SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
Annual Report Pursuant to Section 13 or 15(d)
of the Securities Exchange
Act of 1934
For the fiscal year ended January 29, 2005
Commission file number 1-10299
FOOT
LOCKER, INC.
(Exact name
of Registrant as specified in its charter)
New
York |
13-3513936 |
|||||
(State or other
jurisdiction of |
(I.R.S. Employer Identification No.) |
|||||
incorporation
or organization) |
||||||
112 West
34th Street, New York, New York |
10120 |
|||||
(Address of
principal executive offices) |
(Zip Code) |
|||||
Registrant’s telephone number, including area code:
(212)
720-3700
Securities registered pursuant to Section 12(b) of the Act:
Title of
each class |
Name of each exchange on which registered |
|||||
Common Stock,
par value $0.01 |
New York Stock Exchange |
|||||
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark whether the
Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months
(or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past
90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent
filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in
definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form
10-K. [X]
Indicate by check mark whether the Registrant is an
accelerated filer (as defined in Rule 12b-2 of the Act). Yes [X] No [ ]
See pages 59 through 63 for Index of Exhibits.
Number of shares
of Common Stock outstanding at March 18, 2005: |
156,355,058 | |||||
The aggregate
market value of voting stock held by non-affiliates of the Registrant computed by reference to the closing price as of the last business day of the
Registrant’s most recently completed second fiscal quarter, July 31, 2004, was approximately: |
$ | 2,600,112,397 | * |
| * | For purposes of this calculation only (a) all directors plus one executive officer and owners of five percent or more of the Registrant are deemed to be affiliates of the Registrant and (b) shares deemed to be “held” by such persons at July 31, 2004 include only outstanding shares of the Registrant’s voting stock with respect to which such persons had, on such date, voting or investment power. |
DOCUMENTS
INCORPORATED BY REFERENCE
Portions of the Registrant’s definitive Proxy
Statement (the “Proxy Statement”) to be filed in connection with the 2005 Annual Meeting of Shareholders: Parts III and IV.
TABLE OF CONTENTS
PART I |
||||||||||
Item
1 |
Business |
1 | ||||||||
Item
2 |
Properties |
2 | ||||||||
Item
3 |
Legal Proceedings |
2 | ||||||||
Item
4 |
Submission of Matters to a Vote of Security Holders |
2 | ||||||||
PART II |
||||||||||
Item
5 |
Market for the Company’s Common Equity and Related Stockholder Matters and Issuer Purchases of Equity Securities |
3 | ||||||||
Item
6 |
Selected Financial Data |
3 | ||||||||
Item
7 |
Management’s Discussion and Analysis of Financial Condition and Results of Operations |
3 | ||||||||
Item
7A |
Quantitative and Qualitative Disclosures about Market Risk |
17 | ||||||||
Item
8 |
Consolidated Financial Statements and Supplementary Data |
18 | ||||||||
Item
9 |
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure |
56 | ||||||||
Item
9A |
Controls and Procedures |
56 | ||||||||
PART III |
||||||||||
Item
10 |
Directors and Executive Officers of the Company |
56 | ||||||||
Item
11 |
Executive Compensation |
57 | ||||||||
Item
12 |
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters |
57 | ||||||||
Item
13 |
Certain Relationships and Related Transactions |
57 | ||||||||
Item
14 |
Principal Accountant Fees and Services |
57 | ||||||||
PART IV |
||||||||||
Item
15 |
Exhibits and Financial Statement Schedules |
57 | ||||||||
PART I
| Item 1. | Business |
General
Foot Locker, Inc., incorporated under the laws of
the State of New York in 1989, is a leading global retailer of athletic footwear and apparel, operating as of January 29, 2005, 3,967 primarily
mall-based stores in the United States, Canada, Europe and Asia Pacific, which includes Australia and New Zealand. Foot Locker, Inc. and its
subsidiaries hereafter are referred to as the “Registrant” or “Company.” Information regarding the business is contained under the
“Business Overview” section in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of
Operations.”
The Company maintains a website on the Internet at
www.footlocker-inc.com. The Company’s filings with the Securities and Exchange Commission, including its annual reports on Form 10-K,
quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports are available free of charge through this website as
soon as reasonably practicable after they are filed with or furnished to the SEC by clicking on the “SEC Filings” link. The Corporate
Governance section of the Company’s corporate website contains the Company’s Corporate Governance Guidelines, Committee Charters and the
Company’s Code of Business Conduct for directors, officers and employees, including the Chief Executive Officer, Chief Financial Officer and Chief
Accounting Officer. Copies of these documents may also be obtained free of charge upon written request to the Company’s Corporate Secretary at 112
West 34th Street, New York, NY 10120. The Company intends to disclose promptly amendments to the Code of Business Conduct and Waivers of the
Code for directors and executive officers on the corporate governance section of the Company’s corporate website.
The Certification of the Chief Executive Officer
required by Section 303A.12(a) of The New York Stock Exchange Listing Standards relating to the Company’s compliance with The New York Stock
Exchange Corporate Governance Listing Standards was submitted to The New York Stock Exchange on June 15, 2004.
Information Regarding Business Segments and Geographic Areas
The financial information concerning business
segments, divisions and geographic areas is contained under the “Business Overview” and “Segment Information” sections in
“Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Information regarding sales, operating
results and identifiable assets of the Company by business segment and by geographic area is contained under the “Segment Information”
footnote in “Item 8. Consolidated Financial Statements and Supplementary Data.”
The service marks and trademarks appearing on this
page and elsewhere in this report (except for ESPN, NFL, NBA, Nike, Amazon.com, Burger King, Popeye’s, The San Francisco Music Box Company and
USOC) are owned by Foot Locker, Inc. or its subsidiaries.
Employees
The Company and its consolidated subsidiaries had
16,562 full-time and 27,547 part-time employees at January 29, 2005. The Company considers employee relations to be satisfactory.
Competition
The financial information concerning competition is
contained under the “Business Risk” section in the “Financial Instruments and Risk Management” footnote in “Item 8.
Consolidated Financial Statements and Supplementary Data.”
Merchandise Purchases
The financial information concerning merchandise
purchases is contained under the “Liquidity” section in “Item 7. Management’s Discussion and Analysis of Financial Condition and
Results of Operations” and under the “Business Risk” section in the “Financial Instruments and Risk Management” footnote in
“Item 8. Consolidated Financial Statements and Supplementary Data.”
1
| Item 2. | Properties |
The properties of the Company and its consolidated
subsidiaries consist of land, leased and owned stores and administrative and distribution facilities. Total selling area for the Athletic Stores
segment at the end of 2004 was approximately 8.89 million square feet. These properties are primarily located in the United States, Canada, various
European countries, Australia and New Zealand.
The Company currently operates three distribution
centers, of which one is owned and two are leased, occupying an aggregate of 2.12 million square feet. Two of the three distribution centers are
located in the United States and one is in Europe. The Company also has two additional distribution centers that are leased and partly sublet,
occupying approximately 0.26 million square feet.
| Item 3. | Legal Proceedings |
Legal proceedings pending against the Company or its
consolidated subsidiaries consist of ordinary, routine litigation, including administrative proceedings, incident to the businesses of the Company, as
well as litigation incident to the sale and disposition of businesses that have occurred in the past several years. Management does not believe that
the outcome of such proceedings will have a material effect on the Company’s consolidated financial position, liquidity, or results of
operations.
| Item 4. | Submission of Matters to a Vote of Security Holders |
There were no matters submitted to a vote of
security holders during the fourth quarter of the year ended January 29, 2005.
Executive Officers of the Company
Information with respect to Executive Officers of
the Company, as of March 28, 2005, is set forth below:
Chairman of
the Board, President and Chief Executive Officer |
Matthew D. Serra |
|||||
Executive
Vice President and Chief Financial Officer |
Bruce L. Hartman |
|||||
President
and Chief Executive Officer, Foot Locker, Inc. — U.S.A. |
Richard T. Mina |
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Senior Vice
President, General Counsel and Secretary |
Gary
M. Bahler |
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Senior Vice
President — Real Estate |
Jeffrey L. Berk |
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Senior Vice
President — Chief Information Officer |
Marc
D. Katz |
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Senior Vice
President — Strategic Planning |
Lauren B. Peters |
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Senior Vice
President — Human Resources |
Laurie J. Petrucci |
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Vice
President — Investor Relations and Treasurer |
Peter D. Brown |
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Vice
President and Chief Accounting Officer |
Robert W. McHugh |
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Matthew D. Serra, age 60, has served as
Chairman of the Board since February 1, 2004, President since April 12, 2000 and Chief Executive Officer since March 4, 2001. Mr. Serra served as Chief
Operating Officer from February 2000 to March 3, 2001 and as President and Chief Executive Officer of Foot Locker Worldwide from September 1998 to
February 2000.
Bruce L. Hartman, age 51, has served as
Executive Vice President since April 18, 2002 and Chief Financial Officer since February 27, 1999. He served as Senior Vice President from February
1999 to April 2002.
Richard T. Mina, age 48, has served as
President and Chief Executive Officer of Foot Locker, Inc.- U.S.A. since February 2, 2003. He served as President and Chief Executive Officer of Champs
Sports, an operating division of the Company, from April 1999 to February 1, 2003.
Gary M. Bahler, age 53, has served as Senior
Vice President since August 1998, General Counsel since February 1993 and Secretary since February 1990.
Jeffrey L. Berk, age 49, has served as Senior
Vice President — Real Estate since February 2000.
Marc D. Katz, age 40, has served as Senior
Vice President — Chief Information Officer since May 12, 2003. Mr. Katz served as Vice President and Chief Information Officer from July 2002 to
May 11, 2003. During the period of 1999 to 2002, he served in the following capacities at the Financial Services Center of Foot Locker Corporate
Services: Vice President and Controller from July 2001 to April 2002 and Controller from December 1999 to July 2001.
Lauren B. Peters, age 43, has served as
Senior Vice President — Strategic Planning since April 18, 2002. Ms. Peters served as Vice President — Planning from January 2000 to April
17, 2002.
2
Laurie J. Petrucci, age 46, has served as
Senior Vice President — Human Resources since May 2001. Ms. Petrucci served as Senior Vice President — Human Resources of Foot Locker
Worldwide from March 2000 to April 2001. She served as Vice President of Organizational Development and Training of Foot Locker Worldwide from February
1999 to March 2000.
Peter D. Brown, age 50, has served as Vice
President — Investor Relations and Treasurer since October 2001. Mr. Brown served as Vice President — Investor Relations and Corporate
Development from April 2001 to October 2001 and as Assistant Treasurer — Investor Relations and Corporate Development from August 2000 to April
2001. He served as Vice President and Chief Financial Officer of Lady Foot Locker from October 1999 to August 2000.
Robert W. McHugh, age 46, has served as Vice
President and Chief Accounting Officer since January 2000.
There are no family relationships among the
executive officers or directors of the Company.
PART II
| Item 5. | Market for the Company’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |
Information regarding the Company’s market for
stock exchange listings, common equity, quarterly high and low prices and dividend policy are contained in the “Shareholder Information and Market
Prices” footnote under “Item 8. Consolidated Financial Statements and Supplementary Data.”
This table provides information with respect to
purchases by the Company of shares of its Common Stock during the fourth quarter of 2004:
| Total Number of Shares Purchased(1) |
Average Price Paid per Share(1) |
Total Number of Shares Purchased as Part of Publicly Announced Program (2) |
Approximate Dollar Value of Shares that May Yet be Purchased Under the Program (2) |
|||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Oct. 31, 2004
through Nov. 27, 2004 |
— | $ | — | — | $50,000,000 | |||||||||||||
Nov. 28, 2004
through Jan. 1, 2005 |
6,670 | 26.28 | — | 50,000,000 | ||||||||||||||
Jan. 2, 2005
through Jan. 29, 2005 |
— | — | — | 50,000,000 | ||||||||||||||
Total |
6,670 | $ | 26.28 | — | ||||||||||||||
(1) |
These columns reflect shares purchased through option exercises by stock swaps. |
(2) |
On November 20, 2002, the Company announced that the Board of Directors authorized the purchase of up to $50 million of the Company’s Common Stock; no purchases have been made under this program. This authorization will terminate on February 3, 2006. |
| Item 6. | Selected Financial Data |
Selected financial data is included as the
“Five Year Summary of Selected Financial Data” footnote in “Item 8. Consolidated Financial Statements and Supplementary
Data.”
| Item 7. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
Business Overview
Foot Locker, Inc., through its subsidiaries,
operates in two reportable segments — Athletic Stores and Direct-to-Customers. The Athletic Stores segment is one of the largest athletic footwear
and apparel retailers in the world, whose formats include Foot Locker, Lady Foot Locker, Kids Foot Locker, Champs Sports and Footaction (beginning May
2004). The Direct-to-Customers segment reflects Footlocker.com, Inc., which sells, through its affiliates, including Eastbay, Inc., to customers
through catalogs and Internet websites.
The Foot Locker brand is one of the most widely
recognized names in the market segments in which the Company operates, epitomizing high quality for the active lifestyle customer. This brand equity
has aided the Company’s ability to successfully develop and increase its portfolio of complementary retail store formats, specifically, Lady Foot
Locker and Kids Foot Locker, as well as Footlocker.com, Inc., its direct-to-customers business. Through various marketing channels,
3
including television campaigns and sponsorships of various sporting events, Foot Locker, Inc. reinforces its image with a consistent message: namely, that it is the destination store for athletic apparel and footwear with a wide selection of merchandise in a full-service environment.
Athletic Stores
The Company operates 3,967 stores in the Athletic
Stores segment. The following is a brief description of the Athletic Stores segment’s operating businesses:
Foot Locker — Foot Locker is a leading
athletic footwear and apparel retailer. Its stores offer the latest in athletic-inspired performance products, manufactured primarily by the leading
athletic brands. Foot Locker offers products for a wide variety of activities including running, basketball, hiking, tennis, aerobics, fitness,
baseball, football and soccer. Its 2,135 stores are located in 18 countries including 1,428 in the United States, Puerto Rico, the United States Virgin
Islands and Guam, 130 in Canada, 485 in Europe and a combined 92 in Australia and New Zealand. The domestic stores have an average of 2,400 selling
square feet and the international stores have an average of 1,500 selling square feet.
Champs Sports — Champs Sports is one of
the largest mall-based specialty athletic footwear and apparel retailers in the United States. Its product categories include athletic footwear,
apparel and accessories, and a focused assortment of equipment. This combination allows Champs Sports to differentiate itself from other mall-based
stores by presenting complete product assortments in a select number of sporting activities. Its 570 stores are located throughout the United States
and Canada. The Champs Sports stores have an average of 3,800 selling square feet.
Footaction — Footaction is a national
athletic footwear and apparel retailer that offers street-inspired fashion styles. The primary customers are young urban males with the secondary
customers being young urban women with diverse fashion needs. Its 349 stores are located throughout the United States and Puerto Rico and focus on
marquee allocated footwear and branded apparel. The Footaction stores have an average of 3,000 selling square feet.
Lady Foot Locker — Lady Foot Locker is a
leading U.S. retailer of athletic footwear, apparel and accessories for women. Its stores carry all major athletic footwear and apparel brands, as well
as casual wear and an assortment of proprietary merchandise designed for a variety of activities, including running, basketball, walking and fitness.
Its 567 stores are located in the United States and Puerto Rico and have an average of 1,200 selling square feet.
Kids Foot Locker — Kids Foot Locker is a
national children’s athletic retailer that offers the largest selection of brand-name athletic footwear, apparel and accessories for infants, boys
and girls, primarily on an exclusive basis. Its stores feature an entertaining environment geared to both parents and children. Its 346 stores are
located in the United States and Puerto Rico and have an average of 1,400 selling square feet.
