |
| International | | | 1,394 | | | 1,396 | | | 1,373 |
| Total sales | | $ | 5,750 | | $ | 5,653 | | $ | 5,355 |
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| Long-Lived Assets |
| |
| | | 2006 | | 2005 | | 2004 |
| | | (in millions) |
| United States | | $ | 504 | | $ | 523 | | $ | 547 |
| International | | | 150 | | | 152 | | | 168 |
| Total long-lived assets | | $ | 654 | | $ | 675 | | $ | 715 |
4 Other Income
In 2006, other income includes a gain of $8 million related to a final settlement with the Company’s insurance carriers of claims related to Hurricane Katrina. In 2005, the Company recorded a gain of $3 million of insurance recoveries in excess of losses associated with Hurricane Katrina.
During 2006, the Company purchased and retired $38 million of the $200 million 8.50 percent debentures payable in 2022, at a $2 million discount from face value. Also during 2006, the Company terminated two of its leases and recorded a net gain of $4 million.
In 2005, the Company recorded a net gain of $3 million related to foreign currency option contracts that were entered into by the Company to mitigate the effect of fluctuating foreign exchange rates on the reporting of euro denominated earnings.
5 Short-Term Investments
The Company’s auction rate security investments are accounted for as available-for-sale securities. The fair value of all investments approximate their carrying cost as the investments are generally not held for more than 49 days and they are traded at par value. The following represents the composition of the Company’s auction rate securities by underlying investment.
| | | 2006 | | 2005 |
| | | (in millions) |
| Tax exempt municipal bonds | | $ | 44 | | $ | 41 |
| Equity securities | | | 205 | | | 257 |
| | | $ | 249 | | $ | 298 |
Contractual maturities of the bonds outstanding at February 3, 2007 range from 2026 to 2042.
6 Merchandise Inventories
| | | 2006 | | 2005 |
| | | (in millions) |
| LIFO inventories | | $ | 967 | | $ | 939 |
| FIFO inventories | | | 336 | | | 315 |
| Total merchandise inventories | | $ | 1,303 | | $ | 1,254 |
The value of the Company’s LIFO inventories, as calculated on a LIFO basis, approximates their value as calculated on a FIFO basis.
40
| 7 Other Current Assets | | | | | |
| | | | | | | |
| | | 2006 | | | 2005 | | |
| | (in millions) | | |
| Net receivables | | $ 59 | | | $ 49 | | |
| Prepaid expenses and other current assets | | 36 | | | 31 | | |
| Prepaid rent | | 62 | | | 15 | | |
| Prepaid income taxes | | 67 | | | 49 | | |
| Deferred taxes | | 21 | | | 28 | | |
| Investments | | 14 | | | — | | |
| Current portion of Northern Group note receivable | | 1 | | | 1 | | |
| Fair value of derivative contracts | | 1 | | | — | | |
| | | $261 | | | $173 | | |
| | | | | | | | | |
| | | | | | | | |
8 Property and Equipment, net | | | | | | | |
| | | | | | | | |
| | 2006 | | 2005 | | |
| | (in millions) | |
| Land | $ | 3 | | $ | 3 | | |
| Buildings: | | | | | | | |
| Owned | | 30 | | | 31 | | |
| Furniture, fixtures and equipment: | | | | | | | |
| Owned | | 1,139 | | | 1,087 | | |
| Leased | | 14 | | | 15 | | |
| | | 1,186 | | | 1,136 | | |
| Less: accumulated depreciation | | (870 | ) | | (800 | ) | |
| | | 316 | | | 336 | | |
| Alterations to leased and owned buildings, | | | | | | | |
| net of accumulated amortization | | 338 | | | 339 | | |
| | $ | 654 | | $ | 675 | | |
| | | | | | | | |
| | | | | | | | |
| 9 Goodwill | | | | | | | |
| | | | | | | | |
| | | | 2006 | | | 2005 | | |
| | (in millions) | | |
| Athletic Stores | | $184 | | | $183 | | |
| Direct-to-Customers | | 80 | | | 80 | | |
| | | $264 | | | $263 | | |
The effect of foreign exchange fluctuations for the fiscal year ended February 3, 2007 increased goodwill by $1 million, resulting from the strengthening of the euro in relation to the U.S. dollar.
41
10 Intangible Assets, net
| | | February 3, 2007 | | | | January 28, 2006 |
| | | | | | | Net | | Wtd. Avg. | | | | | | Net |
| | | Gross | | Accum. | | Value | | Useful Life | | Gross | | Accum. | | Value |
| (in millions) | | value | | amort. | | (1) | | in Years | | value | | amort. | | (1) |
| Finite life intangible assets | | | | | | | | | | | | | | | | | | | | | | | |
| Lease acquisition costs | | $ | 178 | | $ | (98 | ) | | $ | 80 | | 11.9 | | | $ | 165 | | $ | (77 | ) | | $ | 88 |
| Trademark | | | 21 | | | (3 | ) | | | 18 | | 20.0 | | | | 21 | | | (2 | ) | | | 19 |
| Loyalty program | | | 1 | | | (1 | ) | | | — | | 2.0 | | | | 1 | | | (1 | ) | | | — |
| Favorable leases | | | 9 | | | (5 | ) | | | 4 | | 3.9 | | | | 10 | | | (4 | ) | | | 6 |
| Total finite life intangible assets | | | 209 | | | (107 | ) | | | 102 | | 12.3 | | | | 197 | | | (84 | ) | | | 113 |
| Intangible assets not subject to | | | | | | | | | | | | | | | | | | | | | | | |
| amortization | | | 3 | | | — | | | | 3 | | | | | | 4 | | | — | | | | 4 |
| Total intangible assets | | $ | 212 | | $ | (107 | ) | | $ | 105 | | | | | $ | 201 | | $ | (84 | ) | | $ | 117 |
____________________
(1) | | Includes effect of foreign currency translation of $5 million in 2006 and $8 million in 2005 primarily related to the strengthening of the euro in relation to the U.S. dollar. |
Intangible assets not subject to amortization at February 3, 2007, includes $3 million related to the trademark of the 11 stores acquired in the Republic of Ireland. The additional minimum liability at January 28, 2006, which represented the amount by which the accumulated benefit obligation exceeded the fair market value of U.S. defined benefit plan’s assets, was offset by an intangible asset to the extent of previously unrecognized prior service costs of $1 million. The adoption of SFAS No. 158 in 2006 has eliminated the intangible asset.
Lease acquisition costs represent amounts that are required to secure prime lease locations and other lease rights, primarily in Europe. Included in finite life intangibles, as a result of the Footaction and Republic of Ireland purchases, are the trademark for the Footaction name, amounts paid for leased locations with rents below their fair value for both acquisitions and amounts paid to obtain names of members of the Footaction loyalty program.
Amortization expense for the intangibles subject to amortization was approximately $19 million, $18 million and $17 million for 2006, 2005 and 2004, respectively. Annual estimated amortization expense for finite life intangible assets is expected to approximate $19 million for 2007, $16 million for 2008, $14 million for 2009, $12 million for 2010 and $10 million for 2011.
11 Other Assets
| | 2006 | | 2005 |
| | (in millions) |
| Deferred tax costs | $21 | | $24 |
| Investments and note receivable | 7 | | 22 |
| Northern Group note receivable, net of current portion | 10 | | 9 |
| Fair value of derivative contracts | — | | 1 |
| Pension benefits | 8 | | — |
| Other | 37 | | 40 |
| | $83 | | $96 |
42
12 Accrued and Other Liabilities
| | 2006 | | 2005 |
| | (in millions) |
| Pension and postretirement benefits | $ | 4 | | $ | 72 |
| Incentive bonuses | | 12 | | | 20 |
| Other payroll and payroll related costs, excluding taxes | | 46 | | | 52 |
| Taxes other than income taxes | | 46 | | | 43 |
| Property and equipment | | 24 | | | 16 |
| Customer deposits1 | | 33 | | | 31 |
| Income taxes payable | | 2 | | | 3 |
| Fair value of derivative contracts | | 2 | | | 1 |
| Current deferred tax liabilities | | 4 | | | 3 |
| Sales return reserve | | 4 | | | 4 |
| Liabilities of discontinued operations | | — | | | 2 |
| Current portion of repositioning and restructuring reserves | | 1 | | | 1 |
| Current portion of reserve for discontinued operations | | 3 | | | 8 |
| Other operating costs | | 65 | | | 49 |
| | $ | 246 | | $ | 305 |
____________________
1 | | Customer deposits include unredeemed gift cards and certificates, merchandise credits and, deferred revenue related to undelivered merchandise, including layaway sales. |
13 Revolving Credit Facility
At February 3, 2007, the Company had unused domestic lines of credit of $186 million, pursuant to a $200 million unsecured revolving credit agreement. $14 million of the line of credit was committed to support standby letters of credit. These letters of credit are primarily used for insurance programs.
In May 2004, shortly after the Footaction acquisition, the Company amended its revolving credit agreement, thereby extending the maturity date to May 2009 from July 2006. The agreement includes various restrictive financial covenants with which the Company was in compliance on February 3, 2007. Deferred financing fees are amortized over the life of the facility on a straight-line basis, which is comparable to the interest method. The unamortized balance at February 3, 2007 is approximately $1.9 million. Interest is determined at the time of borrowing based on variable rates and the Company’s fixed charge coverage ratio, as defined in the agreement. The rates range from LIBOR plus 0.875 percent to LIBOR plus 1.625 percent. The quarterly facility fees paid on the unused portion during 2006 and 2005, which are also based on the Company’s fixed charge coverage ratio, ranged from 0.175 percent to 0.25 percent. There were no short-term borrowings during 2006 or 2005.
Interest expense, including facility fees, related to the revolving credit facility was $2 million in 2006, 2005 and 2004.
14 Long-Term Debt and Obligations under Capital Leases
In May 2004, the Company obtained a 5-year, $175 million amortizing term loan from the bank group participating in its existing revolving credit facility to finance a portion of the purchase price of the Footaction stores. The interest rate on the LIBOR-based, floating-rate loan was 6.5 percent on February 3, 2007 and 5.568 percent on January 28, 2006. The loan requires minimum principal payments each May, equal to a percentage of the original principal amount of 10 percent in 2005 and 2006, 15 percent in years 2007 and 2008 and 50 percent in year 2009. Closing and upfront fees totaling approximately $1 million were paid for the term loan and these fees are being amortized using the interest rate method as determined by the principal repayment schedule. During 2005, the Company repaid $35 million of its 5-year term loan. This payment was in advance of the originally scheduled payment dates of May 19, 2005 and May 19, 2006 as permitted by the agreement. During 2006, the Company repaid an additional $50 million of its 5-year term loan. This payment was in advance of the originally scheduled payment dates of May 19, 2007 and May 19, 2008.
43
During 2006, the Company purchased and retired $38 million of the $200 million 8.50 percent debentures payable in 2022 at a $2 million discount from face value bringing the outstanding amount to $134 million as of February 3, 2007. The Company has various interest rate swap agreements, which convert $100 million of the 8.50 percent debentures from a fixed interest rate to a variable interest rate, which are collectively classified as a fair value hedge. The net fair value of the interest rate swaps at February 3, 2007 was a liability of $4 million, which was included in other liabilities, the carrying value of the 8.50 percent debentures was decreased by the corresponding amount. The net fair value of the interest rate swaps at January 28, 2006 was a liability $1 million, of which $1 million was included in other assets and $2 million was included in other liabilities. Accordingly, the fair value of the interest rate swaps decreased the carrying value of the 8.50 percent debentures at January 28, 2006 by $1 million.
