Direct-to-Customers sales decreased by 4.0 percent to $72 million and by 3.0 percent to $162 million for the thirteen and twenty-six weeks ended August 4, 2007, respectively, as compared with the corresponding prior-year periods. Internet sales increased by 5.6 percent to $57 million and by 6.7 percent to $127 million for the thirteen and twenty-six weeks ended August 4, 2007, respectively, as compared with the corresponding prior-year period. Increases in Internet sales were offset by a decline in catalog sales, reflecting the continuing trend of the Company’s customers to browse and select products through its catalogs, then make their purchases via the Internet. Additionally, sales for the twenty-six weeks ended August 4, 2007 were negatively affected by the termination of a third party arrangement at the end of the first quarter of 2006.
Direct-to-Customers division profit decreased 14.3 percent and 10.5 percent for thirteen and twenty-six weeks ended August 4, 2007, respectively, as compared with the corresponding prior-year periods. Division profit, as a percentage of sales, decreased to 8.3 percent and 10.5 percent for the thirteen and twenty-six weeks ended August 4, 2007, respectively, as compared to 9.3 percent and 11.4 percent, respectively, in the corresponding prior-year periods.
During the first quarter of 2007, the Company launched a new family footwear concept, Footquarters. Sales and division results were not significant for the thirteen and twenty-six weeks ended August 4, 2007. The concept’s results did not meet the Company’s expectations and, therefore, the Company decided not to further invest in this business. Subsequent to the close of the second quarter, the Company converted these stores to Foot Locker and Champs Sports outlet stores. A charge of $1.8 million was recorded in the second quarter, which primarily represented costs associated with the removal of signage and the write-off of unusable fixtures.
Corporate expense consists of unallocated general and administrative expenses as well as depreciation and amortization related to the Company’s corporate headquarters, centrally managed departments, unallocated insurance and benefit programs, certain foreign exchange transaction gains and losses, and other items. Corporate expense was $17 million for the thirteen weeks ended August 4, 2007, an increase of $3 million as compared with the corresponding prior-year period. During the second quarter of 2007, the Company identified an under accrual related to employee vacation entitlements. The accrual was understated by $1 million ($0.6 million after-tax); accordingly, a charge was recorded to reflect the liability as of August 4, 2007. This under accrual was not material to the Company’s consolidated statement of operations or cash flows for this period or any of the earlier reported periods. Additionally, the second quarter of 2006 reflected reduced incentive compensation expense of $3 million, as well as a charge for an anticipated legal settlement of $2 million. Corporate expense for the twenty-six weeks ended August 4, 2007 increased by $1 million to $33 million from the same period in the prior year.
Selling, general and administrative expenses (“SG&A”) of $286 million increased by $13 million, or 4.8 percent, in the second quarter of 2007 as compared with the corresponding prior-year period. SG&A of $576 million increased by $20 million, or 3.6 percent, in the first half of 2007 as compared with the corresponding prior-year period. SG&A, as a percentage of sales increased to 22.3 percent for the thirteen weeks ended August 4, 2007 as compared with 21.0 percent in the corresponding prior-year period. SG&A, as a percentage of sales increased to 22.2 percent for the twenty-six weeks ended August 4, 2007 as compared with 20.8 percent in the corresponding prior-year period. The increases in SG&A as a percentage of sales are due, in large part, to the decline in sales during the current year coupled with the increase in corporate expense, both as discussed above. Excluding the effect of foreign currency fluctuations, SG&A increased $9 million and $10 million for the thirteen and twenty-six weeks ended August 4, 2007, respectively, as compared with the corresponding prior-year periods.
Depreciation and amortization remained essentially unchanged for the thirteen and twenty-six weeks ended August 4, 2007 as compared with the corresponding prior-year period.
Interest Expense
Interest expense was $5 million and $6 million for the thirteen week periods ended August 4, 2007 and July 29, 2006, respectively. Interest expense was $10 million and $11 million for the twenty-six week periods ended August 4, 2007 and July 29, 2006, respectively. The reduction in interest expense relates primarily to the $38 million purchase and retirement in 2006 of the Company’s 8.5 percent debentures. Interest income was $5 million for the thirteen weeks ended August 4, 2007 and July 29, 2006, respectively. Interest income increased to $10 million from $9 million for the twenty-six weeks ended August 4, 2007 and July 29 2006, respectively. The increase in interest income is primarily the result of higher average interest rates on cash, cash equivalents, and short-term investments, coupled with an increase in the average short-term investment balance.