Store Profile
| At January 31, 2004 |
Acquired |
Opened |
Closed |
At January 29, 2005 |
|||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Foot
Locker |
2,088 | 11 | 84 | 48 | 2,135 |
||||||||||||||||||
Champs
Sports |
581 | — | 5 | 16 | 570 |
||||||||||||||||||
Footaction |
— | 349 | 4 | 4 | 349 |
||||||||||||||||||
Lady Foot
Locker |
584 | — | 2 | 19 | 567 |
||||||||||||||||||
Kids Foot
Locker |
357 | — | 1 | 12 | 346 |
||||||||||||||||||
Total
Athletic Stores |
3,610 | 360 | 96 | 99 | 3,967 |
||||||||||||||||||
Direct-to-Customers
Footlocker.com — Footlocker.com, Inc.,
sells, through its affiliates, directly to customers through catalogs and its Internet websites. Eastbay, Inc., one of its affiliates, is one of the
largest direct marketers of athletic footwear, apparel, equipment and team licensed private-label merchandise in the United States and provides the
Company’s seven full-service e-commerce sites access to an integrated fulfillment and distribution system. The Company has an agreement with the
National Football League (NFL) as its official catalog and e-commerce retailer, which includes managing the NFL catalog and e-commerce businesses.
Footlocker.com designs, merchandises and fulfills the NFL’s official catalog (NFL Shop) and the e-commerce site linked to www.NFLshop.com.
The Company has a strategic alliance to offer footwear and apparel on
4
the Amazon.com website and the Foot Locker brands are featured in the Amazon.com specialty stores for apparel and accessories and sporting goods. The Company also has an arrangement with the NBA and Amazon.com whereby Footlocker.com provides the fulfillment services for NBA licensed products sold over the Internet at NBAstore.com and the NBA store on Amazon.com. In addition, the Company has a marketing agreement with the U.S. Olympic Committee (USOC) providing the Company with the exclusive rights to sell USOC licensed products through catalogs and via a new e-commerce site. During the fourth quarter of 2004, the Company entered into an agreement with ESPN for ESPN Shop — an ESPN-branded direct mail catalog and e-commerce site linked to www.ESPNshop.com, where fans can purchase athletic footwear, apparel and equipment which will be managed by Footlocker.com. Both the catalog and the e-commerce site feature a variety of ESPN-branded and non-ESPN-branded athletically inspired merchandise.
Executive Summary
The Company reported income from continuing
operations for the year ended January 29, 2005 of $255 million, or $1.64 per diluted share, an increase of 22 percent as compared with 2003. Net income
for the year ended January 29, 2005 increased to $293 million, or $1.88 per diluted share, and includes $0.24 per diluted share from discontinued
operations. Earnings per share of $0.24 or $38 million in discontinued operations reflects the resolution of U.S. income tax examinations of $37
million, as well as income of $1 million related to a refund of custom duties related to certain of the businesses that comprised the Specialty
Footwear segment.
Sales
All references to comparable-store sales for a given
period relate to sales of stores that are open at the period-end and that have been open for more than one year and exclude the effect of foreign
currency fluctuations. Accordingly, stores opened and closed during the period are not included. Sales from the Direct-to-Customer segment are included
in the calculation of comparable-store sales for all periods presented. All references to comparable-store sales for 2004 exclude the acquisition of
the 349 Footaction stores and the 11 stores purchased in the Republic of Ireland. Sales from acquired businesses that include the purchase of inventory
will be included in the computation of comparable-store sales after 15 months of operations. Accordingly, Footaction sales will be included in the
computation of comparable-store sales beginning in August 2005.
The following table summarizes sales by
segment:
| 2004 |
2003 |
2002 |
||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (in millions) |
||||||||||||||||||
Athletic
Stores |
$ | 4,989 | $ | 4,413 | $ | 4,160 | ||||||||||||
Direct-to-Customers |
366 | 366 | 349 | |||||||||||||||
| $ | 5,355 | $ | 4,779 | $ | 4,509 | |||||||||||||
Sales of $5,355 million in 2004 increased by 12.1
percent from sales of $4,779 million in 2003. Excluding the effect of foreign currency fluctuations, sales increased by 9.8 percent as compared with
2003, primarily as a result of the Company’s acquisition of 349 Footaction stores in May 2004 and the acquisition of 11 stores in the Republic of
Ireland in late October 2004, which accounted for $332 million and $5 million in sales, respectively, for 2004. Comparable-store sales increased by 0.9
percent. The remaining increase is a result of the Company’s continuation of the new store-opening program.
Sales of $4,779 million in 2003 increased by 6.0
percent from sales of $4,509 million in 2002. Excluding the effect of foreign currency fluctuations, sales increased by 2.2 percent as compared with
2002, primarily as a result of the Company’s continuation of the new store-opening program. Comparable-store sales decreased by 0.5
percent.
Gross Margin
Gross margin as a percentage of sales was 30.5
percent in 2004, decreasing by 50 basis points from 31.0 percent in 2003. Of the 50 basis points decrease in 2004, approximately 60 basis points is the
result of the Footaction chain, offset, in part, by a decrease in the cost of merchandise. The effect of vendor allowances on gross margin, as a
percentage of sales, as compared with the corresponding prior year period was not significant.
5
Gross margin as a percentage of sales was 31.0
percent in 2003, an increase of 110 basis points in 2003 from 29.9 percent in 2002. This change primarily reflected a decrease in the cost of
merchandise, as a percentage of sales. Increased vendor allowances improved gross margin, as a percentage of sales, by 28 basis points, year over
year.
Division Profit
The Company evaluates performance based on several
factors, the primary financial measure of which is division profit. Division profit reflects income from continuing operations before income taxes,
corporate expense, non-operating income and net interest expense. The following table reconciles division profit by segment to income from continuing
operations before income taxes.
| 2004 |
2003 |
2002 |
|||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (in millions) |
|||||||||||||||
Athletic
Stores |
$ | 420 | $ | 363 | $279 |
||||||||||
Direct-to-Customers |
45 | 53 | 40 |
||||||||||||
Division
profit |
465 | 416 | 319 |
||||||||||||
Restructuring
(charges) income (1) |
(2 | ) | (1 | ) | 2 |
||||||||||
Total
division profit |
463 | 415 | 321 |
||||||||||||
Corporate
expense |
(74 | ) | (73 | ) | (52 | ) | |||||||||
Total operating
profit |
389 | 342 | 269 |
||||||||||||
Non-operating
income (2) |
— | — | 3 |
||||||||||||
Interest
expense, net |
(15 | ) | (18 | ) | (26) |
||||||||||
Income from
continuing operations before income taxes |
$ | 374 | $ | 324 | $ 246 |
||||||||||
(1) |
As more fully described in the notes to the consolidated financial statements, restructuring charges of $2 million and $1 million in 2004 and 2003, respectively, were recorded related to the dispositions of non-core businesses. Restructuring income of $2 million in 2002 reflects revisions to estimates used in the disposition of non-core businesses and the accelerated store-closing program. |
(2) |
2002 includes $2 million gain related to the condemnation of a part-owned and part-leased property for which the Company received proceeds of $6 million and real estate gains from the sale of corporate properties of $1 million during 2002. |
Segment Information
Athletic Stores
| 2004 |
2003 |
2002 |
|||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (in millions) |
|||||||||||||||
Sales |
$ | 4,989 | $ | 4,413 | $4,160 |
||||||||||
Division
profit |
|||||||||||||||
Stores |
$ | 420 | $ | 363 | $279 |
||||||||||
Restructuring
income |
— | — | 1 |
||||||||||||
Total division
profit |
$ | 420 | $ | 363 | $ 280 |
||||||||||
Sales as a
percentage of consolidated total |
93 | % | 92 | % | 92% |
||||||||||
Number of stores
at year end |
3,967 | 3,610 | 3,625 |
||||||||||||
Selling square
footage (in millions) |
8.89 | 7.92 | 8.04 |
||||||||||||
Gross square
footage (in millions) |
14.78 | 13.14 | 13.22 |
||||||||||||
6
2004 compared with 2003
Athletic Stores sales of $4,989 million increased
13.1 percent in 2004, as compared with $4,413 million in 2003. Excluding the effect of foreign currency fluctuations, primarily related to the euro,
sales from athletic store formats increased 10.6 percent in 2004. This increase was primarily driven by incremental sales related to the acquisition of
the 349 Footaction stores in May 2004 totaling $332 million and the sales of the 11 stores acquired in the Republic of Ireland amounting to $5 million.
The balance of the increase primarily reflects new store growth. Total Athletic Stores comparable-store sales increased by 1.0 percent in
2004.
The Company benefited from continued exclusive
offerings from its primary suppliers, gaining access to greater amounts of marquee products, and a developing trend towards higher priced technical
footwear.
Division profit from Athletic Stores increased by
15.7 percent to $420 million in 2004 from $363 million in 2003. Division profit, as a percentage of sales, increased to 8.4 percent in 2004 from 8.2
percent in 2003. The increase in 2004 was primarily driven by the overall improvement in the selling, general and administrative (“SG&A”)
rate as a result of better expense control. SG&A, as a percentage of sales, declined to 18.8 percent in 2004, as compared with 19.1 percent in the
prior year. Operating performance improved in all of the formats that comprised the Athletic Stores segment. European operations improved as compared
with the prior year, despite a more promotional environment. Additionally, Champs Sports and Lady Foot Locker improved considerably during 2004. Lady
Foot Locker benefited from its modified merchandise assortment. For the year ended January 29, 2005, the Footaction format negatively affected division
profit by 80 basis points. This was primarily the result of a lower gross margin rate as compared with the Athletic Stores segment largely related to
higher occupancy costs as compared with the Athletic Stores segment as a whole.
2003 compared with 2002
Athletic Stores sales of $4,413 million increased
6.1 percent in 2003, as compared with $4,160 million in 2002. Excluding the effect of foreign currency fluctuations, primarily related to the euro,
sales from athletic store formats increased 1.9 percent in 2003, driven by the Company’s new store opening program, particularly in Foot Locker
Europe and Foot Locker Australia. Foot Locker Europe and Foot Locker Australia also continued to generate solid comparable-store sales increases. Total
Athletic Stores comparable-store sales decreased by 0.9 percent in 2003.
Footwear sales in the U.S. were led by the classic
category. Consumer demand for “retro” fashioned athletic footwear was also a primary driver of sales throughout 2003. The Company also
benefited from exclusive offerings from its primary suppliers, such as the Nike 20 pack line in the latter part of 2003. Sales of private label and
licensed product also contributed to the increase in sales, as consumer interest began to show improvement with the strengthening of the
economy.
Comparable-store sales at Kids Foot Locker
continuously improved since its realignment under the Foot Locker U.S. management team in 2002. Kids Foot Locker’s sales significantly improved
during the fourth quarter of 2003, nearly reaching double-digit comparable-store sales increases. Lady Foot Locker sales remained essentially unchanged
in 2003 versus the prior year as this business continued to modify its merchandising mix to better suit its target customers. The Company closed a
number of underperforming stores, focused on remodeling and relocating numerous stores, and changed its merchandise assortment.
Division profit from Athletic Stores increased by
30.1 percent to $363 million in 2003 from $279 million in 2002. Division profit as a percentage of sales increased to 8.2 percent in 2003 from 6.7
percent in 2002. The increase in 2003 was primarily driven by the overall improvement in the gross margin rate as a result of better merchandise
purchasing as well as increased vendor allowances that contributed 30 basis points to the overall improvement. Additionally, during 2002 the Company
recorded $7 million of impairment charges for the Kids Foot Locker and Lady Foot Locker formats. Operating performance improved in the U.S. Foot
Locker, Kids Foot Locker and international formats as compared with the prior year. Champs Sports and Lady Foot Locker remained relatively flat as
compared with 2002. However, for the second half of 2003 the operating results of the Lady Foot Locker format improved considerably, compared with the
corresponding prior year period.
7
Direct-to-Customers
| 2004 |
2003 |
2002 |
||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (in millions) |
||||||||||||||||||
Sales |
$ | 366 | $ | 366 | $ | 349 | ||||||||||||
Division
profit |
$ | 45 | $ | 53 | $ | 40 | ||||||||||||
Sales as a
percentage of consolidated total |
7 | % | 8 | % | 8 | % | ||||||||||||
2004 compared with 2003
Direct-to-Customers sales were $366 million in both
2004 and 2003. The growth of the Internet business continued to drive sales in 2004. Internet sales increased by 11.0 percent to $212 million from $191
million in 2003. Catalog sales decreased by 12.0 percent to $154 million in 2004 from $175 million in 2003. Management believes that the decrease in
catalog sales which was substantially offset by the increase in Internet sales resulted as customers continue to browse and select products through its
catalogs, then make their purchases via the Internet. The Company continues to implement new initiatives to increase this business, including new
marketing arrangements and strategic alliances with well-known third parties. During the fourth quarter of 2004, a new agreement was reached with ESPN
whereby the Company manages the ESPN Shop — an ESPN-branded direct mail catalog and e-commerce destination where fans can purchase athletic
footwear, apparel and equipment.
The Direct-to-Customers business generated division
profit of $45 million in 2004, as compared with $53 million in 2003. The decrease in division profit is a result of expanded catalog circulation
expenses in 2004. Division profit, as a percentage of sales, decreased to 12.3 percent from 14.5 percent, however, the Direct-to-Customer business
remains more profitable than the Company’s Athletic Stores segment.
2003 compared with 2002
Direct-to-Customers sales increased 4.9 percent in
2003 to $366 million as compared with $349 million in 2002, driven by the growth of the Internet business. Internet sales increased by 32.6 percent to
$191 million from $144 million in 2002. Catalog sales declined by 14.6 percent to $175 million in 2003 from $205 million in 2002. During 2003, the
Company extended its agreement with the NFL, entered into new alliance agreements with the NBA and the USOC and expanded its services through on-line
specialty stores with Amazon.com. These agreements generally provide for the Company to merchandise, fulfill and manage the websites of these strategic
partners.
The Direct-to-Customers business generated division
profit of $53 million in 2003, as compared with $40 million in 2002. The increase in division profit was primarily due to increased sales. Division
profit, as a percentage of sales, increased to 14.5 percent in 2003 from 11.5 percent in 2002.
Corporate Expense
Corporate expense consists of unallocated general
and administrative expenses related to the Company’s corporate headquarters, centrally managed departments, unallocated insurance and benefit
programs, certain foreign exchange transaction gains and losses, certain depreciation and amortization expenses and other items.
The increase in corporate expense of $1 million in
2004 comprised several items, and primarily included decreased incentive bonuses of $9 million, offset by increased expenses related to integration
costs of $5 million, restricted stock expense from additional grants of $4 million and costs of $3 million related to the Company’s expanded
loyalty program. Integration costs represent incremental costs directly related to the acquisitions, primarily expenses to re-merchandise the
Footaction stores during the first three months of operations. Depreciation and amortization included in corporate expense, amounted to $23 million in
2004, $25 million in 2003 and $26 million in 2002. The increase in corporate expense in 2003 as compared with 2002 was primarily related to increased
compensation costs for incentive bonuses and increased restricted stock expense from additional grants.
8
Costs and Expenses
Selling, General and Administrative Expenses
SG&A increased by $101 million to $1,088 million
in 2004, or by 10.2 percent, as compared with 2003. Excluding the effect of foreign currency fluctuations, primarily related to the euro, SG&A
increased by $82 million, of which the acquired businesses contributed $68 million. Increased payroll and related costs primarily comprised the balance
of the increase. SG&A as a percentage of sales decreased to 20.3 percent compared with 20.7 percent in 2003. Pension expense declined by $2 million
primarily as a result of the positive market performance experienced in the prior year. Additionally, postretirement income decreased by $2 million in
2004 as compared with 2003 as the amortization of the unrecognized gains, which are amortized over the average remaining life expectancy, continues to
decrease over time.
SG&A increased by $59 million to $987 million in
2003, or by 6.4 percent, as compared with 2002. Excluding the effect of foreign currency fluctuations, primarily related to the euro, SG&A
increased by 2.7 percent. The increases were for additional payroll costs of $16 million in Europe, primarily as a result of new store openings and $12
million related to compensation costs for incentive bonuses due to the Company’s performance. Additionally, pension expense increased by $8
million due to the decline in plan asset values experienced in prior years, partially offset by a $4 million increase in the recognition of
postretirement income and foreign exchange gain recorded in 2002. During 2002, the Company recorded asset impairment charges of $6 million and $1
million related to the Kids Foot Locker and Lady Foot Locker formats, respectively. SG&A as a percentage of sales remained relatively flat compared
with 2002.
Depreciation and Amortization
Depreciation and amortization of $154 million
increased by 1.3 percent in 2004 from $152 million in 2003. Depreciation and amortization of acquired businesses amounted to $7 million for 2004. These
increases were offset by declines that were a result of older assets becoming fully depreciated.