Following is a summary of long-term debt and obligations under capital leases:
| | 2006 | | 2005 |
| | (in millions) |
| 8.50% debentures payable 2022 | $ | 130 | | $ | 171 |
| $175 million term loan | | 90 | | | 140 |
| Total long-term debt | | 220 | | | 311 |
| Obligations under capital leases | | 14 | | | 15 |
| | | 234 | | | 326 |
| Less: Current portion | | 14 | | | 51 |
| | $ | 220 | | $ | 275 |
Maturities of long-term debt and minimum rent payments under capital leases in future periods are:
| | | Long-Term | | Capital | | |
| | | Debt | | Leases | | Total |
| | | (in millions) |
| 2007 | | $ | — | | | $ | 14 | | | $ | 14 |
| 2008 | | | 2 | | | | — | | | | 2 |
| 2009 | | | 88 | | | | — | | | | 88 |
| 2010 | | | — | | | | — | | | | — |
| 2011 | | | — | | | | — | | | | — |
| Thereafter | | | 130 | | | | — | | | | 130 |
| | | | 220 | | | | 14 | | | | 234 |
| Less: Current portion | | | — | | | | 14 | | | | 14 |
| | | $ | 220 | | | $ | — | | | $ | 220 |
Interest expense related to long-term debt and capital lease obligations, including the effect of the interest rate swaps and the amortization of the associated debt issuance costs was $20 million in both 2006 and 2005, and $19 million in 2004. The effect of the interest rate swaps was not significant for the year ended February 3, 2007. The effect of the interest rate swaps resulted in a combined reduction in interest expense of $1 million in 2005, and $3 million in 2004.
15 Leases
The Company is obligated under operating leases for almost all of its store properties. Some of the store leases contain renewal options with varying terms and conditions. Management expects that in the normal course of business, expiring leases will generally be renewed or, upon making a decision to relocate, replaced by leases on other premises. Operating lease periods generally range from 5 to 10 years. Certain leases provide for additional rent payments based on a percentage of store sales. Rent expense includes real estate taxes, insurance, maintenance, and other costs as required by some of the Company’s leases. The present value of operating leases is discounted using various interest rates ranging from 4 percent to 13 percent.
44
| Rent expense consists of the following: |
| |
| | 2006 | | 2005 | | 2004 |
| | (in millions) |
| Minimum rent | $ | 496 | | | $ | 489 | | | $ | 470 | |
| Other occupancy expenses | | 145 | | | | 141 | | | | 135 | |
| Contingent rent based on sales | | 21 | | | | 13 | | | | 11 | |
| Sublease income | | (1 | ) | | | (1 | ) | | | (1 | ) |
| Total rent expense | $ | 661 | | | $ | 642 | | | $ | 615 | |
Future minimum lease payments under non-cancelable operating leases are:
| | (in millions) |
| 2007 | $ | 486 | |
| 2008 | | 432 | |
| 2009 | | 371 | |
| 2010 | | 332 | |
| 2011 | | 289 | |
| Thereafter | | 829 | |
| Total operating lease commitments | $ | 2,739 | |
| Present value of operating lease commitments | $ | 2,069 | |
16 Other Liabilities
| | 2006 | | 2005 |
| | (in millions) |
| Pension benefits | $ | 21 | | $ | 42 |
| Postretirement benefits | | 11 | | | 84 |
| Straight-line rent liability | | 91 | | | 83 |
| Income taxes | | 45 | | | 35 |
| Workers’ compensation / general liability reserves | | 12 | | | 12 |
| Reserve for discontinued operations | | 12 | | | 14 |
| Repositioning and restructuring reserves | | 3 | | | 3 |
| Fair value of derivatives | | 12 | | | 2 |
| Unfavorable leases | | 2 | | | 3 |
| Other | | 9 | | | 15 |
| | $ | 218 | | $ | 293 |
17 Discontinued Operations
On January 23, 2001, the Company announced that it was exiting its 694-store Northern Group segment. During the second quarter of 2001, the Company completed the liquidation of the 324 stores in the United States. On September 28, 2001, the Company completed the stock transfer of the 370 Northern Group stores in Canada, through one of its wholly owned subsidiaries for approximately CAD$59 million, which was paid in the form of a note. Over the last several years, the note has been amended and payments have been received, however the interest and payment terms remained unchanged. The note is required to be repaid upon the occurrence of “payment events,” as defined in the purchase agreement, but no later than September 28, 2008. As of February 3, 2007, CAD$15.5 million remains outstanding on the note. The fair value of the note at February 3, 2007 and January 28, 2006, is $11 million and $1 million is classified as a current receivable, with the remainder classified as long term within other assets in the accompanying Consolidated Balance Sheets. All scheduled principal and interest payments have been received in accordance with the terms of the note. During 2006, the Company revised its estimates related to the U.S. Northern store reserve resulting in a reduction of $2 million.
45
Future adjustments, if any, to the carrying value of the note will be recorded pursuant to SEC Staff Accounting Bulletin Topic 5:Z:5, “Accounting and Disclosure Regarding Discontinued Operations,” which requires changes in the carrying value of assets received as consideration from the disposal of a discontinued operation to be classified within continuing operations. Interest income will also be recorded within continuing operations. The Company will recognize an impairment loss when, and if, circumstances indicate that the carrying value of the note may not be recoverable. Such circumstances would include deterioration in the business, as evidenced by significant operating losses incurred by the purchaser or nonpayment of an amount due under the terms of the note. The purchaser has made all payments required under the terms of the note. The Company has evaluated the projected performance of the business and will continue to monitor its results during the coming year.
Another wholly owned subsidiary of the Company was the assignor of the store leases involved in the transaction and therefore retains potential liability for such leases. As the assignor of the Northern Canada leases, the Company remained secondarily liable under these leases. As of February 3, 2007, the Company estimates that its gross contingent lease liability is CAD$11 million (approximately US$9 million). The Company currently estimates the expected value of the lease liability to be approximately US$1 million. The Company believes that, because it is secondarily liable on the leases, it is unlikely that it would be required to make such contingent payments.
In 1998, the Company exited both its International General Merchandise and Specialty Footwear segments. In 1997, the Company exited its Domestic General Merchandise segment. During 2006, the Company adjusted its International General Merchandise reserve by $2 million, reflecting favorable lease terminations. During 2005, the Company recorded a charge of $2 million to revise estimates on its lease liability for one store in the International General Merchandise segment. During 2004, the Company recorded income of $1 million, after-tax, related to a refund of Canadian customs duties related to certain of the businesses that comprised the Specialty Footwear segment.
The major components of the pre-tax losses (gains) on disposal and disposition activity related to the reserves are presented below. The remaining reserve balances as of February 3, 2007 primarily represent lease obligations; $3 million is expected to be utilized within twelve months and the remaining $12 million thereafter.
| | | 2003 | | 2004 | | 2005 | | 2006 |
| | | | | Charge/ | | Net | | | | Charge/ | | Net | | | | Charge/ | | Net | | |
| | | Balance | | (Income) | | Usage* | | Balance | | (Income) | | Usage* | | Balance | | (Income) | | Usage* | | Balance |
| | | (in millions) |
| Northern Group | | $ | 2 | | | $ | — | | | $ | 1 | | | $ | 3 | | | $ | — | | | $ | 2 | | | $ | 5 | | | $ | (2 | ) | | $ | (1 | ) | | $ | 2 | |
| International General Merchandise | | | 5 | | | | — | | | | — | | | | 5 | | | | 2 | | | | 1 | | | | 8 | | | | (2 | ) | | | — | | | | 6 | |
| Specialty Footwear | | | 2 | | | | (1 | ) | | | 1 | | | | 2 | | | | — | | | | (1 | ) | | | 1 | | | | — | | | | — | | | | 1 | |
| Domestic General Merchandise | | | 10 | | | | — | | | | (2 | ) | | | 8 | | | | — | | | | — | | | | 8 | | | | — | | | | (2 | ) | | | 6 | |
| Total | | $ | 19 | | | $ | (1 | ) | | $ | — | | | $ | 18 | | | $ | 2 | | | $ | 2 | | | $ | 22 | | | $ | (4 | ) | | $ | (3 | ) | | $ | 15 | |
____________________
* | | Net usage includes effect of foreign exchange translation adjustments. |
18 Repositioning and Restructuring Reserves
1999 Restructuring
The Company recorded restructuring charges in 1999 for programs to sell or liquidate eight non-core businesses. The restructuring plan also included an accelerated store-closing program in North America and Asia, corporate headcount reduction and a distribution center shutdown. The dispositions of Randy River Canada, Foot Locker Outlets, Colorado, Going to the Game!, Weekend Edition and the store-closing program were essentially completed in 2000. In 2001, the Company completed the sales of The San Francisco Music Box Company (“SFMB”) and the assets related to its Burger King and Popeye’s franchises. The termination of the Maumelle distribution center lease was completed in 2002.
In connection with the sale of SFMB, the Company remained as guarantor of a distribution center lease. During 2006 and 2004, the Company recorded charges of $1 million and $2 million, respectively, primarily related to the distribution center lease. The lease for the distribution center expires January 31, 2010. As of February 3, 2007, the Company estimates its gross contingent lease liability for the distribution center lease to be approximately $2 million, offset in part by the estimated sublease income of $1 million. The Company entered into a sublease on November 15, 2004 for a significant portion of the distribution center that will expire concurrent with the Company’s lease term. Accordingly, at February 3, 2007 the reserve balance is $1 million.
46
1993 Repositioning and 1991 Restructuring
The Company recorded charges in 1993 and in 1991 to reflect the anticipated costs to sell or close under-performing specialty and general merchandise stores in the United States and Canada. As of February 3, 2007 the reserve balance is $3 million.
19 Income Taxes
Following are the domestic and international components of pre-tax income from continuing operations:
| | | 2006 | | 2005 | | 2004 |
| | | (in millions) |
| Domestic | | $ | 320 | | $ | 309 | | $ | 222 |
| International | | | 72 | | | 96 | | | 152 |
| Total pre-tax income | | $ | 392 | | $ | 405 | | $ | 374 |
The income tax provision consists of the following:
| | | 2006 | | 2005 | | 2004 |
| | | (in millions) |
| Current: | | | | | | | | | | | |
| Federal | | $ | 93 | | $ | 72 | | | $ | 11 | |
| State and local | | | 14 | | | 11 | | | | 6 | |
| International | | | 17 | | | 35 | | | | 52 | |
| Total current tax provision | | | 124 | | | 118 | | | | 69 | |
| Deferred: | | | | | | | | | | | |
| Federal | | | 10 | | | 22 | | | | 43 | |
| State and local | | | 6 | | | 7 | | | | 8 | |
| International | | | 5 | | | (5 | ) | | | (1 | ) |
| Total deferred tax provision | | | 21 | | | 24 | | | | 50 | |
| Total income tax provision | | $ | 145 | | $ | 142 | | | $ | 119 | |
Provision has been made in the accompanying Consolidated Statements of Operations for additional income taxes applicable to dividends received or expected to be received from international subsidiaries. The amount of unremitted earnings of international subsidiaries for which no such tax is provided and which is considered to be permanently reinvested in the subsidiaries totaled $426 million and $388 million at February 3, 2007, and January 28, 2006, respectively.
A reconciliation of the significant differences between the federal statutory income tax rate and the effective income tax rate on pre-tax income from continuing operations is as follows:
| | 2006 | | 2005 | | 2004 |
| |
| Federal statutory income tax rate | 35.0 | % | | 35.0 | % | | 35.0 | % |
| State and local income taxes, net of federal tax benefit | 3.3 | | | 2.8 | | | 2.3 | |
| International income taxed at varying rates | (0.9 | ) | | 0.8 | | | (0.6 | ) |
| Foreign tax credit utilization | (1.2 | ) | | (3.1 | ) | | (2.5 | ) |
| Increase (decrease) in valuation allowance | 0.1 | | | (1.5 | ) | | 0.1 | |
| Federal/foreign tax settlements | (0.1 | ) | | 0.4 | | | (3.3 | ) |
| Tax exempt obligations | (0.5 | ) | | (0.4 | ) | | (0.2 | ) |
| Federal tax credits | (0.2 | ) | | (0.2 | ) | | (0.2 | ) |
| Other, net | 1.4 | | | 1.2 | | | 1.1 | |
| Effective income tax rate | 36.9 | % | | 35.0 | % | | 31.7 | % |
47
Items that gave rise to significant portions of the deferred tax accounts are as follows:
| | 2006 | | 2005 |
| | (in millions) |
| Deferred tax assets: | | | | | | | |
| Tax loss/credit carryforwards | $ | 56 | | | $ | 71 | |
| Employee benefits | | 26 | | | | 75 | |
| Reserve for discontinued operations | | 6 | | | | 8 | |
| Repositioning and restructuring reserves | | 2 | | | | 3 | |
| Property and equipment | | 116 | | | | 108 | |
| Allowance for returns and doubtful accounts | | 4 | | | | 4 | |
| Straight-line rent | | 24 | | | | 22 | |
| Other | | 21 | | | | 19 | |
| Total deferred tax assets | | 255 | | | | 310 | |
| Valuation allowance | | (105 | ) | | | (123 | ) |
| Total deferred tax assets, net | $ | 150 | | | $ | 187 | |
| | 2006 | | 2005 |
| | (in millions) |
| Deferred tax liabilities: | | | | | | | |
| Inventories | $ | 24 | | | $ | 18 | |
| Goodwill | | 13 | | | | 12 | |
| Other | | 8 | | | | 10 | |
| Total deferred tax liabilities | | 45 | | | | 40 | |
| Net deferred tax asset | $ | 105 | | | $ | 147 | |
| Balance Sheet caption reported in: | | | | | | | |
| Deferred taxes | $ | 109 | | | $ | 147 | |
| Other current assets | | 21 | | | | 28 | |
| Other current liabilities | | (4 | ) | | | (3 | ) |
| Other liabilities | | (21 | ) | | | (25 | ) |
| | $ | 105 | | | $ | 147 | |
The Company operates in multiple taxing jurisdictions and is subject to audit. Audits can involve complex issues and may require an extended period of time to resolve. A taxing authority may challenge positions that the Company has adopted in its income tax filings. Accordingly, the Company may apply different tax treatments for transactions in filing its income tax returns than for income tax financial reporting. The Company regularly assesses its tax positions for such transactions and records reserves for those differences.