Income Taxes
The Company’s effective tax rate for the thirteen and twenty-six weeks ended August 4, 2007 was 38.4 percent and 71.6 percent as compared with 44.2 percent and 38.4 percent for the corresponding prior-year periods. The difference in the second quarter rate is primarily due to the proportion of the U.S. loss to the total loss for the quarter, offset in part by the effect of a change in the German statutory tax rates. The 2007 year-to-date effective rate is distorted by the fact that the first quarter represented income whereas the second quarter was a loss of essentially the same amount. The Company expects its effective rate to approximate 35 percent for the remaining quarters of 2007, as well as for the full year. The actual rate will depend in significant part on the proportion of the Company’s worldwide income that is earned in the U.S.
Net Income (Loss)
For the thirteen weeks ended August 4, 2007, the Company reported a net loss $18 million, or $0.12 per diluted share. This compares to net income of $14 million or $0.09 per diluted share for the corresponding prior-year period. The decline is a result of lower sales due to the continued challenging athletic retail environment and approximately $50 million in additional markdowns recorded to liquidate slow-moving merchandise. Included in the thirteen weeks ended July 29, 2006 is a non-cash impairment charge of $17 million ($12 million after-tax) or $0.08 per share, to write-down the value of long-lived assets of underperforming stores in the Company’s European operations. For the twenty-six weeks ended August 4, 2007, the Company reported a net loss of $1 million, or $0.01 per diluted share, a decrease of $0.48 per diluted share from $73 million, or $0.47 per diluted share, for the twenty-six weeks ended July 29, 2006. The twenty-six weeks ended July 29, 2006 reflects a benefit of $1 million, or $0.01 per diluted share, from a cumulative effect of accounting change related to the required adoption of SFAS No. 123 (R).
LIQUIDITY AND CAPITAL RESOURCES
Generally, the Company’s primary sources of cash have been from operations. The Company generally finances real estate with operating leases. The principal uses of cash have been to finance inventory requirements, capital expenditures related to store openings, store remodelings, and management information systems, and to fund other general working capital requirements.
Management believes operating cash flows will be adequate to fund its working capital requirements, future pension contributions for the Company’s retirement plans, anticipated quarterly dividend payments, scheduled debt repayments, potential share repurchases, and to support the development of its short-term and long-term operating strategies. Additionally, the Company has a $200 million revolving credit facility. Other than to support standby letter of credit commitments, of which $14 million were in place at August 4, 2007, this revolving credit facility has not been used during 2007. In 2004, the Company obtained a 5-year, $175 million amortizing term loan from the bank group participating in the revolving credit facility, of which $88 million is outstanding as of August 4, 2007. Under the Company’s revolving credit and term loan agreement the Company is required to satisfy certain financial and operating covenants, including a minimum fixed charge coverage ratio. In addition, this agreement restricts the amount the Company may expend in any year for dividends to 50 percent of its prior year’s net income. Based upon the Company's second quarter financial results and business uncertainties for the second half of the year, the Company may not continue to be in compliance with the fixed charge coverage ratio. In addition, the restricted payment provision may prohibit the Company from the payment of the dividend at the current rate in 2008. In the event that the Company does not satisfy one or more of the covenants, the Company will evaluate several options and expects that it would be able to obtain a waiver, amend the agreement, or enter into a new credit facility.
Any materially 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, as well as other factors listed under the heading “Disclosure Regarding Forward-Looking Statements,” could affect the ability of the Company to continue to fund its needs from business operations.
