Sales of $1,356 million for the third quarter of 2007 decreased 5.2 percent from sales of $1,430 million for the third quarter of 2006. For the thirty-nine weeks ended November 3, 2007, sales of $3,955 million decreased 3.5 percent from sales of $4,098 million for the thirty-nine week period ended October 28, 2006. Excluding the effect of foreign currency fluctuations, total sales for the thirteen week and thirty-nine week periods decreased 7.4 percent and 5.4 percent, respectively, as compared with the corresponding prior-year periods. Comparable-store sales decreased by 5.0 percent and 5.8 percent, for the thirteen and thirty-nine weeks ended November 3, 2007, respectively.
Gross margin, as a percentage of sales, decreased to 28.1 percent for the thirteen weeks ended November 3, 2007 as compared with 29.5 percent in the corresponding prior-year period. Gross margin, as a percentage of sales, decreased to 26.4 percent for the thirty-nine weeks ended November 3, 2007 as compared with 29.3 percent in the corresponding prior-year period. Lower sales in the thirteen weeks ended November 3, 2007 resulted in the occupancy and buyers’ salary expense rate increasing 150 basis points, as a percentage of sales, while the merchandise rate improved by 10 basis points reflecting fewer promotional markdowns. The year-to-date period of 2007 was negatively affected by incremental markdowns taken to liquidate slow-moving inventory. The effect of vendor allowances, as a percentage of sales, negatively affected gross margin by approximately 50 and 30 basis points for the thirteen and thirty-nine weeks ended November 3, 2007, as compared with the corresponding prior-year period.
Athletic Stores sales decreased by 5.6 percent and 3.7 percent for the thirteen and thirty-nine weeks ended November 3, 2007, respectively, as compared with the corresponding prior-year periods. Excluding the effect of foreign currency fluctuations, primarily related to the euro, sales from athletic store formats decreased 8.0 percent and 5.7 percent for the thirteen and thirty-nine weeks ended November 3, 2007 as compared with the corresponding prior-year periods. The decline in sales for the thirteen and thirty-nine weeks ended November 3, 2007 was primarily related to the domestic operations. Comparable-store sales decreased by 5.4 percent and 6.1 percent, for the thirteen and thirty-nine weeks ended November 3, 2007, respectively. Sales in the U.S. were negatively affected by a continuing weakening in consumer spending, unseasonable warmer weather, and a lack of clear fashion trend in athletic footwear and apparel. Internationally, comparable-store sales declined mid-single digits. In Europe, the sales trend of higher priced technical footwear continued to improve during the third quarter, while sales of low-profile footwear styles declined.
Included in the Athletic Stores division results for the third quarter of 2007 is a non-cash impairment charge of $95 million to write-down long-lived assets such as store fixtures and leasehold improvements for 1,004 stores at the Company’s U.S. store operations pursuant to SFAS No. 144. Additionally in the third quarter of 2007, the Company identified 66 unproductive stores for closure and recorded an additional non-cash impairment charge of $7 million related these stores. Exit costs related to 13 stores which closed during the third quarter of 2007, comprising lease terminations costs of $2 million and $1 million in other non-cash charges, were recognized recorded during the quarter.
Direct-to-Customers sales increased by 1.1 percent to $92 million for the thirteen weeks ended November 3, 2007 and decreased by 1.6 percent to $254 million for the thirty-nine weeks ended November 3, 2007, as compared with the corresponding prior-year periods. Internet sales increased to $70 million and $197 million for the thirteen and thirty-nine weeks ended November 3, 2007, respectively, as compared with $63 million and $182 million for the thirteen and thirty-nine weeks ended October 28, 2006, respectively. Increases in Internet sales were offset, in part, 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 thirty-nine weeks ended November 3, 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 for thirteen and thirty-nine weeks ended November 3, 2007 decreased by $1 million to $8 million and by $3 million to $25 million, respectively, as compared with the corresponding prior-year periods. Division profit, as a percentage of sales, decreased to 8.7 percent and 9.8 percent for the thirteen and thirty-nine weeks ended November 3, 2007, respectively, as compared with 9.9 percent and 10.9 for the corresponding prior-year periods.