Depreciation and amortization of $152 million in
2003 remained relatively flat as compared with $153 million in 2002. Excluding the effect of foreign currency fluctuations, depreciation and
amortization declined by $4 million. The decrease relates primarily to assets becoming fully depreciated for the U.S. Athletic stores, offset in part
by an increase related to the European new stores.
Interest Expense, Net
| 2004 |
2003 |
2002 |
||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (in millions) |
||||||||||||||||||
Interest
expense |
$ | 22 | $ | 26 | $ | 33 | ||||||||||||
Interest
income |
(7 | ) | (8 | ) | (7 | ) | ||||||||||||
Interest
expense, net |
$ | 15 | $ | 18 | $ | 26 | ||||||||||||
Weighted-average interest rate (excluding facility fees): |
||||||||||||||||||
Short-term
debt |
— | % | — | % | — | % | ||||||||||||
Long-term
debt |
5.2 | % | 6.1 | % | 7.2 | % | ||||||||||||
Total
debt |
5.2 | % | 6.1 | % | 7.2 | % | ||||||||||||
Short-term
debt outstanding during the year: |
||||||||||||||||||
High |
$ | — | $ | — | $ | — | ||||||||||||
Weighted-average |
$ | — | $ | — | $ | — | ||||||||||||
Interest expense of $22 million declined by 15.4
percent in 2004 from $26 million in 2003. The decrease in 2004 was primarily attributable to the Company’s $150 million 5.50 percent convertible
subordinated notes that were converted to equity in June 2004. Also contributing to the reduction in interest expense was the repurchase of $19 million
of the 8.50 percent debentures payable in 2022 in the latter part of 2003. The Company continued to utilize interest rate swap agreements, which
reduced interest expense by approximately $3 million and $4 million in 2004 and 2003, respectively. These decreases were offset, in part, by an
increase resulting from the interest on the $175 million term loan that commenced in May 2004.
9
Interest income is generated through the investment
of cash equivalents, short-term investments, the accretion of the Northern Group note to its face value and accrual of interest on the outstanding
principal, as well as, interest on income tax refunds. The decrease in interest income of $1 million in 2004 was primarily related to the reduction of
interest income earned on tax refunds and settlements as they were received during 2003. The Northern Group note was recorded in the fourth quarter of
2002 and interest income amounted to $2 million in both 2004 and 2003. Interest income related to cash equivalents and short-term investments was $5
million in 2004 and 2003.
Interest expense of $26 million declined in 2003 by
21.2 percent from $33 million in 2002. Interest expense related to long-term debt declined by $6 million primarily as a result of the $100 million of
interest rate swaps that were outstanding during 2003. These interest rate swaps were entered into to effectively convert a portion of the 8.50 percent
fixed-rate debentures, due in 2022, to a lower variable rate. The Company entered into a $50 million interest rate swap agreement in December 2002 and
subsequently entered into two additional swaps during 2003, totaling $50 million, to convert $50 million of the 8.50 percent debentures to a variable
rate debt which allowed the Company to lower the net amount of interest expense being paid at each interest payment date. The swaps reduced interest
expense by approximately $4 million. The remaining decrease is a result of the lower debt balance as the Company repurchased $19 million of the 8.50
percent debentures in 2003 and $9 million in the latter part of 2002. Interest expense in 2003 was further reduced as a result of the repayment of the
remaining $32 million of the $40 million 7.00 percent medium-term notes that matured in October 2002.
Interest income related to cash equivalents and
short-term investments amounted to $5 million in both 2003 and 2002. Additional interest income on the Northern Group note in 2003 was $2 million.
Interest income of $1 million and $2 million was related to tax refunds and settlements in 2003 and 2002, respectively.
Income Taxes
The effective tax rate for 2004 was 31.7 percent, as
compared with 35.5 percent in the prior year. The reduction was principally related to a lower rate of tax on the Company’s foreign operations and
the settlement of tax examinations.
During the second quarter of 2004 the Commonwealth
of Puerto Rico concluded an examination of the Company’s branch income tax returns, including an income tax audit for the years 1994 through 1999
and a branch profit tax audit for the years 1994 through 2002. As a result, the Company reduced its income tax provision for continuing operations by
$2 million. Also, during the second quarter of 2004, the IRS completed its survey of the Company’s income tax returns for the years from 1999-2001
and its examination of the 2002 year. The IRS and the Company also came to an agreement on the pre-filing review of the Company’s income tax
return for 2003. As a result of these actions by the IRS, the Company reduced its income tax provision for continuing operations by $7 million and
discontinued operations by $37 million. During the third quarter of 2004 the IRS completed its post-filing review of the Company’s income tax
return for 2003 resulting in a $2 million reduction to the income tax provision. During the fourth quarter of 2004 the Company completed an analysis of
the effect of the completion of the IRS’s examination and review of the Company’s income tax returns. This analysis resulted in a reduction
to the income tax provision of $3 million.
The effective rate for 2003 was 35.5 percent, as
compared with 34.2 percent in 2002. The increased tax rate was primarily due to the Company recording tax benefits of $5 million in 2003 as compared to
$9 million in 2002. In addition the rate increased due to a shift in taxable income from lower to higher tax jurisdictions. During 2003, the Company
recorded a $1 million tax benefit related to state tax law changes, a $2 million tax benefit related to a reduction in the valuation allowance for
deferred tax assets related to a multi-state tax planning strategy, a $1 million tax benefit related to a reduction in the valuation allowance for
foreign tax loss carryforwards, and a tax benefit of $1 million related to the settlement of tax examinations.
The effective rate for 2002 was 34.2 percent. The
Company recorded a tax benefit during 2002 of $5 million related to a multi-state tax planning strategy, a $1 million tax benefit related to settlement
of tax examinations, a $2 million benefit related to the reduction in the valuation allowance for deferred tax assets related to foreign tax credits
and a $1 million benefit related to international tax planning strategies. The combined effect of these items, in addition to higher earnings in lower
tax jurisdictions and the utilization of tax loss carryforwards, reduced the effective tax rate.
10
Liquidity and Capital Resources
Liquidity
Generally, the Company’s primary source of cash
has been from operations. The Company usually 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 and current
credit facilities will be adequate to finance its working capital requirements, to make scheduled pension contributions for the Company’s
retirement plans, to fund quarterly dividend payments, to make scheduled debt repayments, and to support the development of its short-term and
long-term operating strategies. The Company expects to contribute an additional $22 million to its U.S. and Canadian qualified pension plans during
fiscal 2005, of which $19 million was made on February 4, 2005. Planned capital expenditures for 2005 are $165 million, of which $143 million relates
to new store openings and modernizations of existing stores and $22 million reflects the development of information systems and other support
facilities. In addition, planned lease acquisition costs are $5 million and primarily relate to the Company’s operations in Europe. The Company
has the ability to revise and reschedule the anticipated capital expenditure program, should the Company’s financial position require
it.
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 74 percent in 2004 and 73 percent
in 2003 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. Of that amount, approximately 45 percent in 2004 and 40 percent in 2003 was purchased from one
vendor — Nike, Inc. (“Nike”) — and 13 percent and 14 percent from another in 2004 and 2003, respectively.
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, 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.
Cash Flow
Operating activities from continuing operations
provided cash of $289 million in 2004 as compared with $264 million in 2003. These amounts reflect income from continuing operations adjusted for
non-cash items and working capital changes. The net increase is primarily related to the increase in net income as compared with the prior year, offset
in part by an additional $56 million in pension contributions and increased working capital usage. Merchandise inventories increased by $120 million to
support the recent acquisitions, offset by an increase in accounts payable. The change in other, net primarily reflects a prepaid income tax that
represents an overpayment of tax which the Company will apply to its 2005 payments.
Operating activities from continuing operations
provided cash of $264 million in 2003 as compared with $347 million in 2002. The decrease was primarily the result of a $50 million pension
contribution and increased working capital, partially offset by increased income from continuing operations. Net income increased by $54 million in
2003. Working capital usage included higher net cash outflow for merchandise inventories in 2003 as compared with 2002 and the Company increased its
inventory position to accommodate anticipated sales in 2004. The decrease in income taxes payable was attributable to increased payments made during
2003. The Company received a refund of tax and interest of $13 million during the fourth quarter of 2003.
Net cash used in investing activities of the
Company’s continuing operations was $424 million in 2004 compared with $265 million in 2003. During 2004, the Company paid $226 million for the
purchase of 349 Footaction stores from Footstar, Inc. and paid €13 million (approximately $17 million, of which $1 million remains to be paid) for the
purchase of 11 stores in the Republic of Ireland. The Company’s purchase of short-term investments, net of sales, increased by $9 million in 2004
as compared with an increase of $106 million in 2003. Capital expenditures of $156 million in 2004 and $144 million in 2003 primarily related to store
remodelings and new stores. Lease acquisition costs, primarily to secure and extend leases for prime locations in Europe, were $17 million and $15
million in 2004 and 2003, respectively.
11
Net cash used in investing activities of the
Company’s continuing operations was $265 million in 2003 compared with $314 million in 2002. Capital expenditures of $144 million in 2003 and $150
million in 2002 primarily related to store remodelings and new stores. The Company’s purchase of short-term investments, net of sales, increased
by $106 million in 2003 as compared with an increase of $152 million in 2002. Lease acquisition costs were $15 million and $18 million in 2003 and
2002, respectively. Proceeds from the disposal of real estate of $6 million in 2002 primarily related to the condemnation of a part-owned and
part-leased property.
Net cash provided by financing activities of
continuing operations was $167 million in 2004 as compared with net cash used of $13 million in 2003. The Company elected to finance a portion of the
purchase price of the Footaction stores, and on May 19, 2004 obtained a 5-year, $175 million term loan from the bank group participating in its
existing revolving credit facility. Concurrent with obtaining the term loan, the Company amended and extended the revolving credit facility to expire
in 2009. Financing fees paid for both the term loan and the revolving credit facility amounted to $2 million. The Company repurchased $19 million of
its 8.50 percent debentures that are due in 2022 during 2003. The Company declared and paid dividends totaling $39 million in 2004 and $21 million in
2003. During 2004 and 2003, the Company received proceeds from the issuance of common stock in connection with employee stock programs of $33 million
and $27 million, respectively.
Net cash used in financing activities of continuing
operations was $13 million in 2003 compared with $36 million in 2002. The Company repurchased $19 million of its 8.50 percent debentures that are due
in 2022 during 2003. During 2002, the Company repaid the remaining $32 million of the $40 million 7.00 percent medium-term notes due in October 2002
and retired approximately $9 million of its 8.50 percent debentures. The Company declared and paid dividends, totaling $21 million for the year. During
2002, the Company declared and paid a dividend during the fourth quarter of $0.03 per share totaling $4 million. During 2003 and 2002, the Company
received proceeds from the issuance of common stock in connection with employee stock programs of $27 million and $10 million,
respectively.
Net cash provided by and used in discontinued
operations includes losses from discontinued operations, changes in assets and liabilities of the discontinued segments and disposition activity
related to the reserves. Net cash provided by discontinued operations was $1 million in 2004 as compared with $7 million in 2003. In 2003, net cash
provided by discontinued operations was $7 million and primarily related to an income tax benefit of $21 million offset, in part, by payments against
related reserves of $13 million. In 2002, discontinued operations utilized cash of $10 million which consisted of payments for the Northern
Group’s operations and disposition activity related to the other discontinued segments.
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. On January 31, 2005,
the Company prepaid the first principal payment of $18 million which would have been due in May 2005. The agreement includes various restrictive
financial covenants with which the Company was in compliance on January 29, 2005.
Additionally in 2004, the Company notified The Bank
of New York, as Trustee under the indenture, that it intended to redeem its entire $150 million outstanding 5.50 percent convertible subordinated
notes. 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. The Company reclassified the remaining $3 million of unamortized deferred costs related to the original issuance of the
convertible debt to equity as a result of the conversion.
During 2003, the Company primarily focused on
repurchasing the 8.50 percent debt, which matures in 2022 in addition to declaring and paying dividends. During the fourth quarters of each year, the
Company increased the quarterly cash dividends paid. During 2003, the Company paid dividends of $0.03 per share in the first three quarters and
increased the payments to $0.06 in the fourth quarter. During 2004, the Company paid cash dividends of $0.06 per share for each of the first three
quarters and increased the payments to $0.075 per share in the fourth quarter, to an annualized rate of $0.30 per share.
Credit Rating
The Company’s corporate credit rating from
Standard & Poor’s is BB+ and Ba1 from Moody’s Investors Service.
12
Debt Capitalization and Equity
For purposes of calculating debt to total
capitalization, the Company includes the present value of operating lease commitments. These commitments are the primary financing vehicle used to fund
store expansion. The following table sets forth the components of the Company’s capitalization, both with and without the present value of
operating leases, and excludes the effect of interest rate swaps of $4 million that increased long-term debt at January 29, 2005 and $1 million that
reduced long-term debt at January 31, 2004:
| 2004 |
2003 |
||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| (in millions) |
|||||||||||
Cash, cash
equivalents and short-term investments, net of debt |
|||||||||||
and capital
lease obligations |
$ | 131 | $ | 112 | |||||||
Present value of
operating leases |
1,989 | 1,683 | |||||||||
Total net
debt |
1,858 | 1,571 | |||||||||
Shareholders’ equity |
1,830 | 1,375 | |||||||||
Total
capitalization |
$ | 3,688 | $ | 2,946 | |||||||
Net debt
capitalization percent |
50.4 | % | 53.3 | % | |||||||
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 increased to $131 million at January 29,
2005 from $112 million at January 31, 2004. The Company increased debt and capital lease obligations by $25 million while increasing cash, cash
equivalents and short-term investments by $44 million. This improvement was offset by an increase of $306 million in the present value of operating
leases primarily related to the Footaction acquisition and additional lease renewals entered into during 2004. Including the present value of operating
leases, the Company’s net debt capitalization percent improved 2.9 percentage points in 2004. Total capitalization increased by $742 million in
2004, which was primarily attributable to an increase in shareholders’ equity. The increase in shareholders’ equity relates to net income of
$293 million in 2004, an increase of $147 million resulting from the conversion of $150 million subordinated notes to equity, net of unamortized
deferred issuance costs, $49 million related to employee stock plans, and an increase of $19 million in the foreign exchange currency translation
adjustment, primarily related to the strength of the euro. The Company declared and paid dividends totaling $39 million during 2004.
The Company also recorded an increase of $14 million
to the minimum liability for the Company’s pension plans during 2004. This increase was primarily a result of the 40 basis point decrease in the
discount rate used to calculate present value of the obligations as of January 29, 2005, offset, in part, by an increase in the plans’ asset
performance. The Company contributed $44 million and $6 million to the Company’s U.S. and Canadian qualified pension plans, respectively, in
February 2004 and an additional $56 million to the Company’s U.S. qualified pension plan in September 2004, in advance of ERISA
requirements.
As of January 31, 2004, the Company’s cash, net
of debt and capital lease obligations, increased to $112 million. In 2003, the Company repurchased $19 million of the 8.50 percent debentures due in
2022. The Company declared and paid dividends totaling $21 million during 2003. The Company’s revolving credit facility was amended in 2003 to
increase the available line of credit by $10 million to $200 million and extended the term to July 2006. The amended agreement includes various
restrictive financial covenants with which the Company was in compliance on January 31, 2004. The Company made a $50 million contribution to its U.S.
qualified retirement plan in February 2003, in advance of ERISA requirements.