The Company’s U.S. Federal income tax filings have been examined by the Internal Revenue Service (the “IRS”) through 2005. The Company participated in the IRS’ Compliance Assurance Process (“CAP”) for 2006, which is expected to conclude during 2007. The Company has started the CAP for 2007.
As of February 3, 2007, the Company has a valuation allowance of $105 million to reduce its deferred tax assets to an amount that is more likely than not to be realized. The valuation allowance primarily relates to the deferred tax assets arising from state tax loss carryforwards, tax loss carryforwards of certain foreign operations, and capital loss carryforwards and unclaimed tax depreciation of the Canadian operations. The valuation allowance for state tax loss carryforwards decreased, principally due to anticipated expirations of those losses. The valuation allowance for Canadian tax loss carryforwards and tax depreciation decreased as a result of currency fluctuations and other adjustments.
48
Based upon the level of historical taxable income and projections for future taxable income over the periods in which the temporary differences are anticipated to reverse, management believes it is more likely than not that the Company will realize the benefits of these deductible differences, net of the valuation allowances at February 3, 2007. However, the amount of the deferred tax asset considered realizable could be adjusted in the future if estimates of taxable income are revised.
At February 3, 2007, the Company’s tax loss/credit carryforwards includes international operating loss carryforwards with a potential tax benefit of $26 million. Those expiring between 2007 and 2013 total $23 million and those that do not expire total $3 million. The Company also has state net operating loss carryforwards with a potential tax benefit of $18 million, which principally relate to the 16 states where the Company does not file combined or consolidated returns. These loss carryforwards expire between 2007 and 2025. The Company has state credits carryforwards of approximately $1 million that expire between 2010 and 2013 and Canadian capital loss carryforwards of approximately $11 million that do not expire.
20 Financial Instruments and Risk Management
Foreign Exchange Risk Management — Derivative Holdings Designated as Hedges
The Company operates internationally and utilizes certain derivative financial instruments to mitigate its foreign currency exposures, primarily related to third party and intercompany forecasted transactions.
For a derivative to qualify as a hedge at inception and throughout the hedged period, the Company formally documents the nature of the hedged items and the relationships between the hedging instruments and the hedged items, as well as its risk-management objectives, strategies for undertaking the various hedge transactions, and the methods of assessing hedge effectiveness and hedge ineffectiveness. Additionally, for hedges of forecasted transactions, the significant characteristics and expected terms of a forecasted transaction must be specifically identified, and it must be probable that each forecasted transaction would occur. If it were deemed probable that the forecasted transaction would not occur, the gain or loss would be recognized in earnings immediately. No such gains or losses were recognized in earnings during 2006 or 2005. Derivative financial instruments qualifying for hedge accounting must maintain a specified level of effectiveness between the hedging instrument and the item being hedged, both at inception and throughout the hedged period, which management evaluates periodically.
The primary currencies to which the Company is exposed are the euro, the British Pound, and the Canadian Dollar. For option and forward foreign exchange contracts designated as cash flow hedges of the purchase of inventory, the effective portion of gains and losses is deferred as a component of accumulated other comprehensive loss and is recognized as a component of cost of sales when the related inventory is sold. The amount classified to cost of sales related to such contracts was not significant in 2006 and was a gain of $2 million in 2005. The ineffective portion of gains and losses related to cash flow hedges recorded to earnings in 2006 was not significant and was approximately $1 million in 2005. When using a forward contract as a hedging instrument, the Company excludes the time value from the assessment of effectiveness. At each year-end, the Company had not hedged forecasted transactions for more than the next twelve months, and the Company expects all derivative-related amounts reported in accumulated other comprehensive loss to be reclassified to earnings within twelve months.
The Company has numerous investments in foreign subsidiaries, and the net assets of those subsidiaries are exposed to foreign exchange-rate volatility. In 2005, the Company hedged a portion of its net investment in its European subsidiaries. The Company entered into a 10-year cross currency swap, effectively creating a €100 million long-term liability and a $122 million long-term asset. During the term of this transaction, the Company will remit to and receive from its counterparty interest payments based on rates that are reset monthly equal to one-month EURIBOR and one-month U.S. LIBOR rates, respectively. In 2006, the Company hedged a portion of its net investment in its Canadian subsidiaries. The Company entered into a 10-year cross currency swap, creating a CAD $40 million liability and a $35 million long-term asset. During the term of this transaction, the Company will remit to and receive from its counterparty interest payments based on rates that are reset monthly equal to one-month CAD B.A. and one-month U.S. LIBOR rates, respectively.
49
The Company has designated these hedging instruments as hedges of the net investments in foreign subsidiaries, and will use the spot rate method of accounting to value changes of the hedging instrument attributable to currency rate fluctuations. As such, adjustments in the fair market value of the hedging instrument due to changes in the spot rate will be recorded in other comprehensive income and are expected to offset changes in the euro-denominated net investment. Amounts recorded to foreign currency translation within accumulated other comprehensive loss will remain there until the net investment is disposed of. The amount recorded within the foreign currency translation adjustment included in accumulated other comprehensive loss on the Consolidated Balance Sheet at February 3, 2007 decreased shareholders’ equity by $5 million, net of tax. At January 28, 2006, the amount recorded to foreign currency translation was not significant. The effect on the Consolidated Statements of Operations related to the net investments hedges was income of $3 million for 2006 and was not significant for 2005.
Foreign Exchange Risk Management — Derivative Holdings Designated as Non-Hedges
The Company mitigates the effect of fluctuating foreign exchange rates on the reporting of foreign currency denominated earnings by entering into a variety of derivative instruments including option currency contracts. These contracts are not designated as hedges and as a result, the changes in the fair value of these financial instruments are charged to the statement of operations immediately. The changes in fair values recorded in the Consolidated Statement of Operations for the year ended February 3, 2007 was not significant and was a net gain of approximately $3 million for contracts that settled in the second quarter of 2005.
The Company also enters into certain forward foreign exchange contracts to hedge intercompany foreign-currency denominated transactions. In 2005, the Company recorded gains of approximately $3 million in selling, general and administrative expenses to reflect the fair value of these contracts. These gains were offset by the foreign exchange losses on the revaluation of the underlying assets or liabilities. The amount recorded during 2006 was not significant.
Foreign Currency Exchange Rates
The table below presents the fair value, notional amounts, and weighted-average exchange rates of foreign exchange forward and option contracts outstanding at February 3, 2007.
| | | Fair Value | | Contract Value | | Weighted-Average |
| | | (US in millions) | | (US in millions) | | Exchange Rate |
| Inventory | | | | | | | | | | | |
| Buy €/Sell British £ | | $ | (1 | ) | | $ | 63 | | | .6799 | |
| Buy $US/Sell € | | | — | | | | 4 | | | 1.3108 | |
| Buy $US/Sell CAD$ | | | — | | | | 2 | | | .9088 | |
| | |
| Earnings | | | | | | | | | | | |
| Sell €/Buy $US | | $ | — | | | $ | 29 | | | 1.2962 | |
| Sell CAD$/ Buy $US | | | — | | | | 7 | | | .8739 | |
| | |
| Intercompany | | | | | | | | | | | |
| Buy €/ Sell British £ | | $ | — | | | $ | 25 | | | .6762 | |
| Buy British £/Sell € | | | — | | | | 25 | | | .6668 | |
| Buy SEK/Sell € | | | — | | | | 1 | | | .7456 | |
| Buy €/Sell $US | | | — | | | | 1 | | | 1.3078 | |
| Buy US/Sell NZD | | | — | | | | 2 | | | .5985 | |
| Buy US/Sell AUD | | | — | | | | 2 | | | .7456 | |
| Buy US/Sell CAD | | | — | | | | 1 | | | .8727 | |
50
Interest Rate Risk Management
The Company has employed various interest rate swaps to minimize its exposure to interest rate fluctuations. These swaps, which mature in 2022, have been designated as a fair value hedge of the changes in fair value of $100 million of the Company’s 8.50 percent debentures payable in 2022 attributable to changes in interest rates and effectively convert the interest rate on the debentures from 8.50 percent to a 1-month variable rate of LIBOR plus 3.45 percent.
The following table presents the Company’s outstanding interest rate derivatives:
| 2006 | | 2005 | | 2004 |
| (in millions) |
| Interest Rate Swaps: | | | | | | | | | | | |
| Fixed to Variable ($US) — notional amount | $ | 100 | | | $ | 100 | | | $ | 100 | |
| Average pay rate | | 8.53 | % | | | 8.00 | % | | | 6.46 | % |
| Average receive rate | | 8.50 | % | | | 8.50 | % | | | 8.50 | % |
| Variable to variable ($US) — notional amount | $ | 100 | | | $ | 100 | | | $ | 100 | |
| Average pay rate | | 5.57 | % | | | 4.82 | % | | | 2.73 | % |
| Average receive rate | | 5.32 | % | | | 4.79 | % | | | 3.25 | % |
Fair Value
The following represents the fair value of foreign exchange derivative contracts and interest rate swaps:
| 2006 | | 2005 |
| (in millions) |
| Current assets | $ 1 | | $ — |
| Non-current assets | — | | 1 |
| Current liabilities | 2 | | 1 |
| Non-current liabilities | 12 | | 2 |
Interest Rates
The Company’s major exposure to market risk is to changes in interest rates, primarily in the United States.
The table below presents the fair value of principal cash flows and related weighted-average interest rates by maturity dates, including the effect of the interest rate swaps outstanding at February 3, 2007, of the Company’s long-term debt obligations.
| | | | | | | | | | | | | | | | | | | Feb. 3, | | Jan. 28, |
| | | | | | | | | | | | | | | | | | | 2007 | | 2006 |
| 2007 | | 2008 | | 2009 | | 2010 | | 2011 | | Thereafter | | Total | | Total |
| ($ in millions) |
| Long-term debt | $ — | | | 2 | | | 88 | | | — | | | — | | | 132 | | | $222 | | $330 |
| Weighted-average interest rate | 7.8 | % | | 7.8 | % | | 7.8 | % | | 8.7 | % | | 8.7 | % | | 8.7 | % | | | | |
Fair Value of Financial Instruments
The carrying value and estimated fair value of long-term debt was $220 million and $222 million, respectively, at February 3, 2007 and $311 million and $330 million, respectively, at January 28, 2006. The carrying value and estimated fair value of long-term investments and notes receivable was $18 million and $19 million, respectively, at February 3, 2007 and $33 million and $33 million, respectively, at January 28, 2006. The carrying value and estimated fair value of short-term investment was $14 million and $15 million, respectively, at February 3, 2007. The carrying values of cash and cash equivalents, other short-term investments and other current receivables and payables approximate their fair value.
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Business Risk
The retailing business is highly competitive. Price, quality and selection of merchandise, reputation, store location, advertising and customer service are important competitive factors in the Company’s business. The Company operates in 20 countries and purchased approximately 78 percent of its merchandise in 2006 from its top 5 vendors. In 2006, the Company purchased approximately 50 percent of its athletic merchandise from one major vendor and approximately 14 percent from another major vendor. Each of our operating divisions are highly dependent on Nike, they individually purchase 40 to 65 percent of their merchandise from Nike. The Company generally considers all vendor relations to be satisfactory.