Corporate Expense
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 essentially unchanged at $14 million for the thirteen weeks ended November 3, 2007, as compared with the corresponding prior-year period. Corporate expense for the thirty-nine weeks ended November 3, 2007 increased by $1 million to $47 million from the same period in the prior year. Included in the year-to-date period is a correction related to an under accrual for 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.
Selling, General and Administrative
Selling, general and administrative expenses (“SG&A”) of $289 million increased by $5 million, or 1.8 percent, in the third quarter of 2007 as compared with the corresponding prior-year period. SG&A of $865 million increased by $25 million, or 3.0 percent, for the thirty-nine weeks ended November 3, 2007 as compared with the corresponding prior-year period. SG&A, as a percentage of sales, increased to 21.3 percent for the thirteen weeks ended November 3, 2007, as compared with 19.9 percent in the corresponding prior-year period. SG&A as a percentage of sales, increased to 21.9 percent for the thirty-nine weeks ended November 3, 2007 as compared with 20.5 percent in the corresponding prior-year period. The increases in SG&A as a percentage of sales are primarily due to the decline in sales in the current year. Excluding the effect of foreign currency fluctuations, SG&A decreased $4 million and increased by $6 million for the thirteen and thirty-nine weeks ended November 3, 2007, respectively, as compared with the corresponding prior-year periods.
Depreciation and Amortization
Depreciation and amortization increased by $1 million in the third quarter of 2007 to $45 million as compared with $44 million for the third quarter of 2006. Depreciation and amortization increased by $1 million for the thirty-nine weeks ending November 3, 2007 to $132 million as compared with $131 million for the thirty-nine weeks ending November 3, 2007. These increases primarily reflect foreign currency fluctuations, offset in part by reduced software amortization as assets became fully amortized.
Interest Expense
Interest expense was $5 million and $6 million for the thirteen week periods ended November 3, 2007 and October 28, 2006, respectively. Interest expense was $15 million and $17 million for the thirty-nine week periods ended November 3, 2007 and October 28, 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 both the thirteen weeks ended November 3, 2007 and October 28, 2006. Interest income increased to $15 million from $14 million for the thirty-nine weeks ended November 3, 2007 and October 28, 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.
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Income Taxes
The Company’s effective tax rate for the thirteen and thirty-nine weeks ended November 3, 2007 was 41.3 percent and 42.2 percent as compared with 35.5 percent and 37.0 percent for the corresponding prior-year periods. Based upon the level of historical state taxable income and projections for future state taxable income, the Company determined during the third quarter of 2007 that it was necessary to increase the valuation allowance related to its state net operating loss carryforwards by $1.6 million. The difference in the 2007 third quarter rate as compared with the corresponding prior year 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 $1.6 million increase in the state valuation allowance and $0.5 million additional federal employment credits reported on the 2006 federal income tax return.
The Company expects its effective rate to approximate 33 percent for the fourth quarter of 2007. 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 (Loss) Income
For the thirteen weeks ended November 3, 2007, the Company reported a loss from continuing operations of $34 million, or $0.22 per diluted share. This compares to income from continuing operations of $65 million, or $0.42 per diluted share. Included in the thirteen weeks ended November 3, 2007 are charges totaling $105 million, pre-tax, representing asset impairment charges related to the U.S. store divisions and expenses related to the store closing program. The thirteen weeks ended November 3, 2007 reflected lower sales due to the continued challenging athletic retail environment. During the third quarter of 2007, the Company revised its estimates by $1 million, after-tax, for lease liabilities related to the former International General Merchandise segment.
During the first quarter of 2006, the Company adopted SFAS No. 123(R) and recorded a cumulative effect of a change in accounting of approximately $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.