Net cash provided by operating activities was $53 million for the twenty-six weeks ended August 4, 2007 and net cash used in operating activities was $113 million for the twenty-six weeks ended July 29, 2006. These amounts reflect net income adjusted for non-cash items and working capital changes. The Company reported a loss of $1 million for the twenty-six weeks ended August 4, 2007, as compared with a profit of $73 million in the corresponding prior-year period primarily as a result of the liquidation of slow-moving merchandise. While the liquidation negatively affected the results for the period, the Company’s operating cash flows were enhanced by the liquidation activity. The Company believes its inventory levels are well positioned for the back-to-school selling period. Additionally, in the first half of 2007 the Company did not contribute to the U.S. and Canadian qualified pension plans as a contribution was not required. This compares with $68 million contributed in the first half of 2006.
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Net cash provided by investing activities was $7 million for the twenty-six weeks ended August 4, 2007 and was $85 million for the twenty-six weeks ended July 29, 2006. The Company’s sales of short-term investments, net of purchases, provided cash of $90 million as compared with $165 million in the corresponding prior-year period. Planned capital expenditures for 2007 are expected to total $147 million, of which $121 million relates to new store openings and modernizations of existing stores, and $26 million reflects the development of information systems and other support facilities. This amount is $23 million less than was originally planned primarily because the Company will no longer be investing in the Footquarters concept coupled with the reduced number of store modernizations planned for the U.S. formats. The Company has the ability to revise and reschedule its anticipated capital expenditure program in the event that any changes to the Company’s financial position require it.
Net cash used in financing activities for the Company’s operations was $82 million for the twenty-six weeks ended August 4, 2007 and was $77 million for the twenty-six weeks ended July 29, 2006. During the second quarters of 2007 and 2006, the Company made payments of $2 million and $50 million, respectively, related to its 5-year term loan. The Company recorded an excess tax benefit related to stock-based compensation of $1 million and $2 million for the twenty-six weeks ended August 4, 2007 and July 29, 2006, respectively. The Company declared and paid a $0.125 per share dividend during the first and second quarters of 2007 totaling $39 million, as compared with a $0.09 per share dividend during the first and second quarters of 2006, which totaled $28 million. The Company received proceeds from the issuance of common stock in connection with employee stock programs of $8 million and $7 million for the twenty-six weeks ended August 4, 2007 and July 29, 2006, respectively. In the first quarter of 2007, the Company announced that the Board of Directors authorized a new $300 million, three-year repurchase program replacing a prior $150 million program. As part of the new authorized repurchase program, the Company purchased 2,283,254 shares of its common stock during the twenty-six weeks ended August 4, 2007 for approximately $50 million. The Company purchased 334,200 shares of its common stock during the twenty-six weeks ended July 29, 2006 for approximately $8 million. Under the current 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.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
There have been no significant changes to the Company’s critical accounting policies and estimates from the information provided in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” included in the Annual Report on Form 10-K for the fiscal year ended February 3, 2007, except for the following.
Income Taxes
The Company accounts for uncertain tax positions in accordance with FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes" ("FIN 48"). 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 that FIN 48 may, over time, create more volatility in the effective tax rate from quarter to quarter because we are required each quarter to determine whether new information changes our assessment of both the probability that a tax position will effectively be sustained and the appropriateness of the amount of recognized benefit.
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, 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), unseasonable weather, economic conditions worldwide, 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 its business plans effectively with regard to each of its business units, 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 4. 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 as of August 4, 2007 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”)). 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’s rules and forms, and is accumulated and communicated to management, including the CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.
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During the quarter ended August 4, 2007, there were no changes in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) of the Exchange Act) that materially affected or are reasonably likely to affect the Company’s internal control over financial reporting.
PART II - OTHER INFORMATION
Item 1. 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. 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 and federal wage and hour laws, including allegations concerning classification of employees as exempt or nonexempt, unpaid overtime, meal and rest breaks, and uniforms. 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.