13
Contractual Obligations and Commitments
The following tables represent the scheduled
maturities of the Company’s contractual cash obligations and other commercial commitments as of January 29, 2005:
| Payments Due by Period |
|||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Contractual Cash Obligations |
Total |
Less than 1 Year |
2 – 3 Years |
4 – 5 Years |
After 5 Years |
||||||||||||||||||
| (in millions) |
|||||||||||||||||||||||
Long-term
debt |
$ | 351 | $ | 18 | $ | 44 | $ | 113 | $ | 176 | |||||||||||||
Operating
leases |
2,723 | 449 | 806 | 578 | 890 | ||||||||||||||||||
Capital lease
obligations |
14 | — | 14 | — | — | ||||||||||||||||||
Other
long-term liabilities (1) |
— | — | — | — | — | ||||||||||||||||||
Total
contractual cash obligations |
$ | 3,088 | $ | 467 | $ | 864 | $ | 691 | $ | 1,066 | |||||||||||||
(1) |
The Company’s other liabilities in the Consolidated Balance Sheet as of January 29, 2005 primarily comprise pension and postretirement benefits, deferred rent liability, income taxes, workers’ compensation and general liability reserves and various other accruals. These liabilities 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 have not been included as they are minimal and not useful to the presentation. Additional information on the balance sheet caption is included in the “Other Liabilities” footnote under “Item 8. Consolidated Financial Statements and Supplementary Data.” |
| Amount of Commitment Expiration by Period |
|||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Other Commercial Commitments |
Total Amounts Committed |
Less than 1 Year |
2 – 3 Years |
4 – 5 Years |
After 5 Years |
||||||||||||||||||
| (in millions) |
|||||||||||||||||||||||
Line of
credit |
$ | 175 | $ | — | $ | — | $ | 175 | $ | — | |||||||||||||
Stand-by
letters of credit |
25 | — | — | 25 | — | ||||||||||||||||||
Purchase
commitments (2) |
1,696 | 1,686 | 6 | 4 | — | ||||||||||||||||||
Other
(3) |
131 | 41 | 58 | 28 | 4 | ||||||||||||||||||
Total
commercial commitments |
$ | 2,027 | $ | 1,727 | $ | 64 | $ | 232 | $ | 4 | |||||||||||||
(2) |
Represents open purchase orders, as well as minimum required purchases under merchandise contractual agreements at January 29, 2005. 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. |
(3) |
Represents payments required by non-merchandise purchase agreements and minimum royalty requirements. |
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”). Included in the “Summary of Significant Accounting Policies” footnote in “Item 8. Consolidated Financial
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.
14
Business Combinations
The Company accounts for acquisitions of other
businesses in accordance with SFAS No. 141, “Business Combinations” (“SFAS 141”). SFAS 141 requires that the Company record the net
assets of acquired businesses at fair value, and make estimates and assumptions to determine the fair value of these acquired assets and liabilities.
The Company allocates the purchase price of acquired businesses based, in part, upon internal estimates of cash flows, recoverability and independent
appraisals. Changes to the assumptions used to estimate the fair value could impact the recorded amounts of the assets acquired and the resultant
goodwill.
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”) is commonly
used by retail companies to value inventories at cost and calculate gross margins by applying a cost-to-retail percentage to the retail value of
inventories. 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. Judgment is required to differentiate between promotional and other markdowns
that may be required to correctly reflect merchandise inventories at the lower of cost or market. 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 previously taken. Vendor allowances are recognized as a reduction in cost of sales in the period in
which the markdowns are taken. The effect of vendor allowances on gross margin, as a percentage of sales, as compared with the corresponding prior year
period was not significant. 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 20 basis points
to the 2004 gross margin rate.
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 they reimburse
specific, incremental and identifiable costs incurred to date, are 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 29 percent of total
advertising costs in 2004 and approximately 8 percent of catalog costs in 2004.
Impairment of Long-Lived Assets
In accordance with SFAS No. 144, the 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 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. The
calculation of fair value of long-lived assets is based on estimated expected discounted future cash flows by store, which 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.
Long-lived tangible assets and intangible assets with finite lives primarily include property and equipment and intangible lease acquisition
costs.
The Company is required to perform an impairment
review of its goodwill, at least annually. 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 exceeds its
estimated fair value. The fair value of each of the Company’s reporting units exceeded its carrying value as of February 1, 2004. The Company used
a combination of a discounted cash flow approach and market-based approach to determine the
15
fair value of a reporting unit. The latter 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.
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, mortality and health care cost trends, 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 2004, as disclosed in “Item 8. Consolidated Financial Statements and Supplementary Data,” to be reasonable. The expected
long-term rate of return on invested plan assets is a component of pension expense and 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 2 percent of the
total pension plans’ assets at January 29, 2005. A decrease of 50 basis points in the weighted-average expected long-term rate of return would
have increased 2004 pension expense by approximately $3 million. The actual return on plan assets in a given year may differ from the expected
long-term rate of return and the resulting gain or loss is deferred and amortized into the plans’ performance over time. 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 is selected with reference to the Aa long-term corporate bond yield. A decrease of 50 basis points in the weighted-average
discount rate would have increased the accumulated benefit obligation as of January 29, 2005 of the pension and postretirement plans by approximately
$30 million and approximately $1 million, respectively. Such a decrease would not have significantly changed 2004 pension expense or postretirement
income. There is limited risk to the Company for increases in healthcare costs related to the postretirement plan as new retirees have assumed the full
expected costs and existing retirees have assumed all increases in such costs since the beginning of fiscal year 2001. The additional minimum liability
included in shareholders’ equity at January 29, 2005 for the pension plans represented the amount by which the accumulated benefit obligation
exceeded the fair market value of the plan assets. The Company contributed $44 million to the U.S. qualified pension plan and contributed $6 million to
the Canadian qualified pension plan in February 2004. In addition, $56 million was contributed to the U.S. qualified pension plan in September
2004.
The Company expects to record postretirement income
of approximately $11 million and pension expense of approximately $13 million in 2005. Pension expense in 2005 reflects the Company’s expected
contributions, of which $19 million was made on February 4, 2005. These contributions have reduced 2005 estimated pension expense by approximately $2
million.
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. A one percent
change in the Company’s overall statutory tax rate for 2004 would have resulted in a $6 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
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 2005 effective tax rate to
be approximately 36.5 percent.
16
Discontinued, Repositioning and Restructuring Reserves
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 disposal and the fair value of non-cash
consideration received. 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 accounting in
the fourth quarter of 2002, the Northern Group note was recorded at its fair value. The Company is required to review the collectibility of 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 requires changes in the carrying value of assets received as consideration from the disposal of a discontinued
operation to be classified within continuing operations. The purchaser has made all payments required under the terms of the Note, however the business
sustained unexpected operating losses during the past fiscal year. The Company has evaluated the projected performance of the business and will
continue to monitor its results during the coming year. At January 29, 2005, $9 million remains outstanding on the Note.
The remaining discontinued reserve balances at
January 29, 2005 totaled $18 million of which $7 million is expected to be utilized within the next twelve months. The remaining repositioning and
restructuring reserves totaled $4 million at January 29, 2005, whereby $1 million is expected to be utilized within the next twelve
months.
Disclosure Regarding Forward-Looking Statements
This report, including the Shareholders’
Letter, 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, risks
associated with foreign global sourcing, including political instability, changes in import regulations, disruptions to transportation services and
distribution, 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 and the ability of the Company to execute its
business plans effectively with regard to each of its business units. 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 |
Information regarding interest rate risk management
and foreign exchange risk management is included in the “Financial Instruments and Risk Management” footnote under “Item 8. Consolidated
Financial Statements and Supplementary Data.”
17
| 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 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.
|
|
|||||||||
MATTHEW D.
SERRA, Chairman of the Board, President and Chief Executive Officer |
BRUCE L. HARTMAN, Executive Vice President and Chief Financial Officer |
|||||||||
March 28, 2005
18
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 January 29,
2005. 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 January 29, 2005.
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 the Company’s 2004 Annual Report on Form 10-K under the heading, Report of Independent Registered Public Accounting Firm
on Internal Control Over Financial Reporting.
|
|
|
|||||||||
MATTHEW D.
SERRA, Chairman of the Board, President and Chief Executive Officer |
BRUCE L. HARTMAN, Executive Vice President and Chief Financial Officer |
|||||||||
March 28, 2005
19
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of
Directors and Shareholders of
Foot Locker, Inc.
Foot Locker, Inc.
We have audited
the accompanying consolidated balance sheets of Foot Locker, Inc. and subsidiaries as of January 29, 2005 and January 31, 2004, and the related
consolidated statements of operations, comprehensive income, shareholders’ equity, and cash flows for each of the years in the three-year period
ended January 29, 2005. 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 January 29, 2005 and January 31, 2004, and the results of their operations and their cash flows for each of the years in the three-year period ended January 29, 2005, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of Foot Locker, Inc.’s internal control over financial reporting as of January 29,
2005, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO), and our report dated March 28, 2005 expressed an unqualified opinion on management’s assessment of, and the effective operation
of, internal control over financial reporting.
New York, New
York
March 28, 2005
March 28, 2005
20
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON
INTERNAL
CONTROL OVER FINANCIAL REPORTING
The Board of
Directors and Shareholders of
Foot Locker, Inc.
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 internal control over financial reporting as of January 29, 2005, based on criteria established in Internal 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. 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, testing and evaluating the design and operating effectiveness of internal control, and 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 U.S. 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 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 (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 January 29, 2005, 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 January 29, 2005, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
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 January 29, 2005 and January
31, 2004, and the related consolidated statements of operations, comprehensive income, shareholders’ equity, and cash flows for each of the years
in the three-year period ended January 29, 2005, and our report dated March 28, 2005 expressed an unqualified opinion on those consolidated financial
statements.
New York, New
York
March 28, 2005
March 28, 2005
21
CONSOLIDATED STATEMENTS OF OPERATIONS
| 2004 |
2003 |
2002 |
|||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (in millions, except per share amounts) |
|||||||||||||||
Sales
|
$ | 5,355 | $ | 4,779 | $ | 4,509 | |||||||||
Costs and
expenses |
|||||||||||||||
Cost of
sales |
3,722 | 3,297 | 3,161 | ||||||||||||
Selling,
general and administrative expenses |
1,088 | 987 | 928 | ||||||||||||
Depreciation
and amortization |
154 | 152 | 153 | ||||||||||||
Restructuring
charges (income) |
2 | 1 | (2 | ) | |||||||||||
Interest
expense, net |
15 | 18 | 26 | ||||||||||||
| 4,981 | 4,455 | 4,266 | |||||||||||||
Other income
(expense) |
— | — | (3 | ) | |||||||||||
| 4,981 | 4,455 | 4,263 | |||||||||||||
Income from
continuing operations before income taxes |
374 | 324 | 246 | ||||||||||||
Income tax
expense |
119 | 115 | 84 | ||||||||||||
Income
from continuing operations |
255 | 209 | 162 | ||||||||||||
Income (loss)
on disposal of discontinued operations, net of income tax benefit of $37, $4, and $2, respectively |
38 | (1 | ) | (9 | ) | ||||||||||
Cumulative
effect of accounting change, net of income tax benefit of $ — |
— | (1 | ) | — | |||||||||||
Net income
|
$ | 293 | $ | 207 | $ | 153 | |||||||||
Basic
earnings per share: |
|||||||||||||||
Income from
continuing operations |
$ | 1.69 | $ | 1.47 | $ | 1.15 | |||||||||
Income (loss)
from discontinued operations |
0.25 | (0.01 | ) | (0.06 | ) | ||||||||||
Cumulative
effect of accounting change |
— | — | — | ||||||||||||
Net
income |
$ | 1.94 | $ | 1.46 | $ | 1.09 | |||||||||
Diluted
earnings per share: |
|||||||||||||||
Income from
continuing operations |
$ | 1.64 | $ | 1.40 | $ | 1.10 | |||||||||
Income (loss)
from discontinued operations |
0.24 | (0.01 | ) | (0.05 | ) | ||||||||||
Cumulative
effect of accounting change |
— | — | — | ||||||||||||
Net
income |
$ | 1.88 | $ | 1.39 | $ | 1.05 | |||||||||
See Accompanying Notes to Consolidated Financial Statements.
22
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
| 2004 |
2003 |
2002 |
|||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (in millions) |
|||||||||||||||
Net income
|
$ | 293 | $ | 207 | $ | 153 | |||||||||
Other
comprehensive income, net of tax |
|||||||||||||||
Foreign
currency translation adjustment: |
|||||||||||||||
Translation
adjustment arising during the period |
19 | 31 | 38 | ||||||||||||
Cash flow
hedges: |
|||||||||||||||
Change in
fair value of derivatives, net of income tax |
(1 | ) | — | — | |||||||||||
Reclassification adjustments, net of income tax expense (benefit) of $1, ($1), and $—, respectively |
1 | (1 | ) | — | |||||||||||
Net change
in cash flow hedges |
— | (1 | ) | — | |||||||||||
Minimum
pension liability adjustment: |
|||||||||||||||
Minimum
pension liability adjustment, net of deferred tax expense (benefit) of $(9), $10 and $(56), respectively |
(14 | ) | 16 | (83 | ) | ||||||||||
Comprehensive income |
$ | 298 | $ | 253 | $ | 108 | |||||||||
See Accompanying Notes to Consolidated Financial Statements.
23
CONSOLIDATED BALANCE SHEETS
| 2004 |
2003 |
||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| (in millions) |
|||||||||||
ASSETS |
|||||||||||
Current
assets |
|||||||||||
Cash and cash
equivalents |
$ | 225 | $ | 190 | |||||||
Short-term
investments |
267 | 258 | |||||||||
Total cash,
cash equivalents and short-term investments |
492 | 448 | |||||||||
Merchandise
inventories |
1,151 | 920 | |||||||||
Assets of
discontinued operations |
1 | 2 | |||||||||
Other current
assets |
188 | 149 | |||||||||
| 1,832 | 1,519 | ||||||||||
Property
and equipment, net |
715 | 668 | |||||||||
Deferred
taxes |
180 | 194 | |||||||||
Goodwill
|
271 | 136 | |||||||||
Intangible
assets, net |
135 | 96 | |||||||||
Other
assets |
104 | 100 | |||||||||
| $ | 3,237 | $ | 2,713 | ||||||||
LIABILITIES AND SHAREHOLDERS’ EQUITY |
|||||||||||
Current
liabilities |
|||||||||||
Accounts
payable |
$ | 381 | $ | 234 | |||||||
Accrued
liabilities |
275 | 300 | |||||||||
Liabilities
of discontinued operations |
2 | 2 | |||||||||
Current
portion of repositioning and restructuring reserves |
1 | 1 | |||||||||
Current
portion of reserve for discontinued operations |
7 | 8 | |||||||||
Current
portion of long-term debt and obligations under capital leases |
18 | — | |||||||||
| 684 | 545 | ||||||||||
Long-term
debt and obligations under capital leases |
347 | 335 | |||||||||
Other
liabilities |
376 | 458 | |||||||||
Total
liabilities |
1,407 | 1,338 | |||||||||
Shareholders’ equity |
1,830 | 1,375 | |||||||||
| $ | 3,237 | $ | 2,713 | ||||||||
See Accompanying Notes to Consolidated Financial Statements.