Included in the Company’s Consolidated Balance Sheet as of February 3, 2007, are the net assets of the Company’s European operations totaling $478 million, which are located in 16 countries, 11 of which have adopted the euro as their functional currency.
21 Retirement Plans and Other Benefits
Pension and Other Postretirement Plans
The Company has defined benefit pension plans covering most of its North American employees, which are funded in accordance with the provisions of the laws where the plans are in effect. In addition to providing pension benefits, the Company sponsors postretirement medical and life insurance plans, which are available to most of its retired U.S. employees. These plans are contributory and are not funded. The measurement date of the assets and liabilities is the last day of the fiscal year.
In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans- An Amendment of FASB Statements No. 87, 88, 106, and 132(R),” (“SFAS No. 158”). This new standard requires an employer to: recognize in its statement of financial position an asset for a plan’s overfunded status or a liability for a plan’s underfunded status; measure a plan’s assets and its obligations that determine its funded status as of the end of the employer’s fiscal year (with limited exceptions); and recognize changes in the funded status of a defined benefit postretirement plan in the year in which the changes occur. Those changes will be reported in comprehensive income/loss. The initial effect of the standard, due to unrecognized prior service cost and net actuarial gains or losses, as well as subsequent changes in the funded status, is recognized as a component of accumulated comprehensive income/loss within shareholders’ equity. Additional minimum pension liabilities (“AML”) and related intangible assets are derecognized upon the adoption of SFAS No. 158. The Company adopted this standard as of February 3, 2007.
The following tables set forth the plans’ changes in benefit obligations and plan assets, funded status and amounts recognized in the Consolidated Balance Sheets, measured at February 3, 2007 and January 28, 2006:
| | | | | | | | Postretirement |
| | Pension Benefits | | Benefits |
| | 2006 | | 2005 | | 2006 | | 2005 |
| | | | | (in millions) | | | | | |
| Change in benefit obligation | | | | | | | | | | | | |
| Benefit obligation at beginning of year | | $ 689 | | | $ 703 | | | $ 17 | | | $ 24 | |
| Service cost | | 10 | | | 9 | | | — | | | — | |
| Interest cost | | 36 | | | 36 | | | 1 | | | 1 | |
| Plan participants’ contributions | | — | | | — | | | 5 | | | 5 | |
| Actuarial gain | | (12 | ) | | — | | | (3 | ) | | (5 | ) |
| Foreign currency translation adjustments | | (2 | ) | | 7 | | | — | | | — | |
| Plan amendment | | 1 | | | — | | | — | | | — | |
| Benefits paid | | (60 | ) | | (66 | ) | | (7 | ) | | (8 | ) |
| Benefit obligation at end of year | | $ 662 | | | $ 689 | | | $ 13 | | | $ 17 | |
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| | | | | | | | | | Postretirement |
| | Pension Benefits | | Benefits |
| | 2006 | | 2005 | | 2006 | | 2005 |
| | (in millions) |
| Change in plan assets | | | | | | | | | | | | | | | | |
| Fair value of plan assets at beginning of year | | $ | 579 | | | $ | 551 | | | | | | | | | |
| Actual return on plan assets | | | 60 | | | | 60 | | | | | | | | | |
| Employer contribution | | | 70 | | | | 29 | | | | | | | | | |
| Foreign currency translation adjustments | | | (2 | ) | | | 5 | | | | | | | | | |
| Benefits paid | | | (60 | ) | | | (66 | ) | | | | | | | | |
| Fair value of plan assets at end of year | | $ | 647 | | | $ | 579 | | | | | | | | | |
| Funded status | | | | | | | | | | | | | | | | |
| Funded status | | $ | (15 | ) | | $ | (110 | ) | | $ | (13 | ) | | $ | (17 | ) |
| Unrecognized prior service cost (benefit) | | | | | | | 3 | | | | | | | | (9 | ) |
| Unrecognized net (gain) loss | | | | | | | 303 | | | | | | | | (60 | ) |
| Prepaid asset (accrued liability) | | | | | | $ | 196 | | | | | | | $ | (86 | ) |
| Balance Sheet caption reported in: | | | | | | | | | | | | | | | | |
| Intangible assets | | $ | — | | | $ | 1 | | | $ | — | | | $ | — | |
| Other assets | | | 8 | | | | — | | | | — | | | | — | |
| Accrued and other liabilities | | | (2 | ) | | | (70 | ) | | | (2 | ) | | | (2 | ) |
| Other liabilities | | | (21 | ) | | | (42 | ) | | | (11 | ) | | | (84 | ) |
| Accumulated other comprehensive loss, pre-tax | | | — | | | | 307 | | | | — | | | | — | |
| | $ | (15 | ) | | $ | 196 | | | $ | (13 | ) | | $ | (86 | ) |
At February 3, 2007, the aggregate amount of accumulated benefit obligations which exceed plan assets totaled $23 million representing the Company’s nonqualified pension plans. The Company's qualified pension plans were fully funded at February 3, 2007. At January 28, 2006, the accumulated benefit obligations of $688 million exceeded plan assets of $579 million for all pension plans.
Amounts recognized in accumulated other comprehensive loss (pre-tax) at February 3, 2007 consists of:
| | Pension | | Postretirement |
| | Benefits | | Benefits |
| Prior service cost (benefit) | $ | 4 | | $ | (7 | ) |
| Net actuarial (gain) loss | | 274 | | | (53 | ) |
| Total amount recognized | $ | 278 | | $ | (60 | ) |
The following represents the change to the Consolidated Balance Sheet as of February 3, 2007 as a result of the adoption of SFAS No. 158:
| | | Prior to | | | | | | | | | |
| | AML and | | | | | Effect of | | Post AML and |
| | Statement | | | | | Adoption | | Statement |
| | No. 158 | | AML | | Statement | | No. 158 |
| | Adjustments | | Adjustment | | No. 158 | | Adjustments |
| | (in millions) |
| Current assets | | 2,034 | | | — | | | — | | | 2,034 | |
| Deferred taxes | | 144 | | | (120 | ) | | 85 | | | 109 | |
| Intangible assets | | 106 | | | (1 | ) | | — | | | 105 | |
| Other assets | | 75 | | | — | | | 8 | | | 83 | |
| Total assets | | $ 3,277 | | | (121 | ) | | 93 | | | $ 3,249 | |
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| | | Prior to | | | | | | | | | |
| | AML and | | | | | Effect of | | Post AML and |
| | Statement | | | | | Adoption | | Statement |
| | No. 158 | | AML | | Statement | | No. 158 |
| | Adjustments | | Adjustment | | No. 158 | | Adjustments |
| | (in millions) |
| Accrued and other liabilities | | 246 | | | — | | | — | | | 246 | |
| Total current liabilities | | 516 | | | — | | | — | | | 516 | |
| Other liabilities | | 300 | | | (308 | ) | | 226 | | | 218 | |
| Other comprehensive loss | | (150 | ) | | 187 | | | (133 | ) | | (96 | ) |
| Total shareholders’ equity | | 2,323 | | | (121 | ) | | 93 | | | 2,295 | |
| Total liabilities and shareholders’ equity | | $ 3,277 | | | (121 | ) | | 93 | | | $ 3,249 | |
The following weighted-average assumptions were used to determine the benefit obligations under the plans:
| Pension Benefits | | Postretirement Benefits |
| 2006 | | 2005 | | 2006 | | 2005 |
| Discount rate | 5.68% | | 5.43% | | 5.80% | | 5.50% |
| Rate of compensation increase | 3.76% | | 3.77% | | | | |
The components of net benefit expense (income) are:
| | Pension Benefits | | Postretirement Benefits |
| | 2006 | | 2005 | | 2004 | | 2006 | | 2005 | | 2004 |
| | (in millions) |
| Service cost | | $ | 10 | | | $ | 9 | | | $ | 9 | | | $ | — | | | $ | — | | | $ | — | |
| Interest cost | | | 36 | | | | 36 | | | | 39 | | | | 1 | | | | 1 | | | | 1 | |
| Expected return on plan assets | | | (56 | ) | | | (49 | ) | | | (48 | ) | | | — | | | | — | | | | — | |
| Amortization of prior service cost (benefit) | | | 1 | | | | 1 | | | | 1 | | | | (1 | ) | | | (1 | ) | | | (1 | ) |
| Amortization of net (gain) loss | | | 12 | | | | 13 | | | | 11 | | | | (10 | ) | | | (12 | ) | | | (13 | ) |
| Net benefit expense (income) | | $ | 3 | | | $ | 10 | | | $ | 12 | | | $ | (10 | ) | | $ | (12 | ) | | $ | (13 | ) |
The following weighted-average assumptions were used to determine net benefit cost:
| | Pension Benefits | | Postretirement Benefits |
| | 2006 | | 2005 | | 2004 | | 2006 | | 2005 | | 2004 |
| Discount rate | | 5.44% | | 5.50% | | 5.90% | | 5.50% | | 5.50% | | 5.90% |
| Rate of compensation increase | | 3.76% | | 3.77% | | 3.79% | | | | | | |
| Expected long-term rate of return on assets | | 8.87% | | 8.88% | | 8.89% | | | | | | |
The amounts in accumulated other comprehensive loss that are expected to be recognized as components of net periodic benefit cost (income) during the next year are as follows:
| | Pension | | Postretirement Benefits | | Total |
| | (in millions) |
| Amortization of prior service cost (benefit) | | $ | 1 | | $ | (1 | ) | | $ | — |
| Amortization of net loss (gain) | | $ | 11 | | $ | (8 | ) | | $ | 3 |
The expected long-term rate of return on invested plan assets is based on historical long-term performance and future expected performance of those assets based upon current asset allocations.
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Beginning with 2001, new retirees were charged the expected full cost of the medical plan and existing retirees will incur 100 percent of the expected future increase in medical plan costs. Any changes in the health care cost trend rates assumed would not affect the accumulated benefit obligation or net benefit income, since retirees will incur 100 percent of such expected future increases.
In December 2003, the United States enacted into law the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the “Act”). The Act establishes a prescription drug benefit under Medicare, known as “Medicare Part D,” and a Federal subsidy to sponsors of retiree health care benefit plans that provide a benefit that is at least actuarially equivalent to Medicare Part D. The Company has determined that it will qualify for the subsidy, however the effect of the subsidy was not significant to either the benefit obligation or net benefit income.
In August 2006, the Pension Protection Act of 2006 was signed into law. The major provisions of the statute will take effect January 1, 2008. Among other things, the statute is designed to ensure timely and adequate funding of pension plans by shortening the time period within which employers must fully fund pension benefits. The Company is currently evaluating the effect, if any, that the Pension Protection Act of 2006 will have on funding requirements. The effect on net periodic benefit cost is not expected to be significant.
The Company’s pension plan weighted-average asset allocations at February 3, 2007 and January 28, 2006, by asset category are as follows:
| 2006 | | 2005 |
| Asset Category | | | | | |
| Equity securities | 64 | % | | 62 | % |
| Foot Locker, Inc. common stock | 1 | % | | 2 | % |
| Debt securities | 33 | % | | 34 | % |
| Real estate | 1 | % | | 1 | % |
| Other | 1 | % | | 1 | % |
| Total | 100 | % | | 100 | % |
The U.S. defined benefit plan held 396,000 shares of Foot Locker, Inc. common stock as of February 3, 2007 and January 28, 2006. Currently, the target composition of the weighted-average plan assets is 64 percent equity and 36 percent fixed income securities, although the Company may alter the targets from time to time depending on market conditions and the funding requirements of the pension plans. The Company believes that plan assets are invested in a prudent manner with an objective of providing a total return that, over the long term, provides sufficient assets to fund benefit obligations, taking into account the Company’s expected contributions and the level of risk deemed appropriate. The Company’s investment strategy is to utilize asset classes with differing rates of return, volatility and correlation to reduce risk by providing diversification relative to equities. Diversification within asset classes is also utilized to reduce the effect that the return of any single investment may have on the entire portfolio.