Item 1A. Risk Factors
There were no material changes to the risk factors disclosed in the 2006 Annual Report on Form 10-K.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
This table provides information with respect to purchases by the Company of shares of its Common Stock during the second quarter of 2007:
| | | | | | | Total Number of | | Approximate Dollar | |
| | Total | | | | | Shares Purchased | | Value of Shares that | |
| | Number of | | Average | | as Part of Publicly | | May Yet be | |
| | Shares | | Price Paid per | | Announced | | Purchased Under the | |
| | Purchased(1) | | Share | | Program | | Program (1) | |
| May 6, 2007 through June 2, 2007 | — | | | — | | — | | $ | 274,328,977 | |
| June 3, 2007 through July 7, 2007 | 1,109,543 | | $ | 21.6330 | | 1,109,543 | | $ | 250,326,223 | |
| July 8, 2007 through August 4, 2007 | — | | | — | | — | | $ | 250,326,223 | |
| Total | 1,109,543 | | $ | 21.6330 | | 1,109,543 | | | | |
| (1) | | On March 7, 2007, the Company announced that the Board of Directors authorized a new $300 million, three-year repurchase program, replacing the $150 million program. This authorization will terminate on January 30, 2010. |
Item 4. Submission of Matters to a Vote of Security Holders
| (a) | | The Company’s annual meeting of shareholders was held on May 30, 2007. There were represented at the meeting, in person or by proxy, 133,051,984 shares of Common Stock, par value $0.01 per share, which represented 85.7 percent of the shares outstanding on April 5, 2007, the record date for the meeting. |
| |
| (b) | | Christopher A. Sinclair was elected as a director in Class II for a one-year term ending at the annual meeting of shareholders in 2008. Each of James E. Preston, Matthew D. Serra, and Dona D. Young was elected as a director in Class I for a three-year term ending at the annual meeting of shareholders of the Company in 2010. All of these individuals previously served as directors of the Company. Nicholas DiPaolo, Alan D. Feldman, Jarobin Gilbert Jr., Matthew M. McKenna, David Y. Schwartz, and Cheryl Nido Turpin, having previously been elected directors of the Company for terms continuing beyond the 2007 annual meeting of shareholders, continue in office as directors of the Company. Purdy Crawford and Philip H. Geier Jr. retired as directors at the conclusion of the annual shareholders’ meeting in accordance with the retirement policy for directors. |
| |
| (c) | | In addition to the election of directors, shareholders ratified the appointment of KPMG as independent accountants and approved the 2007 Stock Plan. The results of the voting were as follows: |
| |
| (1) | | Election of Directors: |
| | | | | | | Abstentions | |
| | | | | | | and | |
| | | | | | | Broker Non- | |
| Name | | Votes For | | Votes Withheld | | Votes | |
| James E. Preston | | 124,557,069 | | 8,494,915 | | 0 | |
| Matthew D. Serra | | 129,150,447 | | 3,901,537 | | 0 | |
| Christopher A. Sinclair | | 129,634,923 | | 3,417,061 | | 0 | |
| Dona D. Young | | 131,039,249 | | 2,012,735 | | 0 | |
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| (2) | | Proposal to ratify the appointment of independent accountants: |
| Votes For | | Votes Against | | Abstentions | | Broker Non-Votes | |
| 132,163,901 | | 810,369 | | 77,714 | | 0 | |
| (3) | | Proposal to approve the 2007 Stock Incentive Plan: |
| Votes For | | Votes Against | | Abstentions | | Broker Non-Votes | |
| 107,859,662 | | 12,412,666 | | 238,863 | | 12,540,793 | |
| Item 6. Exhibits | |
| (a) | | Exhibits | |
| | | The exhibits that are in this report immediately follow the index. |
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SIGNATURE
Pursuant to the requirements 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. |
| Date: September 11, 2007 | (Company) |
| |
| |
| | /s/ Robert W. McHugh |
| | ROBERT W. MCHUGH |
| | Senior Vice President and Chief Financial Officer |
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FOOT LOCKER, INC.
INDEX OF EXHIBITS REQUIRED BY ITEM 6(a) OF FORM 10-Q
AND FURNISHED IN ACCORDANCE WITH ITEM 601 OF REGULATION S-K
| Exhibit No. in | | |
| Item 601 | | Description |
| 12 | | Computation of Ratio of Earnings to Fixed Charges. |
| | | |
| 15 | | Accountant’s Acknowledgment. |
| | | |
| 31.1 | | Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) or 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley act of 2002. |
| | | |
| 31.2 | | Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) or 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley act of 2002. |
| | | |
| 32.1 | | 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. |
| | | |
| 99 | | Report of Independent Registered Public Accounting Firm. |
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