24
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
| 2004 |
2003 |
2002 |
|||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 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 |
144,009 | $ | 411 | 141,180 | $ | 378 | 139,981 | $ | 363 | ||||||||||||||||||
Restricted
stock issued under stock option and award plans |
400 | — | 845 | — | 60 | — | |||||||||||||||||||||
Forfeitures of
restricted stock |
— | 2 | — | 1 | — | 1 | |||||||||||||||||||||
Amortization of
stock issued under restricted stock option plans |
— | 8 | — | 4 | — | 2 | |||||||||||||||||||||
Conversion of
convertible debt |
9,490 | 150 | — | — | — | — | |||||||||||||||||||||
Reclassification of convertible debt issuance costs |
— | (3 | ) | — | — | — | — | ||||||||||||||||||||
Issued under
director and employee stock plans, net of tax |
2,256 | 40 | 1,984 | 28 | 1,139 | 12 | |||||||||||||||||||||
Issued at end
of year |
156,155 | 608 | 144,009 | 411 | 141,180 | 378 | |||||||||||||||||||||
Common stock in
treasury at beginning of year |
(57 | ) | (1 | ) | (105 | ) | (1 | ) | (70 | ) | — | ||||||||||||||||
Reissued under
employee stock plans |
260 | 5 | 152 | 1 | — | — | |||||||||||||||||||||
Restricted
stock issued under stock option and award plans |
— | — | — | — | 30 | — | |||||||||||||||||||||
Forfeitures/cancellations of restricted stock |
(100 | ) | (2 | ) | (80 | ) | (1 | ) | (60 | ) | (1 | ) | |||||||||||||||
Shares of
common stock used to satisfy tax withholding obligations |
(137 | ) | (3 | ) | — | — | — | — | |||||||||||||||||||
Exchange of
options |
(30 | ) | (1 | ) | (24 | ) | — | (5 | ) | — | |||||||||||||||||
Common stock in
treasury at end of year |
(64 | ) | (2 | ) | (57 | ) | (1 | ) | (105 | ) | (1 | ) | |||||||||||||||
| 156,091 | 606 | 143,952 | 410 | 141,075 | 377 | ||||||||||||||||||||||
Retained
Earnings |
|||||||||||||||||||||||||||
Balance at
beginning of year |
1,132 | 946 | 797 | ||||||||||||||||||||||||
Net
income |
293 | 207 | 153 | ||||||||||||||||||||||||
Cash dividends
declared on common stock $0.26, $0.15 and $0.03 per share, respectively |
(39 | ) | (21 | ) | (4 | ) | |||||||||||||||||||||
Balance at end
of year |
1,386 | 1,132 | 946 | ||||||||||||||||||||||||
Accumulated
Other Comprehensive Loss |
|||||||||||||||||||||||||||
Foreign
Currency Translation Adjustment |
|||||||||||||||||||||||||||
Balance at
beginning of year |
16 | (15 | ) | (53 | ) | ||||||||||||||||||||||
Translation
adjustment arising during the period |
19 | 31 | 38 | ||||||||||||||||||||||||
Balance at end
of year |
35 | 16 | (15 | ) | |||||||||||||||||||||||
Cash Flow
Hedges |
|||||||||||||||||||||||||||
Balance at
beginning of year |
(1 | ) | — | — | |||||||||||||||||||||||
Change during
year, net of tax |
— | (1 | ) | — | |||||||||||||||||||||||
Balance at end
of year |
(1 | ) | (1 | ) | — | ||||||||||||||||||||||
Minimum
Pension Liability Adjustment |
|||||||||||||||||||||||||||
Balance at
beginning of year |
(182 | ) | (198 | ) | (115 | ) | |||||||||||||||||||||
Change during
year, net of tax |
(14 | ) | 16 | (83 | ) | ||||||||||||||||||||||
Balance at end
of year |
(196 | ) | (182 | ) | (198 | ) | |||||||||||||||||||||
Total
Accumulated Other Comprehensive Loss |
(162 | ) | (167 | ) | (213 | ) | |||||||||||||||||||||
Total
Shareholders’ Equity |
$ | 1,830 | $ | 1,375 | $ | 1,110 | |||||||||||||||||||||
See Accompanying Notes to Consolidated Financial Statements.
25
CONSOLIDATED STATEMENTS OF CASH FLOWS
| 2004 |
2003 |
2002 |
|||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (in millions) |
|||||||||||||||
From
Operating Activities |
|||||||||||||||
Net
income |
$ | 293 | $ | 207 | $ | 153 | |||||||||
Adjustments
to reconcile net income to net cash provided by operating activities of continuing operations: |
|||||||||||||||
(Income) loss
on disposal of discontinued operations, net of tax |
(38 | ) | 1 | 9 | |||||||||||
Restructuring
charges (income) |
2 | 1 | (2 | ) | |||||||||||
Cumulative
effect of accounting change, net of tax |
— | 1 | — | ||||||||||||
Depreciation
and amortization |
154 | 152 | 153 | ||||||||||||
Impairment of
long-lived assets |
— | — | 7 | ||||||||||||
Restricted
stock compensation expense |
8 | 4 | 2 | ||||||||||||
Tax benefit
on stock compensation |
10 | 2 | 2 | ||||||||||||
Gains on
sales of real estate and assets |
— | — | (3 | ) | |||||||||||
Deferred
income taxes |
50 | (5 | ) | 38 | |||||||||||
Change in
assets and liabilities, net of dispositions: |
|||||||||||||||
Merchandise
inventories |
(183 | ) | (63 | ) | (22 | ) | |||||||||
Accounts
payable and other accruals |
157 | (17 | ) | (22 | ) | ||||||||||
Repositioning
and restructuring reserves |
(1 | ) | (1 | ) | (3 | ) | |||||||||
Pension
contribution |
(106 | ) | (50 | ) | — | ||||||||||
Income
taxes |
— | 9 | 42 | ||||||||||||
Other,
net |
(57 | ) | 23 | (7 | ) | ||||||||||
Net cash
provided by operating activities of continuing operations |
289 | 264 | 347 | ||||||||||||
From
Investing Activities |
|||||||||||||||
Acquisitions |
(242 | ) | — | — | |||||||||||
Purchases of
short-term investments |
(2,884 | ) | (1,546 | ) | (536 | ) | |||||||||
Sales of
short-term investments |
2,875 | 1,440 | 384 | ||||||||||||
Lease
acquisition costs |
(17 | ) | (15 | ) | (18 | ) | |||||||||
Capital
expenditures |
(156 | ) | (144 | ) | (150 | ) | |||||||||
Proceeds from
sales of real estate and assets |
— | — | 6 | ||||||||||||
Net cash used
in investing activities of continuing operations |
(424 | ) | (265 | ) | (314 | ) | |||||||||
From
Financing Activities |
|||||||||||||||
Debt issuance
costs |
(2 | ) | — | — | |||||||||||
Increase
(reduction) in long-term debt |
175 | (19 | ) | (41 | ) | ||||||||||
Reduction in
capital lease obligations |
— | — | (1 | ) | |||||||||||
Dividends
paid on common stock |
(39 | ) | (21 | ) | (4 | ) | |||||||||
Issuance of
common stock |
33 | 27 | 10 | ||||||||||||
Net cash
provided by (used in) financing activities of continuing operations |
167 | (13 | ) | (36 | ) | ||||||||||
Net Cash
Provided by (Used in) Discontinued Operations |
1 | 7 | (10 | ) | |||||||||||
Effect of
Exchange Rate Fluctuations on Cash and Cash Equivalents |
2 | (8 | ) | 3 | |||||||||||
Net Change
in Cash and Cash Equivalents |
35 | (15 | ) | (10 | ) | ||||||||||
Cash and
Cash Equivalents at Beginning of Year |
190 | 205 | 215 | ||||||||||||
Cash and
Cash Equivalents at End of Year |
$ | 225 | $ | 190 | $ | 205 | |||||||||
Cash Paid
During the Year: |
|||||||||||||||
Interest |
$ | 23 | $ | 25 | $ | 27 | |||||||||
Income
taxes |
$ | 121 | $ | 77 | $ | 39 | |||||||||
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.
26
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 reporting period for the Company is the Saturday
closest to the last day in January. Fiscal years 2004, 2003 and 2002 represented the 52 weeks ended January 29, 2005, January 31, 2004 and February 1,
2003, respectively. References to years in this annual report relate to fiscal years rather than calendar years.
Revenue Recognition
Revenue from retail store sales is recognized when
the product is delivered to customers. Retail sales include merchandise, net of returns and exclude all taxes. The Company recognizes revenue,
including 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. Revenue from Internet and catalog sales is recognized when the product is shipped to customers. Sales include shipping and
handling fees for all periods presented.
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 fair market value of
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
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 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:
| 2004 |
2003 |
2002 |
|||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (in millions) |
|||||||||||||||
Advertising
expenses |
$ | 102.5 | $ | 97.5 | $ | 89.2 | |||||||||
Cooperative
advertising reimbursements |
(24.8 | ) | (23.4 | ) | (15.4 | ) | |||||||||
Net
advertising expense |
$ | 77.7 | $ | 74.1 | $ | 73.8 | |||||||||
27
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 $3.5 million and $2.9 million at January 29, 2005 and January 31, 2004,
respectively.
Catalog costs, which are included as a component of
selling, general and administrative expenses, net of reimbursements for cooperative reimbursements, were as follows:
| 2004 |
2003 |
2002 |
|||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (in millions) |
|||||||||||||||
Catalog
costs |
$ | 50.3 | $ | 42.4 | $ | 41.9 | |||||||||
Cooperative
reimbursements |
(2.9 | ) | (3.5 | ) | (2.9 | ) | |||||||||
Net catalog
expense |
$ | 47.4 | $ | 38.9 | $ | 39.0 | |||||||||
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 stock-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.
| 2004 |
2003 |
2002 |
|||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (in millions) |
|||||||||||||||
Income from
continuing operations |
$ | 255 | $ | 209 | $ | 162 | |||||||||
Effect of
Dilution: |
|||||||||||||||
Convertible
debt |
2 | 5 | 5 | ||||||||||||
Income from
continuing operations assuming dilution |
$ | 257 | $ | 214 | $ | 167 | |||||||||
Weighted-average common shares outstanding |
150.9 | 141.6 | 140.7 | ||||||||||||
Effect of
Dilution: |
|||||||||||||||
Stock options
and awards |
3.0 | 1.8 | 0.6 | ||||||||||||
Convertible
debt |
3.2 | 9.5 | 9.5 | ||||||||||||
Weighted-average common shares outstanding assuming dilution |
157.1 | 152.9 | 150.8 | ||||||||||||
Options to purchase 1.5 million, 3.6 million and 6.8
million shares of common stock as of January 29, 2005, January 31, 2004 and February 1, 2003, 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.
Stock-Based Compensation
The Company accounts for stock-based compensation
plans in accordance with the intrinsic-value based method permitted by SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS
No. 123”) which has not resulted in compensation cost for stock options and shares purchased under employee stock purchase plans. No compensation
expense for employee stock options is reflected in net income, as all stock options granted under those plans had an exercise price not less than the
quoted market price at the date of grant. The market value at date of grant of restricted stock is recorded as compensation expense over the period of
vesting.
28
The following table illustrates the effect on net
income and earnings per share as if the Company had applied the fair value recognition provisions of SFAS No. 123 to measure stock-based compensation
expense during the three-year period ended January 29, 2005.
| 2004 |
2003 |
2002 |
|||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (in millions, except per share amounts) |
|||||||||||||||
Net
income: |
|||||||||||||||
As
reported |
$ | 293 | $ | 207 | $ | 153 | |||||||||
Compensation
expense included in reported net income, net of income tax benefit |
5 | 2 | 1 | ||||||||||||
Total
compensation expense under fair value method for all awards, net of income tax benefit |
(13 | ) | (7 | ) | (6 | ) | |||||||||
Pro
forma |
$ | 285 | $ | 202 | $ | 148 | |||||||||
Basic
earnings per share: |
|||||||||||||||
As
reported |
$ | 1.94 | $ | 1.46 | $ | 1.09 | |||||||||
Pro
forma |
$ | 1.89 | $ | 1.43 | $ | 1.05 | |||||||||
Diluted
earnings per share: |
|||||||||||||||
As
reported |
$ | 1.88 | $ | 1.39 | $ | 1.05 | |||||||||
Pro
forma |
$ | 1.83 | $ | 1.36 | $ | 1.02 | |||||||||
On December 15, 2004, the FASB issued SFAS No. 123R,
“Share-Based Payment” (“SFAS No. 123R”). SFAS No. 123R requires companies to measure compensation cost for share-based payments at
fair value. The Statement is effective as of the beginning of the first interim or annual reporting period that begins after June 15, 2005. The Company
has not yet determined the effect of this statement on its consolidated financial position, results of operations or cash flows.
Cash and Cash Equivalents
The Company considers all highly liquid investments
with original maturities of three months or less to be cash equivalents. Cash equivalents at January 29, 2005 and January 31, 2004 were $140 million
and $130 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 January 29, 2005, 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.
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.
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
29
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 11 year period. Capitalized software, net of accumulated amortization, is included in property and equipment and was $50 million at January 29, 2005 and $55 million at January 31, 2004.
The Company adopted SFAS No. 143, “Accounting
for Asset Retirement Obligations” (“SFAS No. 143”) as of February 2, 2003. The statement requires that the fair value of a liability for
an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate can be made. The carrying amount of the
related long-lived asset shall be increased by the same amount as the liability and that amount will be amortized over the useful life of the
underlying long-lived asset. The difference between the fair value and the value of the ultimate liability will be accreted over time using the
credit-adjusted risk-free interest rate in effect when the liability is initially recognized. Asset retirement obligations of the Company may at any
time include structural alterations to store locations and equipment removal costs from distribution centers required by certain leases. On February 2,
2003, the Company recorded a liability of $2 million for the expected present value of future retirement obligations, increased property and equipment
by $1 million and recognized a $1 million after tax charge for the cumulative effect of the accounting change.
Recoverability of Long-Lived Assets
The Company adopted SFAS No. 144, “Accounting
for the Impairment or Disposal of Long-Lived Assets” (“SFAS No. 144”), which superseded SFAS No. 121. In accordance with 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 principally 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.
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 no longer be amortized but 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 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 or other comprehensive
loss, depending on whether a derivative is designated and effective as part of a hedge transaction and, if it is, the type of hedge transaction. The
effective portion of the gain or loss on the hedging derivative instrument is reported as a component of other comprehensive loss and reclassified to
earnings in the period in which the hedged item affects earnings. 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.
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 approximate 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
30
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 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 position for such transactions and records reserves for those
differences.
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.
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 $14 million at January 29, 2005 and January 31, 2004. 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 2004, 2003 and 2002.
Accounting for Leases
The Company recognizes rent expense for operating leases as of
the earlier of 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.
Reclassifications
Certain balances in prior fiscal years have been
reclassified to conform to the presentation adopted in the current year.
The Company reclassified short-term investments on
its Consolidated Balance Sheets in 2003 and on its 2003 and 2002 Statements of Cash Flows, which were previously presented as cash and cash
equivalents. The amounts reclassified totaled $258 million and $152 million in 2003 and 2002, respectively. The purchases and sales related to the
investments held in each of the three years ended January 29, 2005 have been presented on the Consolidated Statements of Cash Flows in the investing
activities section.
The Company receives allowances from landlords to
improve tenant locations. Historically, the Company has recorded tenant allowances as a reduction to the cost of the leasehold improvements and
amortized the credits through amortization expense over the term of the lease period, which was not in accordance with U.S. generally accepted
accounting principles. The Company corrected its accounting during the fourth quarter of 2004, by reclassifying those amounts received in past years
from property and equipment to the deferred rent liability on the Consolidated Balance Sheets. Balances reclassified from property and equipment to the
straight-line liability, which is included in other liabilities, was $22 million in 2004 and $24 million in 2003. The Company also reclassified amounts
on the Consolidated Statements of Operations to reflect an increase in amortization expense and a decrease in occupancy costs, a component of costs of
sales, in each of the respective years. Reclassified in the income statement was $5 million in 2004 and in 2003
31
and $4 million in 2002. There was no change to net income for the years presented. The effect on the Consolidated Statements of Cash Flows was not significant for the years ended January 31, 2004 and February 1, 2003 and therefore have not been reclassified.
Recent Accounting Pronouncements Not Previously Discussed Herein
In November 2004, the FASB issued SFAS No. 151,
“Inventory Costs — an amendment of ARB 43, Chapter 4.” This Statement 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. In addition, this Statement
requires that allocation of fixed production overheads to the costs of conversions be based on the normal capacity of the production facilities. The
Statement is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. Management does not believe that the effect of
the adoption of this Statement will have a material effect on its financial position and results of operations.
In December 2004, the FASB issued SFAS No. 153,
“Exchanges of Nonmonetary Assets — an amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions.”
This Statement requires that exchanges should be recorded and measured at the fair value of the assets exchanged, with certain exceptions. The
Statement is effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. Management does not believe that the
adoption of this Statement will have a material effect on its financial position and results of operations as the Company does not currently have any
exchanges of nonmonetary assets.
| 2 | Acquisitions |
Footaction
The Company consummated its purchase of 349
Footaction stores from Footstar, Inc. on May 7, 2004. Footstar, Inc. filed for Chapter 11 bankruptcy protection on March 2, 2004; consequently, the
disposition of its Footaction stores was conducted under a Bankruptcy Code Section 363 sale process. The U.S. Bankruptcy Court approved the sale on
April 21, 2004 and the waiting period required under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 expired on May 4, 2004. The agreement to
acquire the Footaction stores was in line with the Company’s strategic priorities, including the acquisition of compatible athletic footwear and
apparel retail companies. The Company’s consolidated results of operations include those of Footaction beginning with the date that the
acquisition was consummated.