Estimated future benefit payments for each of the next five years and the five years thereafter are as follows:
| | Pension | | Postretirement |
| | Benefits | | Benefits |
| | (in millions) |
| 2007 | | $ | 64 | | $ | 2 |
| 2008 | | | 62 | | | 2 |
| 2009 | | | 61 | | | 2 |
| 2010 | | | 58 | | | 2 |
| 2011 | | | 56 | | | 1 |
| 2012–2015 | | | 259 | | | 5 |
In the fourth quarter of 2006, the Company and its U.S. pension plan, the Foot Locker Retirement Plan, were named as defendants in a class action in federal court in Illinois. The Complaint alleged that the Company’s pension plan violated the Employee Retirement Income Security Act of 1974 as a result of the Company’s conversion of its defined benefit plan to a defined benefit pension plan with a cash balance feature in 1996. In March 2007, the class action was dismissed without prejudice. In February 2007, the same plaintiff filed a class action in federal court in New York against the Company and its U.S. pension plan, the Foot Locker Retirement Plan. The Complaint alleged that the
55
Company’s pension plan violated the Employee Retirement Income Security Act of 1974, including, without limitation, its age discrimination and notice provisions, as a result of the Company’s conversion of its defined benefit plan to a defined benefit pension plan with a cash balance feature in 1996. The Company plans to defend the action vigorously.
Savings Plans
The Company has two qualified savings plans, a 401(k) Plan that is available to employees whose primary place of employment is the U.S., and an 1165 (e) Plan, which began during 2004 that is available to employees whose primary place of employment is in Puerto Rico. Both plans require that the employees have attained at least the age of twenty-one and have completed one year of service consisting of at least 1,000 hours. The savings plans allow eligible employees to contribute up to 25 percent and 10 percent, for the U.S. and Puerto Rico plans, respectively, of their compensation on a pre-tax basis. The Company matches 25 percent of the first 4 percent of the employees’ contributions with Company stock and such matching Company contributions are vested incrementally over 5 years for both plans. The charge to operations for the Company’s matching contribution for the U.S. plan was $1.9 million, $1.6 million, and $1.3 million in 2006, 2005 and 2004, respectively.
22 Share-Based Compensation
Stock Options
Under the 2003 Stock Option and Award Plan (the “2003 Stock Option Plan”), options, restricted stock, stock appreciation rights (SARs), or other stock-based awards may be granted to officers and other employees, including those at the subsidiary levels, at not less than the market price on the date of the grant. Unless a longer or shorter period is established at the time of the option grant, generally, one-third of each stock option grant becomes exercisable on each of the first three anniversary dates of the date of grant. The maximum number of shares of stock reserved for issuance pursuant to the 2003 Stock Option Plan is 4,000,000 shares. The number of shares reserved for issuance as restricted stock and other stock-based awards cannot exceed 1,000,000 shares. The options terminate up to 10 years from the date of grant.
Under the Company’s 1998 Stock Option and Award Plan (the “1998 Plan”), options to purchase shares of common stock may be granted to officers and other employees at not less than the market price on the date of grant. Under the plan, the Company may grant to officers and other employees, including those at the subsidiary level, stock options, SARs, restricted stock or other stock-based awards. Generally, one-third of each stock option grant becomes exercisable on each of the first three anniversary dates of the date of grant. The options terminate up to 10 years from the date of grant. In 2000, the Company amended the 1998 Plan to provide for awards of up to 12,000,000 shares of the Company’s common stock. The number of shares reserved for issuance as restricted stock and other stock-based awards, as amended, cannot exceed 3,000,000 shares.
In addition, options to purchase shares of common stock remain outstanding under the Company’s 1995 Stock Option and Award Plan (the “1995 Plan”). The 1995 Plan is substantially the same as the 1998 Plan. The number of shares authorized for awards under the 1995 Plan is 6,000,000 shares. The number of shares reserved for issuance as restricted stock under the 1995 Plan was 1,500,000 shares. As of March 8, 2005 no further awards may be made under the 1995 Plan. Options granted under the 1986 Stock Option Plan generally became exercisable in two equal installments on the first and the second anniversaries of the date of grant, no further options may be granted under this Plan.
The 2002 Foot Locker Directors’ Stock Plan (the “2002 Directors Plan”) replaced both the Directors’ Stock Plan, which was adopted in 1996, and the Directors’ Stock Option Plan, which was adopted in 2000. There are 500,000 shares authorized under the 2002 Directors Plan. No further grants or awards may be made under either of the prior plans. Options granted prior to 2003 have a three-year vesting schedule. Options granted beginning in 2003 become exercisable one year from the date of grant.
Employee Stock Purchase Plan
The Company’s 2003 Employees Stock Purchase Plan (the “2003 Employee Stock Purchase Plan”) terms are substantially the same as the 1994 Employees Stock Purchase Plan (the “1994 Employee Stock Purchase Plan”), which expired in June 2004. Under the Company’s 2003 Employee Stock Purchase Plan participating employees are able to contribute up to 10 percent of their annual compensation through payroll deductions to acquire shares of the Company’s
56
common stock at 85 percent of the lower market price on one of two specified dates in each plan year. Under the 2003 Employee Stock Purchase Plan, 3,000,000 shares of common stock are authorized for purchase beginning June 2005. Of the 3,000,000 shares of common stock authorized for purchase under this plan, 806 participating employees purchased 105,123 shares in 2006 and 1,191 participating employees purchased 237,353 shares in 2005.
Valuation Model and Assumptions
The Company uses a Black-Scholes option-pricing model to estimate the fair value of share-based awards under SFAS No. 123(R), which is the same valuation technique it previously used for pro forma disclosures under SFAS No. 123. The Black-Scholes option-pricing model incorporates various and highly subjective assumptions, including expected term and expected volatility.
The Company estimates the expected term of share-based awards granted using the Company’s historical exercise and post-vesting employment termination patterns, which it believes are representative of future behavior. The expected term for the Company’s employee stock purchase plan valuation is based on the length of each purchase period as measured at the beginning of the offering period, which is one year. The Company estimates the expected volatility of its common stock at the grant date using a weighted-average of the Company’s historical volatility and implied volatility from traded options on the Company’s common stock. The Company believes that the combination of historical volatility and implied volatility provides a better estimate of future stock price volatility. The risk-free interest rate assumption is determined using the Federal Reserve nominal rates for U.S. Treasury zero-coupon bonds with maturities similar to those of the expected term of the award being valued. The expected dividend yield is derived from the Company’s historical experience.
Additionally, SFAS No. 123(R) requires the Company to estimate pre-vesting option forfeitures at the time of grant and periodically revise those estimates in subsequent periods if actual forfeitures differ from those estimates. The Company records stock-based compensation expense only for those awards expected to vest using an estimated forfeiture rate based on its historical pre-vesting forfeiture data. Previously, the Company accounted for forfeitures as they occurred under the pro forma disclosure provisions of SFAS No. 123 for periods prior to 2006.
The following table shows the Company’s assumptions used to compute the stock-based compensation expense and pro forma information:
| | Stock Option Plans | | Stock Purchase Plan |
| | 2006 | | 2005 | | 2004 | | 2006 | | 2005 | | 2004 |
| Weighted-average risk free rate | | | | | | | | | | | | | | | | | | |
| of interest | | 4.68 | % | | 3.99 | % | | 2.57 | % | | 4.39 | % | | 4.19 | % | | 1.33 | % |
| Expected volatility | | 30 | % | | 28 | % | | 33 | % | | 22 | % | | 25 | % | | 32 | % |
| Weighted-average expected | | | | | | | | | | | | | | | | | | |
| award life | | 4.0 years | | | 3.8 years | | | 3.7 years | | | 1.0 years | | | .7 years | | | .7 years | |
| Dividend yield | | 1.5 | % | | 1.1 | % | | 1.1 | % | | 1.4 | % | | — | | | — | |
| Weighted-average fair value | | $6.36 | | | $6.69 | | | $6.51 | | | $4.71 | | | $5.54 | | | $11.44 | |
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The information set forth in the following table covers options granted under the Company’s stock option plans:
| | 2006 | | 2005 | | 2004 |
| | | | | Weighted- | | | | | Weighted- | | | | | Weighted- |
| | Number | | Average | | Number | | Average | | Number | | Average |
| | of | | Exercise | | of | | Exercise | | of | | Exercise |
| | Shares | | Price | | Shares | | Price | | Shares | | Price |
| | (in thousands, except prices per share) |
| Options outstanding at beginning | | | | | | | | | | | | | | | | | | |
| of year | | 5,962 | | | $ | 18.45 | | 5,909 | | | $ | 16.69 | | 6,886 | | | $ | 14.73 |
| Granted | | 858 | | | $ | 23.98 | | 1,014 | | | $ | 27.42 | | 1,183 | | | $ | 25.20 |
| Exercised | | (459 | ) | | $ | 15.12 | | (682 | ) | | $ | 15.03 | | (1,853 | ) | | $ | 14.43 |
| Expired or cancelled | | (313 | ) | | $ | 24.83 | | (279 | ) | | $ | 22.11 | | (307 | ) | | $ | 19.13 |
| Options outstanding at end of year | | 6,048 | | | $ | 19.15 | | 5,962 | | | $ | 18.45 | | 5,909 | | | $ | 16.69 |
| Options exercisable at end of year | | 4,455 | | | $ | 16.94 | | 4,042 | | | $ | 16.00 | | 3,441 | | | $ | 15.34 |
| Options available for future grant at end | | | | | | | | | | | | | | | | | | |
| of year | | 4,931 | | | | | | 5,768 | | | | | | 7,464 | | | | |
The total intrinsic value of options exercised for 2006 and 2005 was $4.0 million and $7.6 million, respectively. The aggregate intrinsic value for stock options outstanding and for stock options exercisable as of February 3, 2007 was $30 million. The intrinsic value for stock options outstanding and exercisable is calculated as the difference between the fair market value as the end of the period and the exercise price of the shares. The Company received $6.8 million and $9.5 million in cash from option exercises for 2006 and 2005, respectively. The tax benefit realized by the Company on the stock option exercises for 2006 was approximately $1 million.
The following table summarizes information about stock options outstanding and exercisable at February 3, 2007:
| | Options Outstanding | | Options Exercisable |
| | | | Weighted- | | | | | | |
| | | | Average | | Weighted- | | | | Weighted- |
| | | | Remaining | | Average | | | | Average |
| | | | Contractual | | Exercise | | | | Exercise |
| Range of Exercise Prices | | | Shares | | Life | | Price | | Shares | | Price |
| | (in thousands, except prices per share) |
| $ 4.53 to $11.91 | | 1,540 | | 4.8 | | $ 10.64 | | 1,540 | | $ 10.64 |
| $12.31 to $16.02 | | 1,306 | | 4.6 | | 14.90 | | 1,306 | | 14.90 |
| $16.19 to $25.19 | | 1,241 | | 7.4 | | 22.80 | | 399 | | 20.52 |
| $25.28 to $26.66 | | 1,211 | | 5.3 | | 25.42 | | 920 | | 25.39 |
| $26.87 to $28.50 | | 750 | | 7.9 | | 27.86 | | 290 | | 27.80 |
| $ 4.53 to $28.50 | | 6,048 | | 5.8 | | $ 19.15 | | 4,455 | | $ 16.94 |
Changes in the Company’s nonvested options at February 3, 2007 are summarized as follows:
| | | | Weighted- |
| | | | average grant |
| Number of | | date fair value |
| shares | | per share |
| (in thousands) | | |
| Nonvested at January 29, 2006 | 1,920 | | | $ 23.59 |
| Granted | 858 | | | 23.98 |
| Vested | (872 | ) | | 20.35 |
| Cancelled | (313 | ) | | 24.83 |
| Nonvested at February 3, 2007 | 1,593 | | | 25.33 |
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As of February 3, 2007 there was $3.3 million of total unrecognized compensation cost related to nonvested stock options, which is expected to be recognized over a weighted-average period of 0.86 years.
Restricted Stock
Restricted shares of the Company’s common stock may be awarded to certain officers and key employees of the Company. For executives outside of the United States the Company issues restricted stock units. Each restricted stock unit represents the right to receive one share of the Company’s common stock provided that the vesting conditions are satisfied. In 2005 and 2004, 20,000 and 72,005 restricted stock units were awarded, respectively. Compensation expense is recognized using the fair market value at the date of grant and is amortized over the vesting period. These awards fully vest after the passage of time, generally three years. Restricted stock is considered outstanding at the time of grant, as the holders of restricted stock are entitled to receive dividends and have voting rights.