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 remodeling, and management information systems, and to fund 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 November 3, 2007, this revolving credit facility has not been used during 2007. In October 2007, the Company amended its revolving credit agreement to provide for a one-year extension of its revolving credit facility to May 19, 2010, as well as changes to certain financial and operating covenants. The Company is in compliance with all of its covenants as of November 3, 2007.
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 of continuing operations was $63 million for the thirty-nine weeks ended November 3, 2007 and net cash used in operating activities was $74 million for the thirty-nine weeks ended October 28, 2006. These amounts reflect net income adjusted for non-cash items and working capital changes. The Company reported a loss of $34 million for the thirty-nine weeks ended November 3, 2007, as compared with a profit of $138 million in the corresponding prior-year period. During the third quarter of 2007, the Company recorded non-cash charges totaling $103 million, comprising impairment of long-lived assets and store closing costs. The cash outflow related to merchandise inventories, net of accounts payable and other accruals, was lower than the corresponding prior-year period, reflecting the liquidation activity during the second quarter of 2007 and reduced purchases to keep inventory levels in line with sales. Additionally, during the thirty-nine weeks ended November 3, 2007, the Company did not contribute to the U.S. and Canadian qualified pension plans, because no contribution was required. This compares with $68 million contributed to the plans in the thirty-nine weeks ended October 28, 2006.
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Net cash provided by investing activities was $6 million and $37 million for the thirty-nine weeks ended November 3, 2007 and October 28, 2006, respectively. The Company’s sales of short-term investments, net of purchases, provided cash of $123 million as compared with $162 million in the corresponding prior-year period. Capital expenditures for the thirty-nine weeks ended November 3, 2007 were $117 million, as compared with $129 million in the corresponding prior-year period. Planned capital expenditures for 2007 are expected to total $146 million, of which $119 million relates to new store openings and modernizations of existing stores and $27 million to the development of information systems and other support facilities. This amount is $24 million less than what was originally planned, primarily as 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 $100 million and $126 million for the thirty-nine weeks ended November 3, 2007 and October 28, 2006, respectively. During the thirty-nine weeks ended November 3, 2007 and October 28, 2006, the Company made payments of $2 million and $50 million, respectively, related to its 5-year term loan. Additionally, during the third quarter of 2006, the Company purchased and retired $38 million of its 8.50 percent debentures payable in 2022 at a $2 million discount from face value. The Company declared and paid a $0.125 per share dividend during the first, second and third quarters of 2007 totaling $58 million, as compared with a $0.09 per share dividend during the first, second and third quarters of 2006 totaling $42 million. The Company received proceeds from the issuance of common stock in connection with the employee stock programs of $9 million and $8 million for the thirty-nine weeks ended November 3, 2007 and October 28, 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 thirty-nine weeks ended November 3, 2007 for approximately $50 million. The Company purchased 334,200 shares of its common stock during the thirty-nine weeks ended October 28, 2006 for approximately $8 million. One of the provisions of the October 2007 amendment to the Company’s revolving credit agreement provides, with regard to stock repurchases, that not more than $50 million in the aggregate may be expended for stock repurchases after October 26, 2007 unless the fixed charge coverage ratio, as defined in the revolving credit agreement, is at least 2.0 to 1.0 for the quarter immediately preceding any such repurchase and the Company has delivered its annual audited financial statements with respect to 2007. Under the current share repurchase program, subject to legal and contractual restrictions, including restrictions in the revolving credit agreement, 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 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 assessments 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 asa result of new information, future events, or otherwise.
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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 November 3, 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 rules and form, and is accumulated and communicated to management, including the CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.
During the quarter ended November 3, 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 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 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: December 7, 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 | | |
| of Regulation S-K | | Description |
| 12 | | Computation of Ratio of Earnings to Fixed Charges. |
| | |
| 15 | | Accountants’ 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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