The Company integrated the Footaction business into
the Athletic Stores segment and is operating the majority of the stores under the Footaction name. The purchase price of $222 million was increased for
direct costs related to the acquisition totaling $4 million. Direct costs include investment banking, legal and accounting fees and other costs. The
Company has allocated the purchase price of approximately $226 million based, in part, upon internal estimates of cash flows, recoverability and
independent appraisals, and may be revised as more definitive facts and evidence become available. Pro forma effects of the acquisition have not been
presented, as their effects were not significant to the consolidated results of operations. The allocation of the purchase price is detailed
below:
| (in millions) |
||||||
|---|---|---|---|---|---|---|
Inventory |
$ | 39 | ||||
Property and
equipment |
45 | |||||
Intangible
assets — amortizing |
29 | |||||
Goodwill |
122 | |||||
Total
assets |
235 | |||||
Accounts
payable and accrued liabilities (1) |
5 | |||||
Other
liabilities (2) |
4 | |||||
Total
liabilities |
9 | |||||
Total
purchase price |
$ | 226 | ||||
(1) |
“Accounts payable and accrued liabilities” include approximately $3 million for anticipated payments to landlords to cancel two of the acquired leases. Also included is approximately $1 million of liabilities related to gift cards assumed. The remaining $1 million relates to transfer taxes and real estate charges assumed from Footstar, Inc. as part of the acquisition. |
(2) |
“Other liabilities” includes $4 million of liabilities assumed for leased locations with rents above their fair value. |
32
In accordance with the purchase agreement, $13.7
million of the purchase price was deposited into an escrow account pending resolution of 15 lease related issues. During 2004, 12 of the issues were
resolved and $9.1 million was released from escrow to the seller and $2.2 million was returned to the Company. Accordingly, this reduced the purchase
price and goodwill by $2.2 million and as of January 29, 2005, $2.4 million remained in escrow.
The Republic of Ireland
On October 18, 2004, the Company purchased 11 stores
in the Republic of Ireland from the Champion Sports Group Limited, an athletic footwear and apparel company. The transaction was effected through a
wholly owned subsidiary. The Company operates these stores under the Foot Locker brand as part of the Athletic Stores segment.
The Company has allocated the purchase price of
approximately €13 million (approximately $17 million), inclusive of $1 million of direct costs related to the acquisition, based, in part, upon
internal estimates of cash flows, recoverability and independent appraisals, and may be revised as more definitive facts and evidence become available.
Pro forma effects of the acquisition have not been presented, as their effects were not significant to the consolidated results of
operations.
The allocation of the purchase price is detailed
below:
| (in millions) |
||||||
|---|---|---|---|---|---|---|
Intangible
assets — amortizing |
$ | 2 | ||||
Intangible
assets — non-amortizing |
3 | |||||
Goodwill |
12 | |||||
Total
assets |
17 | |||||
Other amounts
due and payable (1) |
(1 | ) | ||||
Cash paid as
of January 29, 2005 |
$ | 16 | ||||
(1) |
“Other amounts due and payable” includes professional fees related to the transaction. |
| 3 | Goodwill |
The carrying value of goodwill related to the
Athletic Stores segment was $191 million at January 29, 2005 and $56 million at January 31, 2004. The carrying value of goodwill related to the
Direct-to-Customers segment was $80 million at January 29, 2005 and January 31, 2004.
| Jan. 31, 2004 |
Acquisitions (1) |
Additions |
Other (2) |
Jan. 29, 2005 |
|||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (in millions) |
|||||||||||||||||||||||
Goodwill |
$ | 136 | 134 | — | 1 | $ | 271 | ||||||||||||||||
(1) |
Attributable to the acquisition of 349 Footaction stores and 11 stores in the Republic of Ireland. |
(2) |
Includes effect of foreign currency translation. |
4 Intangible Assets, net
| 2004 |
2003 |
||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| (in millions) |
|||||||||||
Intangible
assets not subject to amortization |
$ | 4 | $ | 2 | |||||||
Intangible
assets subject to amortization (net of accumulated amortization of $70 and $51, respectively) |
131 | 94 | |||||||||
| $ | 135 | $ | 96 | ||||||||
Intangible assets not subject to amortization at
January 29, 2005, include the 11 stores acquired in the Republic of Ireland of $3 million related to the trademark. The minimum pension liability
required at January 29, 2005 and January 31, 2004, 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 at January 29, 2005 and $2 million at January 31, 2004.
33
The changes in the carrying amount of intangibles
subject to amortization for the year ended January 29, 2005 are as follows:
| 2003 |
Acquisitions (1) |
Additions |
Amortization / Other (2) |
2004 |
Wtd. Avg. Useful Life in Years |
||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (in millions) |
|||||||||||||||||||||||||||
Finite life
intangible assets |
|||||||||||||||||||||||||||
Lease
acquisition costs |
$ | 94 | $ | — | $ | 17 | $ | (9 | ) | $ | 102 | 12.2 | |||||||||||||||
Trademark |
— | 21 | — | (1 | ) | 20 | 20.0 | ||||||||||||||||||||
Loyalty
program |
— | 1 | — | — | 1 | 2.0 | |||||||||||||||||||||
Favorable
leases |
— | 9 | — | (1 | ) | 8 | 4.1 | ||||||||||||||||||||
Total |
$ | 94 | $ | 31 | $ | 17 | $ | (11 | ) | $ | 131 | 12.6 | |||||||||||||||
(1) |
Attributable to the acquisition of 349 Footaction stores and 11 stores in the Republic of Ireland. |
(2) |
Includes effect of foreign currency translation. |
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 $17 million, $11 million and $8 million for 2004, 2003 and 2002, respectively. Annual estimated amortization expense for
finite life intangible assets is expected to approximate $19 million for 2005, $18 million for 2006, $16 million for 2007, $14 million for 2008 and $13
million for 2009.
| 5 | Segment Information |
The Company has determined that its reportable
segments are those that are based on its method of internal reporting. As of January 29, 2005, 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
| 2004 |
2003 |
2002 |
|||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (in millions) |
|||||||||||||||
Athletic
Stores |
$ | 4,989 | $ | 4,413 | $ | 4,160 | |||||||||
Direct-to-Customers |
366 | 366 | 349 | ||||||||||||
Total
sales |
$ | 5,355 | $ | 4,779 | $ | 4,509 | |||||||||
34
Operating
Results
| 2004 |
2003 |
2002 |
|||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (in millions) |
|||||||||||||||
Athletic
Stores (1) |
$ | 420 | $ | 363 | $ | 280 | |||||||||
Direct-to-Customers |
45 | 53 | 40 | ||||||||||||
| 465 | 416 | 320 | |||||||||||||
All Other
(2) |
(2 | ) | (1 | ) | 1 | ||||||||||
Division
profit |
463 | 415 | 321 | ||||||||||||
Corporate
expense (3) |
(74 | ) | (73 | ) | (52 | ) | |||||||||
Operating
profit |
389 | 342 | 269 | ||||||||||||
Non-operating
income (4) |
— | — | 3 | ||||||||||||
Interest
expense, net |
(15 | ) | (18 | ) | (26 | ) | |||||||||
Income from
continuing operations before income taxes |
$ | 374 | $ | 324 | $ | 246 | |||||||||
(1) |
2002 includes reductions in restructuring charges of $1 million. Additionally, the Company recorded non-cash pre-tax charges in selling, general and administrative expenses of approximately $7 million in 2002, which represented impairment of long-lived assets such as store fixtures and leasehold improvements related to Athletic Stores. |
(2) |
2004 includes restructuring charges of $2 million. 2003 includes restructuring charges of $1 million. 2002 includes a $1 million reduction in restructuring charges. |
(3) |
2004 includes integration costs of $5 million related to the acquisitions of Footaction and the 11 stores in the Republic of Ireland. |
(4) |
2002 includes $2 million gain related to the condemnation of a part-owned and part-leased property for which the Company received proceeds of $6 million and real estate gains from the sale of corporate properties of $1 million during 2002. |
| Depreciation and Amortization |
Capital Expenditures |
Total Assets |
|||||||||||||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2004 |
2003 |
2002 |
2004 |
2003 |
2002 |
2004 |
2003 |
2002 |
|||||||||||||||||||||||||||||||
| (in millions) |
|||||||||||||||||||||||||||||||||||||||
Athletic
Stores |
$ | 126 | $ | 123 | $ | 123 | $ | 139 | $ | 126 | $ | 124 | $ | 2,335 | $ | 1,739 | $ | 1,591 | |||||||||||||||||||||
Direct-to-Customers |
5 | 4 | 4 | 8 | 6 | 8 | 190 | 183 | 177 | ||||||||||||||||||||||||||||||
| 131 | 127 | 127 | 147 | 132 | 132 | 2,525 | 1,922 | 1,768 | |||||||||||||||||||||||||||||||
Corporate |
23 | 25 | 26 | 9 | 12 | 18 | 711 | 789 | 744 | ||||||||||||||||||||||||||||||
Discontinued
operations |
1 | 2 | 2 | ||||||||||||||||||||||||||||||||||||
Total
Company |
$ | 154 | $ | 152 | $ | 153 | $ | 156 | $ | 144 | $ | 150 | $ | 3,237 | $ | 2,713 | $ | 2,514 | |||||||||||||||||||||
Sales and long-lived asset information by geographic
area as of and for the fiscal years ended January 29, 2005, January 31, 2004 and February 1, 2003 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. No individual
country included in the International category is significant.
Sales
| 2004 |
2003 |
2002 |
|||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (in millions) |
|||||||||||||||
United
States |
$ | 3,982 | $ | 3,597 | $ | 3,639 | |||||||||
International |
1,373 | 1,182 | 870 | ||||||||||||
Total
sales |
$ | 5,355 | $ | 4,779 | $ | 4,509 | |||||||||
Long-Lived Assets
| 2004 |
2003 |
2002 |
|||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (in millions) |
|||||||||||||||
United
States |
$ | 547 | $ | 525 | $ | 544 | |||||||||
International |
168 | 143 | 120 | ||||||||||||
Total
long-lived assets |
$ | 715 | $ | 668 | $ | 664 | |||||||||
35
| 6 | Short-Term Investments |
These 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.
| 2004 |
2003 |
||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| (in millions) |
|||||||||||
Tax exempt
municipal bonds |
$ | 50 | $ | 44 | |||||||
Taxable
bonds |
40 | — | |||||||||
Equity
securities |
177 | 214 | |||||||||
| $ | 267 | $ | 258 | ||||||||
Contractual maturities of the bonds outstanding at
January 29, 2005 range from 2021 to 2039.
| 7 | Merchandise Inventories |
| 2004 |
2003 |
||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| (in millions) |
|||||||||||
LIFO
inventories |
$ | 856 | $ | 651 | |||||||
FIFO
inventories |
295 | 269 | |||||||||
Total
merchandise inventories |
$ | 1,151 | $ | 920 | |||||||
| The value of the Company’s LIFO inventories, as calculated on a LIFO basis, approximates their value as calculated on a FIFO basis. |
| 8 | Other Current Assets |
| 2004 |
2003 |
||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| (in millions) |
|||||||||||
Net
receivables |
$ | 47 | $ | 41 | |||||||
Prepaid expenses
and other current assets |
47 | 45 | |||||||||
Prepaid income
taxes |
40 | — | |||||||||
Deferred
taxes |
53 | 60 | |||||||||
Current portion
of Northern Group note receivable |
1 | 2 | |||||||||
Fair value of
derivative contracts |
— | 1 | |||||||||
| $ | 188 | $ | 149 | ||||||||
| 9 | Property and Equipment, net |
| 2004 |
2003 |
||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| (in millions) |
|||||||||||
Land |
$ | 3 | $ | 3 | |||||||
Buildings: |
|||||||||||
Owned |
31 | 32 | |||||||||
Furniture,
fixtures and equipment: |
|||||||||||
Owned |
1,072 | 1,015 | |||||||||
Leased |
14 | 14 | |||||||||
| 1,120 | 1,064 | ||||||||||
Less:
accumulated depreciation |
(755 | ) | (706 | ) | |||||||
| 365 | 358 | ||||||||||
Alterations to leased and owned buildings, net of accumulated amortization |
350 | 310 | |||||||||
| $ | 715 | $ | 668 | ||||||||
36
| 10 | Other Assets |
| 2004 |
2003 |
||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| (in millions) |
|||||||||||
Deferred tax
costs |
$ | 25 | $ | 35 | |||||||
Investments and
notes receivable |
22 | 23 | |||||||||
Northern Group
note receivable, net of current portion |
8 | 6 | |||||||||
Income taxes
receivable |
— | 1 | |||||||||
Fair value of
derivative contracts |
2 | — | |||||||||
Other |
47 | 35 | |||||||||
| $ | 104 | $ | 100 | ||||||||
| 11 | Accrued Liabilities |
| 2004 |
2003 |
||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| (in millions) |
|||||||||||
Pension and
postretirement benefits |
$ | 30 | $ | 57 | |||||||
Incentive
bonuses |
34 | 38 | |||||||||
Other payroll
and payroll related costs, excluding taxes |
51 | 44 | |||||||||
Taxes other than
income taxes |
45 | 44 | |||||||||
Property and
equipment |
22 | 32 | |||||||||
Gift cards and
certificates |
22 | 16 | |||||||||
Income taxes
payable |
9 | 9 | |||||||||
Fair value of
derivative contracts |
3 | 3 | |||||||||
Current deferred
tax liabilities |
1 | — | |||||||||
Other operating
costs |
58 | 57 | |||||||||
| $ | 275 | $ | 300 | ||||||||
| 12 | Revolving Credit Facility |
At January 29, 2005, the Company had unused domestic
lines of credit of $175 million, pursuant to a $200 million unsecured revolving credit agreement. $25 million of the line of credit was committed to
support standby letters of credit. These letters of credit are primarily used for insurance programs.
On May 19, 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 January 29, 2005. Existing unamortized financing fees as
well as new up-front fees paid, and direct costs incurred, to amend the agreement are amortized over the life of the facility on a straight-line basis,
which is comparable to the interest method, totaling approximately $4 million at January 29, 2005. 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 1.375 percent
to LIBOR plus 2.25 percent. In addition, the quarterly facility fees paid on the unused portion during 2004, which is also based on the Company’s
fixed charge coverage ratio, ranged from 0.25 percent in the earlier part of 2004 to 0.175 percent by the end of 2004, which was based on the
Company’s third quarter fixed charge coverage ratio. Quarterly facility fees paid in 2003 ranged from 0.50 percent, in the earlier part, to 0.25
percent during the fourth quarter of 2003, also based on the Company’s improved fixed charge coverage ratio. There were no short-term borrowings
during 2004 or 2003.
Interest expense, including facility fees, related
to the revolving credit facility was $2 million in 2004 and $3 million in both 2003 and 2002.
37
| 13 | Long-Term Debt and Obligations under Capital Leases |
In 2001, the Company issued $150 million of
subordinated convertible notes due 2008, at an interest rate of 5.50 percent. The notes were convertible into the Company’s common stock at the
option of the holder at a conversion price of $15.806 per share. The Company notified The Bank of New York, as Trustee under the indenture, that it
intended to redeem its entire $150 million outstanding 5.50 percent convertible subordinated notes. 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. The Company reclassified the
remaining $3 million of unamortized deferred costs related to the original issuance of the convertible debt to equity as a result of the
conversion.
During 2002, the Company purchased and retired $9
million of the $200 million 8.50 percent debentures payable in 2022. In 2003, the Company purchased and retired an additional $19 million of the $200
million debentures, bringing the total amount retired to date to $28 million. The Company entered into an interest rate swap agreement in December 2002
to convert $50 million of the 8.50 percent debentures to variable rate debt. The interest rate swap did not have a significant effect on interest
expense in 2002. In 2003, the Company entered into two additional swaps, to convert an additional $50 million of the 8.50 percent debentures to
variable rate debt. The outstanding interest rate swaps during 2003 converted a total of $100 million of the 8.50 percent fixed rate on the debentures
to lower variable rates resulting in a reduction of interest expense of approximately $4 million. During July 2004, the Company entered into an
additional $100 million of interest rate swaps to further reduce the existing $100 million of outstanding swaps to a lower average rate. The effect of
all swaps resulted in a combined reduction in interest expense of $3 million in 2004. As of January 29, 2005, swaps converting a total of $100 million of
debentures were outstanding.