Restricted shares and units activity for the year-ended February 3, 2007, January 28, 2006 and January 29, 2005 is summarized as follows:
| | 2006 | | 2005 | | 2004 |
| | (in thousands) |
| Outstanding at beginning of the year | | 1,041 | | | 1,177 | | | 1,150 | |
| Granted | | 157 | | | 245 | | | 402 | |
| Vested | | (600 | ) | | (205 | ) | | (345 | ) |
| Cancelled or forfeited | | (61 | ) | | (176 | ) | | (30 | ) |
| Outstanding at end of year | | 537 | | | 1,041 | | | 1,177 | |
| Aggregate value (in millions) | | $ 13.6 | | | $ 18.0 | | | $ 18.8 | |
| Weighted average remaining contractual life | | 0.93 | | | 0.69 | | | 1.25 | |
The weighted average grant-date fair value per share was $24.08, $26.55 and $25.34 for 2006, 2005 and 2004, respectively. The total value of awards for which restrictions lapsed during the year-ended February 3, 2007, January 28, 2006 and January 29, 2005 was $6.7 million, $4.0 million and $3.0 million, respectively. As of February 3, 2007, there was $4.0 million of total unrecognized compensation cost, related to nonvested restricted stock awards. The Company recorded compensation expense related to restricted shares, net of forfeitures, of $4.0 million in 2006, $6.1 million in 2005 and $8.0 million in 2004.
23 Legal Proceedings
Legal proceedings pending against the Company or its consolidated subsidiaries consist of ordinary, routine litigation, including administrative proceedings, incidental to the business of the Company, as well as litigation incidental to the sale and disposition of businesses that have occurred in past years. Management does not believe that the outcome of such proceedings would have a material adverse effect on the Company’s consolidated financial position, liquidity, or results of operations, taken as a whole.
These legal proceedings include commercial, intellectual property, customer, and labor-and-employment-related claims. Certain of the Company’s subsidiaries are defendants in a number of lawsuits filed in state and federal courts containing various class action allegations under state wage and hour laws, including allegations concerning classification of employees as exempt or nonexempt, unpaid overtime, meal and rest breaks, and uniforms.
24 Commitments
In connection with the sale of various businesses and assets, the Company may be obligated for certain lease commitments transferred to third parties and pursuant to certain normal representations, warranties, or indemnifications entered into with the purchasers of such businesses or assets. Although the maximum potential amounts for such obligations cannot be readily determined, management believes that the resolution of such contingencies will not have a material effect on the Company’s consolidated financial position, liquidity, or results of operations. The Company
59
is also operating certain stores and making rental payments for which lease agreements are in the process of being negotiated with landlords. Although there is no contractual commitment to make these payments, it is likely that a lease will be executed.
The Company does not have any off-balance sheet financing, other than operating leases entered into in the normal course of business and disclosed above, or unconsolidated special purpose entities. The Company does not participate in transactions that generate relationships with unconsolidated entities or financial partnerships, including variable interest entities.
25 Shareholder Information and Market Prices (Unaudited)
Foot Locker, Inc. common stock is listed on The New York Stock Exchange as well as on the böerse-stuttgart stock exchange in Germany and the Elektronische Börse Schweiz (EBS) stock exchange in Switzerland. In addition, the stock is traded on the Cincinnati stock exchange.
As of February 3, 2007, the Company had 23,709 shareholders of record owning 155,702,670 common shares.
Market prices for the Company’s common stock were as follows:
| | 2006 | | 2005 |
| | High | | Low | | High | | Low |
| Common Stock | | | | | | | | |
| Quarter | | | | | | | | |
| 1stQ | | $ 24.39 | | $ 22.26 | | $ 29.95 | | $ 25.88 |
| 2ndQ | | 28.00 | | 21.50 | | 27.65 | | 24.31 |
| 3rdQ | | 27.80 | | 22.34 | | 25.37 | | 18.75 |
| 4thQ | | 24.92 | | 21.10 | | 24.07 | | 18.74 |
During 2006, the Company declared quarterly dividends of $0.09 per share during the first, second and third quarters. On November 15, 2006, the Company increased the quarterly dividend per share by 39 percent to $0.125, beginning in the fourth quarter of 2006.
During 2005, the Company declared quarterly dividends of $0.075 per share during the first, second and third quarters. On November 16, 2005, the Company increased the quarterly dividend per share by 20 percent to $0.09, beginning in the fourth quarter of 2005.
60
26 Quarterly Results (Unaudited)
| | 1stQ | | 2ndQ | | 3rdQ | | 4thQ | | Year |
| | (in millions, except per share amounts) |
| Sales | | | | | | | | | | | | |
| 2006(a) | | $ | 1,365 | | 1,303 | | 1,430 | | 1,652 | | | 5,750 |
| 2005 | | | 1,377 | | 1,304 | | 1,408 | | 1,564 | | | 5,653 |
| Gross margin(b) | | | | | | | | | | | | |
| 2006(a) | | $ | 419 | | 361 | | 422 | | 534 | | | 1,736 |
| 2005 | | | 418 | | 377 | | 430 | | 484 | (d) | | 1,709 |
| Operating profit(c) | | | | | | | | | | | | |
| 2006(a) | | $ | 93 | | 27 | | 94 | | 167 | | | 381 |
| 2005 | | | 94 | | 71 | | 104 | | 140 | | | 409 |
| Income from continuing operations | | | | | | | | | | | | |
| 2006(a) | | $ | 58 | | 14 | | 65 | | 110 | | | 247 |
| 2005 | | | 58 | | 44 | | 65 | | 96 | | | 263 |
| Net income | | | | | | | | | | | | |
| 2006(a) | | $ | 59 | | 14 | | 65 | | 113 | | | 251 |
| 2005 | | | 58 | | 44 | | 66 | | 96 | | | 264 |
| Basic earnings per share: | | | | | | | | | | | | |
| 2006(a) | | | | | | | | | | | | |
| Income from continuing operations | | $ | 0.37 | | 0.09 | | 0.42 | | 0.71 | | | 1.59 |
| Income from discontinued operations | | | — | | — | | — | | 0.02 | | | 0.02 |
| Cumulative effect of accounting change | | | 0.01 | | — | | — | | — | | | 0.01 |
| Net income | | | 0.38 | | 0.09 | | 0.42 | | 0.73 | | | 1.62 |
| 2005 | | | | | | | | | | | | |
| Income from continuing operations | | $ | 0.37 | | 0.29 | | 0.42 | | 0.62 | | | 1.70 |
| Income from discontinued operations | | | — | | — | | 0.01 | | — | | | 0.01 |
| Net income | | | 0.37 | | 0.29 | | 0.43 | | 0.62 | | | 1.71 |
| Diluted earnings per share: | | | | | | | | | | | | |
| 2006(a) | | | | | | | | | | | | |
| Income from continuing operations | | $ | 0.37 | | 0.09 | | 0.42 | | 0.70 | | | 1.58 |
| Income from discontinued operations | | | — | | — | | — | | 0.02 | | | 0.02 |
| Cumulative effect of accounting change | | | 0.01 | | — | | — | | — | | | — |
| �� Net income | | | 0.38 | | 0.09 | | 0.42 | | 0.72 | | | 1.60 |
| 2005 | | | | | | | | | | | | |
| Income from continuing operations | | $ | 0.37 | | 0.28 | | 0.41 | | 0.61 | | | 1.67 |
| Income from discontinued operations | | | — | | — | | 0.01 | | — | | | 0.01 |
| Net income | | | 0.37 | | 0.28 | | 0.42 | | 0.61 | | | 1.68 |
____________________
(a) | The fourth quarter of 2006 represents the 14 weeks ended February 3, 2007. |
|
(b) | Gross margin represents sales less cost of sales. |
|
(c) | Operating profit represents income from continuing operations before income taxes, interest expense, net and non-operating income. |
|
(d) | The fourth quarter of 2005 includes permanent markdowns of $7 million. |
61
FIVE-YEAR SUMMARY OF SELECTED FINANCIAL DATA
The selected financial data below should be read in conjunction with the Consolidated Financial Statements and the notes thereto and other information contained elsewhere in this report.
| | 2006(1) | | 2005 | | 2004 | | 2003 | | 2002 | |
| ($ in millions, except per share amounts) | | | | | | | | | | | | |
| Summary of Continuing Operations | | | | | | | | | | | | |
| Sales | | $ | 5,750 | | 5,653 | | 5,355 | | 4,779 | | 4,509 | |
| Gross margin(2) | | | 1,736 | | 1,709 | | 1,633 | | 1,482 | | 1,348 | |
| Selling, general and administrative expenses | | | 1,163 | | 1,129 | | 1,090 | | 988 | | 926 | |
| Impairment charge | | | 17 | | — | | — | | — | | — | |
| Depreciation and amortization(2) | | | 175 | | 171 | | 154 | | 152 | | 153 | |
| Interest expense, net | | | 3 | | 10 | | 15 | | 18 | | 26 | |
| Other income | | | (14 | ) | (6 | ) | — | | — | | (3 | ) |
| Income from continuing operations | | | 247 | | 263 | | 255 | | 209 | | 162 | |
| Cumulative effect of accounting change(3) | | | 1 | | — | | — | | (1 | ) | — | |
| Basic earnings per share from continuing operations | | | 1.59 | | 1.70 | | 1.69 | | 1.47 | | 1.15 | |
| Basic earnings per share from cumulative effect of accounting change | | | 0.01 | | — | | — | | — | | — | |
| Diluted earnings per share from continuing operations | | | 1.58 | | 1.67 | | 1.64 | | 1.40 | | 1.10 | |
| Diluted earnings per share from cumulative effect of accounting change | | | — | | — | | — | | — | | — | |
| Common stock dividends declared | | | 0.40 | | 0.32 | | 0.26 | | 0.15 | | 0.03 | |
| Weighted-average common shares outstanding (in millions) | | | 155.0 | | 155.1 | | 150.9 | | 141.6 | | 140.7 | |
| Weighted-average common shares outstanding assuming dilution (in millions) | | | 156.8 | | 157.6 | | 157.1 | | 152.9 | | 150.8 | |
| Financial Condition | | | | | | | | | | | | |
| Cash, cash equivalents and short-term investments | | $ | 470 | | 587 | | 492 | | 448 | | 357 | |
| Merchandise inventories | | | 1,303 | | 1,254 | | 1,151 | | 920 | | 835 | |
| Property and equipment, net(4) | | | 654 | | 675 | | 715 | | 668 | | 664 | |
| Total assets(4) | | | 3,249 | | 3,312 | | 3,237 | | 2,713 | | 2,514 | |
| Short-term debt | | | — | | — | | — | | — | | — | |
| Long-term debt and obligations under capital leases | | | 234 | | 326 | | 365 | | 335 | | 357 | |
| Total shareholders’ equity | | | 2,295 | | 2,027 | | 1,830 | | 1,375 | | 1,110 | |
| Financial Ratios | | | | | | | | | | | | |
| Return on equity (ROE) | | | 11.5 | % | 13.6 | | 15.9 | | 16.8 | | 15.4 | |
| Operating profit margin | | | 6.8 | % | 7.2 | | 7.3 | | 7.2 | | 6.0 | |
| Income from continuing operations as a percentage of sales | | | 4.3 | % | 4.7 | | 4.8 | | 4.4 | | 3.6 | |
| Net debt capitalization percent(5) | | | 44.4 | % | 45.2 | | 50.4 | | 53.3 | | 58.6 | |
| Net debt capitalization percent (without present value of operating leases)(5) | | | — | | — | | — | | — | | — | |
| Current ratio | | | 3.9 | | 2.8 | | 2.7 | | 2.8 | | 2.2 | |
| Other Data | | | | | | | | | | | | |
| Capital expenditures | | $ | 165 | | 155 | | 156 | | 144 | | 150 | |
| Number of stores at year end | | | 3,942 | | 3,921 | | 3,967 | | 3,610 | | 3,625 | |
| Total selling square footage at year end (in millions) | | | 8.74 | | 8.71 | | 8.89 | | 7.92 | | 8.04 | |
| Total gross square footage at year end (in millions) | | | 14.55 | | 14.48 | | 14.78 | | 13.14 | | 13.22 | |
____________________
(1) | 2006 represents the 53 weeks ended February 3, 2007. |
|
(2) | Gross margin and depreciation expense include the effects of the reclassification of tenant allowances as deferred credits, which are amortized as a reduction of rent expense as a component of costs of sales. Gross margin was reduced by $5 million in 2004 and 2003 and $4 million in 2002 and accordingly, depreciation expense was increased by the corresponding amount. |
|
(3) | 2006 relates to the adoption of SFAS No. 123(R), “Share-Based Payment.” 2003 relates to adoption of SFAS No. 143, “Accounting for Asset Retirement Obligations.” |
|
(4) | Property and equipment, net and total assets include the reclassification of tenant allowances as deferred credits, which were previously recorded as a reduction to the cost of property and equipment, and are now classified as part of the deferred rent liability. Property and equipment, net and total assets were increased by $22 million in 2004, $24 million in 2003 and $28 million in 2002. |
| |
(5) Item 10. | Represents total debt, net of cash, cash equivalentsDirectors, Executive Officers and short-term investments and includes the effect of interest rate swaps of $4 million and $1 million that decreased long-term debt at February 3, 2007 and January 28, 2006, respectively, $4 million that increased long-term debt at January 29, 2005 and $1 million that reduced long-term debt at January 31, 2004.Corporate Governance |
62
Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure
There were no disagreements between the Company and its independent registered public accounting firm on matters of accounting principles or practices.