The fair value of the interest rate swaps at January
29, 2005 comprised $2 million, which was included in other assets. The carrying value of the 8.50 percent debentures was increased by $4 million for
the swaps that were classified as fair value hedges and the remaining $2 million of swaps were classified as cash flow hedges, whereby the changes in
their fair value have been included in other comprehensive loss. The fair value of the swaps, included in other liabilities, was approximately $1
million at January 31, 2004 and the carrying value of the 8.50 percent debentures was decreased by the corresponding amount.
On May 19, 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 initial interest rate on the LIBOR-based, floating-rate loan was 2.625 percent and was 3.875 percent on January 29, 2005.
The loan requires minimum principal payments each May, equal to a percentage of the original principal amount of 10 percent in years 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.
Following is a summary of long-term debt and
obligations under capital leases:
| 2004 |
2003 |
||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| (in millions) |
|||||||||||
8.50% debentures
payable 2022 |
$ | 176 | $ | 171 | |||||||
$175 million
term loan |
175 | — | |||||||||
5.50%
convertible notes |
— | 150 | |||||||||
Total
long-term debt |
351 | 321 | |||||||||
Obligations
under capital leases |
14 | 14 | |||||||||
| 365 | 335 | ||||||||||
Less: Current
portion |
18 | — | |||||||||
| $ | 347 | $ | 335 | ||||||||
38
Maturities of long-term debt and minimum rent
payments under capital leases in future periods are:
| Long-Term Debt |
Capital Leases |
Total |
|||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (in millions) |
|||||||||||||||
2005 |
$ | 18 | $ | — | $ | 18 | |||||||||
2006 |
18 | — | 18 | ||||||||||||
2007 |
26 | 14 | 40 | ||||||||||||
2008 |
26 | — | 26 | ||||||||||||
2009 |
87 | — | 87 | ||||||||||||
Thereafter |
176 | — | 176 | ||||||||||||
| 351 | 14 | 365 | |||||||||||||
Less: Current portion |
18 | — | 18 | ||||||||||||
| $ | 333 | $ | 14 | $ | 347 | ||||||||||
Interest expense related to long-term debt and
capital lease obligations, including the amortization of the associated debt issuance costs, was $19 million in 2004, $22 million in 2003 and $28
million in 2002.
14 Leases
The Company is obligated under operating leases for
almost all of its store properties. Some of the store leases contain purchase or 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.
Rent expense consists of the
following:
| 2004 |
2003 |
2002 |
|||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (in millions) |
|||||||||||||||
Rent |
$ | 605 | $ | 532 | $ | 491 | |||||||||
Contingent
rent based on sales |
11 | 11 | 11 | ||||||||||||
Sublease
income |
(1 | ) | (1 | ) | (1 | ) | |||||||||
Total rent
expense |
$ | 615 | $ | 542 | $ | 501 | |||||||||
Future minimum lease payments under non-cancelable
operating leases are:
| (in millions) |
||||||
|---|---|---|---|---|---|---|
2005 |
$ | 449 | ||||
2006 |
423 | |||||
2007 |
383 | |||||
2008 |
322 | |||||
2009 |
256 | |||||
Thereafter |
890 | |||||
Total
operating lease commitments |
$ | 2,723 | ||||
Present value
of operating lease commitments |
$ | 1,989 | ||||
39
| 15 | Other Liabilities |
| 2004 |
2003 |
||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| (in millions) |
|||||||||||
Pension
benefits |
$ | 130 | $ | 175 | |||||||
Postretirement
benefits |
95 | 113 | |||||||||
Straight-line
rent liability |
77 | 67 | |||||||||
Income
taxes |
29 | 62 | |||||||||
Workers’
compensation / general liability reserves |
11 | 12 | |||||||||
Reserve for
discontinued operations |
11 | 11 | |||||||||
Repositioning
and restructuring reserves |
3 | 2 | |||||||||
Fair value of
derivatives |
— | 1 | |||||||||
Unfavorable
leases |
3 | — | |||||||||
Other |
17 | 15 | |||||||||
| $ | 376 | $ | 458 | ||||||||
| 16 | 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 (approximately US$38 million), which was paid in the form of a note (the “Note”). 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. The net amount of the assets and liabilities of the former operations was written down to the estimated fair value of the Note. The
transaction was accounted for pursuant to SEC Staff Accounting Bulletin Topic 5:E “Accounting for Divestiture of a Subsidiary or Other Business
Operation,” as a “transfer of assets and liabilities under contractual arrangement” as no cash proceeds were received and the
consideration comprised the Note, the repayment of which was dependent on the future successful operations of the business.
An agreement in principle had been reached during
December 2002 to receive CAD$5 million (approximately US$3 million) cash consideration in partial prepayment of the Note and accrued interest, and
further, the Company agreed to reduce the face value of the Note to CAD$17.5 million (approximately US$12 million). During the fourth quarter of 2002,
circumstances had changed sufficiently such that it became appropriate to recognize the transaction as an accounting divestiture. Accordingly, the Note
was recorded in the financial statements at its estimated fair value of CAD$16 million (approximately US$10 million). On May 6, 2003, the amendments to
the Note were executed and a cash payment of CAD$5.2 million was received from the purchasers of the Northern Group, representing principal and
interest through the date of the amendment. On January 15, 2004, the Company received an additional payment of CAD$1 million, representing a partial
repayment of the Note. On August 20, 2004, the Company received a contingent payment of CAD$1 million, which was based upon a certain transaction that
occurred. As a result of the settlement of the contingent transaction, the CAD$17.5 million Note was replaced with a new CAD$15.5 million note. The
terms of the new note are substantially the same as the May 6, 2003 Note, including the expiration date and interest payment terms.
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, however the business has sustained unexpected operating losses during the past
fiscal year. The Company has evaluated the projected performance of the business and will continue to monitor its results during the coming
year.
At January 29, 2005 and January 31, 2004, US$1
million and US$2 million, respectively, are 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 timely and in accordance with the terms of
the Note.
40
As indicated above, as the assignor of the Northern
Canada leases, the Company remained secondarily liable under these leases. As of January 29, 2005, the Company estimates that its gross contingent
lease liability is CAD$31 million (approximately US$25 million). The Company currently estimates the expected value of the lease liability to be
approximately US$1 million. The Company believes that it is unlikely that it would be required to make such contingent payments.
During the third quarter of 2003, a charge in the
amount of $1 million before-tax was recorded to cover additional liabilities related to the exiting of the former leased corporate office in excess of
the previous estimate. In the fourth quarter of 2003, the Company made a CAD$10 million payment (approximately US$7 million) to the landlord, which
released the Company from all future liability related to the lease. Net disposition activity of $13 million in 2002 included the $18 million reduction
in the carrying value of the net assets and liabilities, recognition of the Note of $10 million, real estate disposition activity of $1 million and
severance and other costs of $4 million.
In 1998, the Company exited both its International
General Merchandise and Specialty Footwear segments. During the first quarter of 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.
In 1997, the Company exited its Domestic General
Merchandise segment. In 2002, the successor-assignee of the leases of a former business included in the Domestic General Merchandise segment filed a
petition in bankruptcy, and rejected in the bankruptcy proceeding 15 leases it originally acquired from a subsidiary of the Company, two of the actions
brought against this subsidiary remain unresolved as of January 29, 2005. The gross contingent lease liability, related to these two leases, is
approximately $3 million. The Company believes that it may have valid defenses; however, the outcome of the remaining actions cannot be predicted with
any degree of certainty. The Company recorded charges totaling $4 million related to certain of these actions, as well as others that have been
settled, during the second and fourth quarters of 2003.
The results of operations and assets and liabilities
for the Northern Group segment, the International General Merchandise segment, the Specialty Footwear segment and the Domestic General Merchandise
segment have been classified as discontinued operations for all periods presented in the Consolidated Statements of Operations and Consolidated Balance
Sheets.
The assets of the discontinued operations consisted
primarily of fixed assets related to the Domestic General Merchandise segment as of January 29, 2005 and as of January 31, 2004. Liabilities of
discontinued operations at January 29, 2005 and January 31, 2004, included accounts payable, restructuring reserves and other accrued liabilities
related to the Northern Group and the Domestic General Merchandise segments.
The remaining reserve balances for all of the
discontinued segments totaled $18 million as of January 29, 2005, $7 million of which is expected to be utilized within twelve months and the remaining
$11 million thereafter.
41
The major components of the pre-tax losses (gains)
on disposal and disposition activity related to the reserves are presented below:
Northern Group
| 2001 |
2002 |
2003 |
2004 |
||||||||||||||||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Balance |
Charge/ (Income) |
Net Usage* |
Balance |
Charge/ (Income) |
Net Usage* |
Balance |
Charge/ (Income) |
Net Usage* |
Balance |
||||||||||||||||||||||||||||||||||
| (in millions) |
|||||||||||||||||||||||||||||||||||||||||||
Asset
write-offs & impairments |
$ | — | $ | 18 | $ | (18) | $ | — | $ | — | $ | — | $ | — | $ | — | $ | — | $ | — | |||||||||||||||||||||||
Recognition of
note receivable |
— | (10) | 10 | — | — | — | — | — | — | — | |||||||||||||||||||||||||||||||||
Real estate
& lease liabilities |
6 | 1 | (1 | ) | 6 | 1 | (7 | ) | — | — | — | — | |||||||||||||||||||||||||||||||
Severance &
personnel |
2 | — | (2 | ) | — | — | — | — | — | — | — | ||||||||||||||||||||||||||||||||
Operating
losses & other costs |
3 | — | (2 | ) | 1 | — | 1 | 2 | — | 1 | 3 | ||||||||||||||||||||||||||||||||
Total |
$ | 11 | $ | 9 | $ | (13 | ) | $ | 7 | $ | 1 | $ | (6 | ) | $ | 2 | $ | — | $ | 1 | $ | 3 | |||||||||||||||||||||
International General Merchandise
| 2001 |
2002 |
2003 |
2004 |
||||||||||||||||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Balance |
Charge/ (Income) |
Net Usage* |
Balance |
Charge/ (Income) |
Net Usage* |
Balance |
Charge/ (Income) |
Net Usage* |
Balance |
||||||||||||||||||||||||||||||||||
| (in millions) |
|||||||||||||||||||||||||||||||||||||||||||
Woolco |
$ | — | $ | 1 | $ | — | $ | 1 | $ | — | $ | (1 | ) | $ | — | $ | — | $ | — | $ | — | ||||||||||||||||||||||
The Bargain!
Shop |
6 | — | — | 6 | — | (1 | ) | 5 | — | — | 5 | ||||||||||||||||||||||||||||||||
Total |
$ | 6 | $ | 1 | $ | — | $ | 7 | $ | — | $ | (2 | ) | $ | 5 | $ | — | $ | — | $ | 5 | ||||||||||||||||||||||
Specialty Footwear
| 2001 |
2002 |
2003 |
2004 |
||||||||||||||||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Balance |
Charge/ (Income) |
Net Usage |
Balance |
Charge/ (Income) |
Net Usage |
Balance |
Charge/ (Income) |
Net Usage |
Balance |
||||||||||||||||||||||||||||||||||
| (in millions) |
|||||||||||||||||||||||||||||||||||||||||||
Lease
liabilities |
$ | 7 | $ | (4) | $ | (1) | $ | 2 | $ | — | $ | — | $ | 2 | $ | — | $ | — | $ | 2 | |||||||||||||||||||||||
Operating
losses & other costs |
2 | — | (1 | ) | 1 | — | (1 | ) | — | (1 | ) | 1 | — | ||||||||||||||||||||||||||||||
Total |
$ | 9 | $ | (4 | ) | $ | (2 | ) | $ | 3 | $ | — | $ | (1 | ) | $ | 2 | $ | (1 | ) | $ | 1 | $ | 2 | |||||||||||||||||||
Domestic General Merchandise
| 2001 |
2002 |
2003 |
2004 |
||||||||||||||||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Balance |
Charge/ (Income) |
Net Usage |
Balance |
Charge/ (Income) |
Net Usage |
Balance |
Charge/ (Income) |
Net Usage |
Balance |
||||||||||||||||||||||||||||||||||
| (in millions) |
|||||||||||||||||||||||||||||||||||||||||||
Lease
liabilities |
$ | 10 | $ | — | $ | (3 | ) | $ | 7 | $ | — | $ | (1 | ) | $ | 6 | $ | — | $ | — | $ | 6 | |||||||||||||||||||||
Legal and other
costs |
2 | 5 | (4 | ) | 3 | 4 | (3 | ) | 4 | — | (2 | ) | 2 | ||||||||||||||||||||||||||||||
Total |
$ | 12 | $ | 5 | $ | (7 | ) | $ | 10 | $ | 4 | $ | (4 | ) | $ | 10 | $ | — | $ | (2 | ) | $ | 8 | ||||||||||||||||||||
* |
Net usage includes effect of foreign exchange translation adjustments |
42
17 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 an assignor or guarantor of leases of SFMB related to a distribution center and five store locations. In May 2003, SFMB filed a voluntary
petition under Chapter 11 of the Bankruptcy Code in the U.S. Bankruptcy Court for the District of Delaware. During July and August 2003, SFMB rejected
four of the store leases and the distribution center lease and assumed one of the store leases in the bankruptcy proceedings. During the second
quarters of 2003 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, while the store leases expired on January 31, 2004. As of January 29, 2005, the Company
estimates its gross contingent lease liability for the distribution center lease to be approximately $4 million, offset in part by the estimated
sublease income of $2 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. In addition, the Company is considering additional sublease offers for the remaining square
footage. Accordingly, at January 29, 2005 the reserve balance is $2 million.
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 January
29, 2005 the reserve balance is $2 million.
Total Repositioning and Restructuring Reserves
The components of the pre-tax losses (gains) on
restructuring charges and disposition activity related to the reserves are presented below:
| 2001 |
2002 |
2003 |
2004 |
||||||||||||||||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Balance |
Charge/ (Income) |
Net Usage |
Balance |
Charge/ (Income) |
Net Usage |
Balance |
Charge/ (Income) |
Net Usage |
Balance |
||||||||||||||||||||||||||||||||||
| (in millions) |
|||||||||||||||||||||||||||||||||||||||||||
Real
estate |
$ | 3 | $ | — | $ | (1 | ) | $ | 2 | $ | 1 | $ | (1 | ) | $ | 2 | $ | 2 | $ | (1 | ) | $ | 3 | ||||||||||||||||||||
Other
disposition costs |
5 | (2 | ) | (2 | ) | 1 | — | — | 1 | — | — | 1 | |||||||||||||||||||||||||||||||
Total |
$ | 8 | $ | (2 | ) | $ | (3 | ) | $ | 3 | $ | 1 | $ | (1 | ) | $ | 3 | $ | 2 | $ | (1 | ) | $ | 4 | |||||||||||||||||||
At January 29, 2005, $1 million of the total
restructuring reserves is expected to be utilized within the next twelve months and the remaining $3 million thereafter.