Item 9A. Controls and Procedures
(a) | Evaluation of Disclosure Controls and Procedures. |
|
| The Company’s management performed an evaluation under the supervision and with the participation of the Company’s Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), and completed an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as that term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of February 3, 2007. Based on that evaluation, the Company’s CEO and CFO concluded that the Company’s disclosure controls and procedures were effective as of February 3, 2007 in alerting them in a timely manner to all material information required to be disclosed in this report. |
|
(b) | Management’s Annual Report on Internal Control over Financial Reporting. |
|
| The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting (as that term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f)). To evaluate the effectiveness of the Company’s internal control over financial reporting, the Company uses the framework in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO Framework”). Using the COSO Framework, the Company’s management, including the CEO and CFO, evaluated the Company’s internal control over financial reporting and concluded that the Company’s internal control over financial reporting was effective as of February 3, 2007. KPMG LLP, the independent registered public accounting firm that audits the Company’s consolidated financial statements included in this annual report, has issued an attestation report on the Company’s assessment of and effectiveness of internal control over financial reporting, which is included herein under the caption “Management’s Report on Internal Control over Financial Reporting” in “Item 8. Consolidated Financial Statements and Supplementary Data.” |
|
(c) | Attestation Report of the Independent Registered Public Accounting Firm. |
|
| KPMG's attestation report on management's assessment and the effectiveness of our internal control over financial reporting is included in "Item 8. Consolidated Financial Statements and Supplementary Data." |
| |
(d) | Changes in Internal Control over Financial Reporting. |
|
| During the Company’s last fiscal quarter there were no changes in internal control over financial reporting that materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
|
Item 9B. Other Information
None.
63
PART III
Item 10 Directors, Executive Officers and Corporate Governance
| (a) | Directors of the Company |
|
Information relative to directors of the Company is set forth under the section captioned “Proposal 1-Election of Directors” in the Proxy Statement and is incorporated herein by reference.
| | Information relative to directors of the Company is set forth under the section captioned “Election of Directors” in the Proxy Statement and is incorporated herein by reference. |
|
| (b) | Executive Officers of the Company |
Information with respect to executive officers of the Company is set forth immediately following Item 4 in Part I.
|
| | Information with respect to executive officers of the Company is set forth immediately following Item 4 in Part I. |
|
| (c) | Information with respect to compliance with Section 16(a) of the Securities Exchange Act of 1934 is set forth under the section captioned “Section 16(a) Beneficial Ownership Reporting Compliance” in the Proxy Statement and is incorporated herein by reference. |
|
| (d) | Information on our audit committee and the audit committee financial expert is contained in the Proxy Statement under the section captioned “Committees of the Board of Directors” and is incorporated herein by reference. |
|
| (e) | Information about the Code of Business Conduct governing our employees, including our Chief Executive Officer, Chief Financial Officer, Chief Accounting Officer, and the Board of Directors, is set forth under the heading “Code of Business Conduct” under the Corporate Governance Information section of the Proxy Statement and is incorporated herein by reference. |
| Item 11. | Executive Compensation |
Item 11. Executive Compensation
Information set forth in the Proxy Statement beginning with the section captioned “Directors Compensation and Benefits” through and including the section captioned “Pension Benefits” is incorporated herein by reference, and information set forth in the Proxy Statement under the heading "Compensation Comittee“Compensation Committee Interlocks and Insider Participation"Participation” is incorporated herein by reference.
| Item 12. | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters |
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Information set forth in the Proxy Statement under the sections captioned “Equity Compensation Plan Information” and “Beneficial Ownership of the Company’s Stock” is incorporated herein by reference.
| Item 13. | Certain Relationships and Related Transactions, and Director Independence |
Item 13. Certain Relationships and Related Transactions, and Director Independence
Information set forth in the Proxy Statement under the section captioned “Related Person Transactions” and under the section captioned "Independence"“Directors’ Independence” is incorporated herein by reference.
| Item 14. | Principal Accountant Fees and Services |
Item 14. Principal Accountant Fees and Services
Information about the principal accountant fees and services is set forth under the section captioned “Audit and Non-Audit Fees” in the Proxy Statement and is incorporated herein by reference. Information about the Audit Committee’s pre-approval policies and procedures is set forth in the section captioned “Audit Committee Pre-Approval Policies and Procedures” in the Proxy Statement and is incorporated herein by reference.
64TABLE OF CONTENTS
PART IV
| Item 15. | Exhibits and Financial Statement Schedules |
Item 15. Exhibits and Financial Statement Schedules
(a)(1)(a)(2) Financial Statements
The list of financial statements required by this item is set forth in Item 8. “Consolidated Financial Statements and Supplementary Data.”
(a)(3) and (c) Exhibits
An index of the exhibits which are required by this item and which are included or incorporated herein by reference in this report appears on pages 6770 through 70.73. The exhibits filed with this report immediately follow the index.
65TABLE OF CONTENTS
SIGNATURES
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
| FOOT LOCKER, INC.
|
|  |
| By: |
| |
| Matthew D. Serra FOOT LOCKER, INC. |
| | By:
Ken C. Hicks
Chairman of the Board, President and |
|
Chief Executive Officer |
| |
| |
| Date: April 2, 2007 March 29, 2010 |
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on April 2, 2007,March 29, 2010, by the following persons on behalf of the Company and in the capacities indicated.
 | |  |
Matthew D. Serra
Ken C. Hicks
Chairman of the Board,
President and
Chief Executive Officer | | 
Robert W. McHugh
Senior Vice President and
Chief Financial Officer |
|
/s/ GIOVANNA CIPRIANO | | /s/ MATTHEW M. MCKENNA |
Giovanna Cipriano
Executive Vice President and
Chief Financial Officer |
/s/ GIOVANNA CIPRIANO
Giovanna Cipriano
Senior Vice President and Chief Accounting Officer | | /s/ JAMES E. PRESTON
James E. Preston
Director |
/s/ NICHOLAS DIPAOLO
Nicholas DiPaolo
Director | | /s/ DAVID Y. SCHWARTZ
David Y. Schwartz
Director |
/s/ ALAN D. FELDMAN
Alan D. Feldman
Director | | /s/ CHERYL NIDO TURPIN
Cheryl Nido Turpin
Director |
/s/ JAROBIN GILBERT JR.
Jarobin Gilbert Jr.
Director | | /s/ DONA D. YOUNG
Dona D. Young
Director |
/s/ MATTHEW M. MCKENNA
Matthew M. McKenna
Director |
| | |
| | |
/s/ PURDY CRAWFORD | | /s/ JAMES E. PRESTON |
Purdy Crawford
Director | | James E. Preston
Director |
|
/s/ NICHOLAS DIPAOLO | | /s/ DAVID Y. SCHWARTZ |
Nicholas DiPaolo
Director | | David Y. Schwartz
Director |
|
/s/ ALAN D. FELDMAN | | /s/ CHRISTOPHER A. SINCLAIR |
Alan D. Feldman
Director | | Christopher A. Sinclair
Director |
|
/s/ PHILIP H. GEIER JR. | | /s/ CHERYL NIDO TURPIN |
Philip H. Geier Jr.
Director | | Cheryl Nido Turpin
Director |
| | |
/s/ JAROBIN GILBERT JR. | | /s/ DONA D. YOUNG |
Jarobin Gilbert Jr.
Director | | Dona D. Young
Director |
66TABLE OF CONTENTS
FOOT LOCKER, INC.
INDEX OF EXHIBITS REQUIRED
BY ITEM 15 OF FORM 10-K
AND FURNISHED IN ACCORDANCE
WITH ITEM 601 OF REGULATION S-K
| | |
Exhibit No.
in Item 601 of
Regulation S-K | | Description |
| 3(i)(a) | | Certificate of Incorporation of the Registrant, as filed by the Department of State of the State of New York on April 7, 1989 (incorporated herein by reference to Exhibit 3(i)(a) to the Quarterly Report on Form 10-Q for the quarterly period ended July 26, 1997, filed by the Registrant with the SEC on September 4, 1997 (the “July 26, 1997 Form 10-Q”)). |
| | |
| 3(i)(b) | | Certificates of Amendment of the Certificate of Incorporation of the Registrant, as filed by the Department of State of the State of New York on (a) July 20, 1989, (b) July 24, 1990, (c) July 9, 1997 (incorporated herein by reference to Exhibit 3(i)(b) to the July 26, 1997 Form 10-Q), (d) June 11, 1998 (incorporated herein by reference to Exhibit 4.2(a) of the Registration Statement on Form S-8 (Registration No. 333-62425), and (e) November 1, 2001 (incorporated herein by reference to Exhibit 4.2 to the Registration Statement on Form S-8 (Registration No. 333-74688) previously filed by the Registrant with the SEC). |
| | |
| 3(ii) | | By-laws of the Registrant, as amended (incorporated herein by reference to Exhibit 10.13.1 to the QuarterlyRegistrant’s Current Report on Form 10-Q for the quarterly period ended8-K dated May 5, 2001 (the “May 5, 2001 Form 10-Q”),20, 2009 filed by the Registrant with the SEC on June 13, 2001)May 27, 2009). |
| | |
| 4.1 | | The rights of holders of the Registrant’s equity securities are defined in the Registrant’s Certificate of Incorporation, as amended (incorporated herein by reference to (a) Exhibits 3(i)(a) and 3(i)(b) to the July 26, 1997 Form 10-Q, Exhibit 4.2(a) to the Registration Statement on Form S-8 (Registration No. 333-62425) previously filed by the Registrant with the SEC, and Exhibit 4.2 to the Registration Statement on Form S-8 (Registration No. 333-74688) previously filed by the Registrant with the SEC). |
| 4.2 | |
4.2 | | Indenture dated as of October 10, 1991 (incorporated herein by reference to Exhibit 4.1 to the Registration Statement on Form S-3 (Registration No. 33-43334) previously filed by the Registrant with the SEC). |
| 4.3 | |
4.3 | | Form of 8-1/2% Debentures due 2022 (incorporated herein by reference to Exhibit 4 to the Registrant’s Form 8-K dated January 16, 1992). |
| 10.1 | |
10.1 | | 1986 Foot Locker 1995 Stock Option and Award Plan (incorporated herein by reference to Exhibit 10(b)10(p) to the Registrant’s Annual Report on Form 10-K for the year ended January 28, 1995 filed by the Registrant with the SEC on April 24, 1995 (the “1994 Form 10-K”)). |
| 10.2 | |
10.2 | | Amendment to the 1986 Foot Locker Stock Option Plan (incorporated herein by reference to Exhibit 10(a) to the Registrant’s Annual Report on Form 10-K for the year ended January 27, 1996, filed by the Registrant with the SEC on April 26, 1996 (the “1995 Form 10-K”)). |
| | |
10.3 | | Foot Locker 1995 Stock Option and Award Plan (incorporated herein by reference to Exhibit 10(p) to the 1994 Form 10-K). |
| | |
10.4 | | Foot Locker 1998 Stock Option and Award Plan (incorporated herein by reference to Exhibit 10.4 to the Registrant’s Annual Report on Form 10-K for the year ended January 31, 1998, filed by the Registrant with the SEC on April 21, 1998). |
| 10.3 | |
10.5 | | Amendment to the Foot Locker 1998 Stock Option and Award Plan (incorporated herein by reference to Exhibit 10.2 to the Registrant’s Quarterly Report on Form 10-Q for the period ended July 29, 2000, filed by the Registrant with the SEC on September 7, 2000 (the “July 29, 2000 Form 10-Q”)). |
| 10.4 | |
10.6 | | Executive Supplemental Retirement Plan (incorporated herein by reference to Exhibit 10(d) to the Registration Statement on Form 8-B filed by the Registrant with the SEC on August 7, 1989 (Registration No. 1-10299) (the “8-B Registration Statement”)). |
67
Exhibit No.
in Item 601 of
Regulation S-K10.5 | | Description |
10.7 | | Amendment to the Executive Supplemental Retirement Plan (incorporated herein by reference to Exhibit 10(c)(i) to the 1994 Form 10-K ).10-K). |
| | |
| Exhibit No.
in Item 601 of
Regulation S-K | | Description |
10.810.6 | | Amendment to the Executive Supplemental Retirement Plan (incorporated herein by reference to Exhibit 10(d)(ii) to the 1995Annual Report on Form 10-K)10-K for the year ended January 27, 1996, filed by the Registrant with the SEC on April 26, 1996 (the “1995 Form 10-K”)). |
| 10.7 | |
10.9 | | Supplemental Executive Retirement Plan, as amendedAmended and Restated (incorporated herein by reference to Exhibit 10.1 to the Current Report on Form 8-K dated August 21, 200613, 2007 filed by the Registrant with the SEC on August 25, 2006)17, 2007). |
| 10.8 | | |
10.10 | | Long-Term Incentive Compensation Plan, as amended and restated (incorporated herein by reference to Exhibit 10(f)10.8 to the 1995 Form 10-K). |
| | |
10.11 | | Annual Incentive Compensation Plan, as amended (incorporated herein by reference to Exhibit 10.3 to the Quarterly Report on Form 10-Q10-K for the quarterly periodyear ended August 2, 2003January 31, 2009, filed by the Registrant with the SEC on September 15, 2003March 30, 2009 (the “August 2, 2003“2008 Form 10-Q”10-K”)). |
| 10.9 | | Annual Incentive Compensation Plan, as amended and restated (incorporated herein by reference to Exhibit 10.1 to the Current Report on Form 8-K dated March 26, 2008 filed by the Registrant on April 1, 2008). |
10.1210.10 | | Form of indemnification agreement, as amended (incorporated herein by reference to Exhibit 10(g) to the 8-B Registration Statement). |
| 10.11 | |
10.13 | | Amendment to form of indemnification agreement (incorporated herein by reference to Exhibit 10.5 to the Quarterly Report on Form 10-Q for the quarterly period ended May 5, 2001 filed by the Registrant with the SEC on June 13, 2001 (the “May 5, 2001 Form 10-Q”)). |
| 10.12 | |
10.14 | | Foot Locker Voluntary Deferred Compensation Plan (incorporated herein by reference to Exhibit 10(i) to the 1995 Form 10-K). |
| | |
10.15 | | Foot Locker Directors Stock Option Plan (incorporated herein by reference to Exhibit 10.1 to the July 29, 2000 Form 10-Q). |
| 10.13 | |
10.16 | | Trust Agreement dated as of November 12, 1987 (“Trust Agreement”), between F.W. Woolworth Co. and The Bank of New York, as amended and assumed by the Registrant (incorporated herein by reference to Exhibit 10(j) to the 8-B Registration Statement). |
| 10.14 | |
10.17 | | Amendment to Trust Agreement made as of April 11, 2001 (incorporated herein by reference to Exhibit 10.4 to May 5, 2001 Form 10-Q). |
| 10.15 | |
10.18 | | Foot Locker Directors’ Retirement Plan, as amended (incorporated herein by reference to Exhibit 10(k) to the 8-B Registration Statement). |
| 10.16 | |
10.19 | | Amendments to the Foot Locker Directors’ Retirement Plan (incorporated herein by reference to Exhibit 10(c) to the Registrant’s Quarterly Report on Form 10-Q for the period ended October 28, 1995, filed by the Registrant with the SEC on December 11, 1995). |
| 10.17 | |
10.20 | | Employment Agreement with Matthew D. Serra dated as of October 5, 2006December 12, 2008 (incorporated herein by reference to Exhibit 10.1 to the Current Report on Form 8-K dated October 5, 2006December 12, 2008 filed by the Registrant with the SEC on October 10, 2006December 18, 2008 (the “October 10, 2006“December 12, 2008 Form 8-K”)). |
| 10.18 | | Amendment to Employment Agreement with Matthew D. Serra dated June 25, 2009 (incorporated herein by reference to Exhibit 10.1 to the Current Report on Form 8-K dated June 24, 2009 filed by the Registrant with the SEC on June 26, 2009 (the “June 26, 2009 Form 8-K”)). |
| 10.19 | | Employment Agreement with Ken C. Hicks dated June 25, 2009 (incorporated herein by reference to Exhibit 10.2 to the June 26, 2009 Form 8-K). |
| 10.20 | | Employment Agreement with Ronald J. Halls dated June 30, 2009 (incorporated herein by reference to Exhibit 10.1 to the Current Report on Form 8-K dated June 30, 2009 filed by the Registrant with the SEC on July 1, 2009). |
| | |
Exhibit No.
in Item 601 of
Regulation S-K | | Description |
| 10.21 | | Amendment of Restricted Stock Agreement for Matthew D. Serra dated October 6, 2006 (incorporated herein by reference to Exhibit 10.2 to the October 10, 2006 Form 8-K). |
| | |
| 10.22 | | Amendments to the Credit Agreement (incorporated herein by reference to Exhibits 10.1 to the Current Reports on Form 8-K dated (i) November 13, 2006 filed by the Registrant with the SEC on November 17, 2006, and (ii) March 7, 2007 filed by the Registrant with the SEC on March 12, 2007). |
68
Exhibit No.
in Item 601 of
Regulation S-K | | Description |
10.23 | | Restricted Stock Agreement with Matthew D. Serra dated as of February 9, 2005 (incorporated herein by reference to Exhibit 10.2 to the February 9, 2005 Form 8-K). |
| 10.23 | |
10.24 | | Foot Locker Executive Severance Pay Plan (incorporated herein by reference to Exhibit 10.1 to the Registrant’s Quarterly Report on Form 10-Q for the period ended October 31, 1998 (the “October 31, 1998). |
| | |
10.25 | | Form of Senior Executive Employment Agreement (incorporated herein by reference to Exhibit 10.2310.2 to the Registrant’s Annual Report onDecember 12, 2008 Form 10-K for the year ended January 29, 2000 filed by the Registrant with the SEC on April 21, 2000 (the “1999 Form 10-K”))8-K). |
| 10.24 | |
10.26 | | Form of Executive Employment Agreement (incorporated herein by reference to Exhibit 10.2410.21 to the 19992008 Form 10-K). |
| 10.25 | |
10.27 | | Foot Locker, Inc. Excess Cash Balance Plan (incorporated herein by reference to Exhibit 10(c)10.22 to the 19952008 Form 10-K). |
| 10.26 | |
10.28 | | Form of Restricted Stock Agreement (incorporated herein by reference to Exhibit 10.30 to the Registrant’s Annual Report on Form 10-K for the year ended January 30, 1999 filed by the Registrant on April 30, 1999 (the “1998 Form 10-K”)). |
| | |
10.29 | | Fifth Amended and Restated Credit Agreement dated as of April 9, 1997, amended and restated as of May 19, 2004 (“Credit Agreement”) (incorporated herein by reference to Exhibit 10.1 to the Quarterly Report on Form 10-Q for the period ended July 31, 2004, filed by the Registrant with the SEC on September 8, 2004). |
| | |
10.30 | | Amendment No. 1 to the Credit Agreement (incorporated herein by reference to Exhibit 10.1 to the Form 8-K filed by the Registrant on May 18, 2005). |
| 10.27 | |
10.31 | | Letter of Credit Agreement dated as of March 19, 1999 (incorporated herein by reference to Exhibit 10.35 to the 1998 Form 10-K). |
| | |
10.32 | | Foot Locker 2002 Directors Stock Plan as amended (incorporated herein by reference to Exhibit 10.110.24 to the Current Report on2008 Form 8-K dated February 16, 2005, filed by the Registrant with the SEC on February 18, 2005)10-K). |
| 10.28 | | |
10.33 | | Foot Locker 2003 Stock Option and Award Plan (incorporated herein by reference to Exhibit 10.2 to the Quarterly Report on Form 10-Q for the quarterly period ended August 2, 2003 Form 10-Q)filed by the Registrant with the SEC on September 15, 2003). |
| 10.29 | | |
10.34 | | Automobile Expense Reimbursement Program for Senior Executives (incorporated herein by reference to Exhibit 10.3610.26 to the Annual Report on2008 Form 10-K for the year ended January 29, 2005 filed by the Registrant on March 29, 2005 (the “2004 Form 10-K”)10-K). |
| 10.30 | | |
10.35 | | Executive Medical Expense Allowance Program for Senior Executives (incorporated herein by reference to Exhibit 10.3710.27 to the 20042008 Form 10-K). |
| 10.31 | |
10.36 | | Financial Planning Allowance Program for Senior Executives (incorporated herein by reference to Exhibit 10.3810.28 to the 20042008 Form 10-K). |
| 10.32 | |
10.37 | | Form of Nonstatutory Stock Option Award Agreement for Executive Officers (incorporated herein by reference to Exhibit 10.40 to the Annual Report on Form 10-K for the year ended January 28, 2006 filed by the Registrant with the SEC on March 27, 2006 (the “2005 Form 10-K”)). |
| 10.33 | | |
10.38 | | Form of Incentive Stock Option Award Agreement for Executive Officers (incorporated herein by reference to Exhibit 10.41 to the 2005 Form 10-K). |
| 10.34 | | |
10.39 | | Form of Nonstatutory Stock Option Award Agreement for Non-employee Directors (incorporated herein by reference to Exhibit 10.2 to the July 31, 2004 Form 10-Q). |
| 10.35 | |
10.40 | | Long-termLong-Term Disability Program for Senior Executives (incorporated herein by reference to Exhibit 10.4210.32 to the 20042008 Form 10-K). |
| 10.36 | | Foot Locker 2007 Stock Incentive Plan (incorporated herein by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K dated May 30, 2007 filed by the Registrant with the SEC on June 5, 2007). |
| 10.37 | | Credit Agreement dated as of March 20, 2009 (incorporated herein by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K/A dated March 20, 2009 filed by the Registrant with the SEC on December 7, 2009). |
69TABLE OF CONTENTS
| | |
Exhibit No.
in Item 601 of
Regulation S-K | | Description |
| 10.38 | | Guaranty dated as of March 20, 2009 (incorporated herein by reference to Exhibit 10.2 to the Registrant’s Current Report on Form 8-K dated March 20, 2009 filed by the Registrant with the SEC on March 24, 2009). |
| 10.39 | | Security Agreement dated as of March 20, 2009 (incorporated herein by reference to Exhibit 10.3 to the Registrant’s Current Report on Form 8-K dated March 20, 2009 filed by the Registrant with the SEC on March 24, 2009 and Exhibit 10.3 to the Current Report on Form 8-K/A filed by the Registrant with the SEC on May 21, 2009). |
| 10.40 | | Ken C. Hicks bonus waiver letter (incorporated herein by reference to the Current Report on Form 8-K filed by the Registrant with the SEC on March 29, 2010). |
| 12 | | Computation of Ratio of Earnings to Fixed Charges. |
| | |
18 | | Letter on Change in Accounting Principle (incorporated herein by reference to Exhibit 18 to the 1999 Form 10-K). |
| | * |
| 21 | | Subsidiaries of the Registrant. |
| | * |
| 23 | | Consent of Independent Registered Public Accounting Firm. |
| | * |
| 31.1 | | Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| | * |
| 31.2 | | Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| | * |
| 32 | | Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.* |
70
Exhibits filed with this Form 10-K:
Exhibit No.
in Item 601 of
Regulation S-K | * | Description |
12 | | Computation of Ratio of Earnings to Fixed Charges. |
| | |
21 | | Subsidiaries of the Registrant. |
| | |
23 | | Consent of Independent Registered Public Accounting Firm. |
| | |
31.1 | | Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| | |
31.2 | | Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| | |
32 | | Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.Exhibits filed with this Form 10-K |
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