| 18 | Income Taxes |
Following are the domestic and international
components of pre-tax income from continuing operations:
| 2004 |
2003 |
2002 |
|||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (in millions) |
|||||||||||||||
Domestic |
$ | 222 | $ | 186 | $ | 160 | |||||||||
International |
152 | 138 | 86 | ||||||||||||
Total pre-tax
income |
$ | 374 | $ | 324 | $ | 246 | |||||||||
43
The income tax provision consists of the
following:
| 2004 |
2003 |
2002 |
|||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (in millions) |
|||||||||||||||
Current: |
|||||||||||||||
Federal |
$ | 11 | $ | 48 | $ | 16 | |||||||||
State and
local |
6 | 14 | 5 | ||||||||||||
International |
52 | 58 | 25 | ||||||||||||
Total current
tax provision |
69 | 120 | 46 | ||||||||||||
Deferred: |
|||||||||||||||
Federal |
43 | 11 | 31 | ||||||||||||
State and
local |
8 | (6 | ) | — | |||||||||||
International |
(1 | ) | (10 | ) | 7 | ||||||||||
Total
deferred tax provision |
50 | (5 | ) | 38 | |||||||||||
Total income
tax provision |
$ | 119 | $ | 115 | $ | 84 | |||||||||
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 $327 million and $239 million at January 29, 2005 and January 31, 2004,
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:
| 2004 |
2003 |
2002 |
||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Federal
statutory income tax rate |
35.0 | % | 35.0 | % | 35.0 | % | ||||||||
State and
local income taxes, net of federal tax benefit |
2.3 | 2.4 | 2.0 | |||||||||||
International
income taxed at varying rates |
(0.6 | ) | 0.5 | 1.0 | ||||||||||
Foreign tax
credit utilization |
(2.5 | ) | (1.0 | ) | (1.2 | ) | ||||||||
Increase
(decrease) in valuation allowance |
0.1 | (1.5 | ) | (2.0 | ) | |||||||||
Federal/foreign tax settlements |
(3.3 | ) | — | — | ||||||||||
State and
local tax settlements |
— | (0.2 | ) | (0.3 | ) | |||||||||
Tax exempt
obligations |
(0.2 | ) | (0.2 | ) | (0.1 | ) | ||||||||
Work
opportunity tax credit |
(0.2 | ) | (0.1 | ) | (0.3 | ) | ||||||||
Other,
net |
1.1 | 0.6 | 0.1 | |||||||||||
Effective
income tax rate |
31.7 | % | 35.5 | % | 34.2 | % | ||||||||
Items that gave rise to significant portions of the
deferred tax accounts are as follows:
| 2004 |
2003 |
||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| (in millions) |
|||||||||||
Deferred tax
assets: |
|||||||||||
Tax
loss/credit carryforwards |
$ | 89 | $ | 99 | |||||||
Employee
benefits |
116 | 135 | |||||||||
Reserve for
discontinued operations |
5 | 8 | |||||||||
Repositioning
and restructuring reserves |
3 | 2 | |||||||||
Property and
equipment |
89 | 81 | |||||||||
Allowance for
returns and doubtful accounts |
7 | 10 | |||||||||
Straight-line
rent |
19 | 17 | |||||||||
Goodwill |
— | 1 | |||||||||
Other |
17 | 22 | |||||||||
Total deferred
tax assets |
345 | 375 | |||||||||
Valuation
allowance |
(124 | ) | (122 | ) | |||||||
Total
deferred tax assets, net |
$ | 221 | $ | 253 | |||||||
44
| 2004 |
2003 | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| (in millions) |
|||||||||||
Deferred tax
liabilities: |
|||||||||||
Inventories |
$ | 8 | $ | 13 | |||||||
Goodwill |
2 | — | |||||||||
Other |
1 | 1 | |||||||||
Total deferred
tax liabilities |
11 | 14 | |||||||||
Net deferred tax
asset |
$ | 210 | $ | 239 | |||||||
Balance Sheet
caption reported in: |
|||||||||||
Deferred
taxes |
$ | 180 | $ | 194 | |||||||
Other current
assets |
53 | 60 | |||||||||
Other current
liabilities |
(1 | ) | — | ||||||||
Other
liabilities |
(22 | ) | (15 | ) | |||||||
| $ | 210 | $ | 239 | ||||||||
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 position 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 2003. The IRS has begun a voluntary pre-filing review process for
2004. The pre-filing review process is expected to conclude during 2005. The Company has also agreed to participate in the IRS’ Compliance
Assurance Process (“CAP”) for 2005.
The American Jobs Creation Act of 2004 (the
“Act”) was signed into law on October 22, 2004. The Act contains numerous amendments and additions to the U.S. corporate income tax rules.
None of these changes, either individually or in the aggregate, is expected to have a significant effect on the Company’s income tax liability.
The Company does not expect to take advantage of the Act’s repatriation provisions.
As of January 29, 2005, the Company had a valuation
allowance of $124 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 net change in the total valuation allowance for the year ended January 29,
2005, was principally due to an increase in the Canadian and state valuation allowances relating, respectively, to a current year increase in Canadian
deferred tax assets and state net operating losses for which the Company does not expect to receive future benefit.
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 January 29, 2005.
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 29, 2005, the Company’s tax
loss/credit carryforwards included international operating loss carryforwards with a potential tax benefit of $33 million. Those expiring between 2005
and 2011 total $32 million and those that do not expire total $1 million. The Company also had state net operating loss carryforwards with a potential
tax benefit of $28 million, which principally related to the 16 states where the Company does not file a combined return. These loss carryforwards
expire between 2005 and 2025 as well as foreign tax credits totaling $1 million, which expire 2015. The Company had U.S. Federal alternative minimum
tax credits and Canadian capital loss carryforwards of approximately $17 million and $10 million, respectively, which do not expire.
45
| 19 | Financial Instruments and Risk Management |
Foreign Exchange 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. Also, the Company mitigates the effect of fluctuating foreign exchange rates on the reporting of foreign currency denominated earnings.
Such strategies may at times include holding a variety of derivative instruments, which includes entering into forwards and option contracts, whereby
the changes in the fair value of these financial instruments are charged to the statements of operations immediately. For a derivative to qualify as a
hedge at inception and throughout the hedged period, the Company formally documents the nature and relationships between the hedging instruments and
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 2004 or 2003.
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. When using a forward contract as a hedging instrument, the Company excludes the time
value from the assessment of effectiveness. The change in a forward contract’s time value is reported in earnings. For forward foreign exchange
contracts designated as cash flow hedges 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. Amounts classified to cost of sales related to
such contracts were a loss of approximately $1 million in 2004 and a gain of $2 million in 2003. The ineffective portion of gains and losses related to
cash flow hedges recorded to earnings in 2004 was approximately $1 million and was not significant in 2003. The Company also enters into other forward
contracts to hedge intercompany royalty cash flows that are denominated in foreign currencies. The effective portion of gains and losses associated
with these forward contracts is reclassified from accumulated other comprehensive loss to selling, general and administrative expenses in the same
quarter as the underlying intercompany royalty transaction occurs and were not significant for any of the periods presented.
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 changes in fair value of forward contracts and
option contracts that do not qualify as hedges are recorded in earnings. In 2004, the Company entered into certain forward foreign exchange contracts
to hedge intercompany foreign-currency denominated firm commitments and recorded losses of approximately $2 million in selling, general and
administrative expenses to reflect their fair value. These losses were offset by the foreign exchange gains on the revaluation of the underlying
commitments, which were expected to be settled in 2004 and 2005.
In 2003, the Company recorded a gain of
approximately $7 million for the change in fair value of derivative instruments not designated as hedges, which was offset by a foreign exchange loss
related to the underlying transactions. These amounts were primarily related to the intercompany foreign-currency denominated firm commitments, as the
gains on the other forward contracts were not significant.
The fair value of derivative contracts outstanding
at January 29, 2005 comprised other assets of $2 million and current liabilities of $3 million. The fair value of derivative contracts outstanding at
January 31, 2004 comprised current assets of $1 million, current liabilities of $3 million, and other liabilities of $1 million.
46
Foreign Currency Exchange Rates
The table below presents the fair value, notional
amounts, and weighted-average exchange rates of foreign exchange forward contracts outstanding at January 29, 2005.
| Fair Value (US in millions) |
Contract Value (US in millions) |
Weighted-Average Exchange Rate |
||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Inventory |
||||||||||||||
Buy €/Sell
British £ |
$ | — | $ | 59 | 0.6996 | |||||||||
Intercompany |
||||||||||||||
Buy €/Sell
$US |
$ | — | $ | 6 | 1.2290 | |||||||||
Buy $US/Sell
€ |
(3 | ) | 69 | 1.2432 | ||||||||||
Buy €/Sell
British £ |
— | 17 | 0.7187 | |||||||||||
| $ | (3 | ) | $ | 151 | ||||||||||
Interest Rate Risk Management
The Company has employed interest rate swaps to
minimize its exposure to interest rate fluctuations. In 2002, the Company entered into an interest rate swap agreement with a notional amount of $50
million to receive interest at a fixed rate of 8.50 percent and pay interest at a variable 6-month rate of LIBOR in arrears plus 3.1 percent. During 2003, the
Company entered into two additional swaps to convert an additional $50 million of the 8.50 percent debentures to an average variable 6-month rate of
LIBOR in arrears plus 3.313 percent. 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. During July 2004, the Company entered into an
additional $100 million of interest rate swaps, designated as cash flow hedges, to effectively convert the interest rate on its existing $100 million
swaps from a 6-month variable rate to a 1-month variable rate of LIBOR plus 0.25 percent.
The fair value of the swaps was approximately $2
million at January 29, 2005. The carrying value of the 8.50 percent debentures was increased by $4 million for the portion of the swaps designated as
fair value hedges. Accumulated other comprehensive loss was decreased by the fair value of $2 million related to the swaps that were designated as cash
flow hedges.
The fair value of the swaps, included as an addition
to other liabilities, was approximately $1 million at January 31, 2004 and the carrying value of the 8.50 percent debentures was decreased by the
corresponding amount.
The following table presents the Company’s
outstanding interest rate derivatives:
| 2004 |
2003 |
2002 |
|||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| ($ in millions) |
|||||||||||||||
Interest Rate
Swaps: |
|||||||||||||||
Fixed to
Variable ($US) |
$ | 100 | $ | 100 | $ | 50 | |||||||||
Average pay
rate |
6.46 | % | 5.07 | % | 4.53 | % | |||||||||
Average
receive rate |
8.50 | % | 8.50 | % | 8.50 | % | |||||||||
Variable to
variable ($US) |
$ | 100 | $ | — | $ | — | |||||||||
Average pay
rate |
2.73 | % | — | % | — | % | |||||||||
Average
receive rate |
3.25 | % | — | % | — | % | |||||||||
Interest Rates
The Company’s major exposure to market risk is
to changes in interest rates, primarily in the United States. There were no short-term borrowings outstanding as of January 29, 2005 or January 31,
2004, respectively.
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 January 29,
2005, of the Company’s long-term debt obligations.
| 2005 |
2006 |
2007 |
2008 |
2009 |
Thereafter |
Jan. 29, 2005 Total |
Jan. 31, 2004 Total |
||||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| ($ in millions) |
|||||||||||||||||||||||||||||||||||
Long-term
debt |
$ | 18 | 18 | 26 | 26 | 87 | 193 | $ | 368 | $ | 435 | ||||||||||||||||||||||||
Weighted-average interest rate |
5.2 | % | 5.3 | % | 5.4 | % | 5.6 | % | 6.6 | % | 6.9 | % | |||||||||||||||||||||||
47
Fair Value of Financial Instruments
The carrying value and estimated fair value of
long-term debt was $351 million and $368 million, respectively, at January 29, 2005 and $321 million and $435 million, respectively, at January 31,
2004. The carrying value and estimated fair value of long-term investments and notes receivable was $32 million and $33 million, respectively, at
January 29, 2005, and $31 million and $33 million, respectively, at January 31, 2004. The carrying values of cash and cash equivalents, short-term
investments and other current receivables and payables approximate their fair value.
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 18 countries and purchases merchandise from hundreds of vendors worldwide. In 2004, the Company
purchased approximately 45 percent of its athletic merchandise from one major vendor and approximately 13 percent from another major vendor. The
Company generally considers all vendor relations to be satisfactory.
Included in the Company’s Consolidated Balance
Sheet as of January 29, 2005, are the net assets of the Company’s European operations totaling $415 million, which are located in 14 countries, 10
of which have adopted the euro as their functional currency.
| 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 January
each year.
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 29, 2005
and January 31, 2004:
| Pension Benefits |
Postretirement Benefits |
||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2004 |
2003 |
2004 |
2003 |
||||||||||||||||
| (in millions) |
|||||||||||||||||||
Change in
benefit obligation |
|||||||||||||||||||
Benefit
obligation at beginning of year |
$ | 697 | $ | 685 | $ | 27 | $ | 30 | |||||||||||
Service
cost |
9 | 8 | — | — | |||||||||||||||
Interest
cost |
39 | 43 | 1 | 1 | |||||||||||||||
Plan
participants’ contributions |
— | — | 5 | 5 | |||||||||||||||
Actuarial
loss |
16 | 18 | — | 1 | |||||||||||||||
Foreign
currency translation adjustments |
5 | 11 | — | — | |||||||||||||||
Benefits
paid |
(63 | ) | (68 | ) | (9 | ) | (10 | ) | |||||||||||
Benefit
obligation at end of year |
$ | 703 | $ | 697 | $ | 24 | $ | 27 | |||||||||||
Change in
plan assets |
|||||||||||||||||||
Fair value of
plan assets at beginning of year |
$ | 474 | $ | 380 | |||||||||||||||
Actual return
on plan assets |
28 | 101 | |||||||||||||||||
Employer
contribution |
108 | 54 | |||||||||||||||||
Foreign
currency translation adjustments |
4 | 7 | |||||||||||||||||
Benefits
paid |
(63 | ) | (68 | ) | |||||||||||||||
Fair value of
plan assets at end of year |
$ | 551 | $ | 474 | |||||||||||||||
48
| Pension Benefits |
Postretirement Benefits |
||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2004 |
2003 |
2004 |
2003 | ||||||||||||||||
| (in millions) |
|||||||||||||||||||
Funded
status |
|||||||||||||||||||
Funded
status |
$ | (152 | ) | $ | (223 | ) | $ | (24 | ) | $ | (27 | ) | |||||||
Unrecognized
prior service cost (benefit) |
4 | 5 | (10 | ) | (11 | ) | |||||||||||||
Unrecognized
net (gain) loss |
324 | 296 | (67 | ) | (80 | ) | |||||||||||||
Prepaid asset
(accrued liability) |
$ | 176 | $ | 78 | $ | (101 | ) | $ | (118 | ) | |||||||||
Balance
Sheet caption reported in: |
|||||||||||||||||||
Intangible
assets |
$ | 1 | $ | 2 | $ | — | $ | — | |||||||||||
Accrued
liabilities |
(24 | ) | (52 | ) | (6 | ) | (5 | ) | |||||||||||
Other
liabilities |
(130 | ) | (175 | ) | (95 | ) | (113 | ) | |||||||||||
Accumulated
other comprehensive loss, pre-tax |
329 | 303 | — | — | |||||||||||||||
| $ | 176 | $ | 78 | $ | (101 | ) | $ | (118 | ) | ||||||||||
The change in the additional minimum liability in
2004 was an increase of $14 million after-tax and a decrease of $16 million after-tax in 2003 to accumulated other comprehensive loss.
As of January 29, 2005 and January 31, 2004, the
accumulated benefit obligation for all pension plans, totaling $702 million and $696 million, respectively, exceeded plan assets.
The following weighted-average assumptions were used
to determine the benefit obligations under the plans:
| Pension Benefits |
Postretirement Benefits |
||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2004 |
2003 |
2004 |
2003 |
||||||||||||||||
Discount
rate |
5.50 | % | 5.90 | % | 5.50 | % | 5.90 | % | |||||||||||
Rate of
compensation increase |
3.79 | % | 3.72 | % | |||||||||||||||
The components of net benefit expense (income)
are:
| Pension Benefits |
Postretirement Benefits |
||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2004 |
2003 |
2002 |
2004 |
2003 |
2002 |
||||||||||||||||||||||
| (in millions) |
|||||||||||||||||||||||||||
Service
cost |
$ | 9 | $ | 8 | $ | 8 | $ | — | $ | — | $ | — | |||||||||||||||
Interest
cost |
39 | 43 | 44 | 1 | 2 | 2 | |||||||||||||||||||||
Expected return
on plan assets |
(48 | ) | (46 | ) | (50 | ) | — | — | — | ||||||||||||||||||
Amortization of
prior service cost (benefit) |
1 | — | 1 | (1 | ) | (1 | ) | (1 | ) | ||||||||||||||||||
Amortization of
net (gain) loss |
11 | 9 | 3 | (13 | ) | (16 | ) | (12 | ) | ||||||||||||||||||
Net benefit
expense (income) |
$ | 12 | $ | 14 | $ | 6 | $ | (13 | ) | $ | (15 | ) | $ | (11 | ) | ||||||||||||
The following weighted-average assumptions were used
to determine net benefit cost:
| Pension Benefits |
Postretirement Benefits |
||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2004 |
2003 |
2002 |
2004 |
2003 |
2002 |
||||||||||||||||||||||
Discount
rate |
5.90 | % | 6.50 | % | 7.00 | % | 5.90 | % | 6.50 | % | 7.00 | % | |||||||||||||||
Rate of
compensation increase |
3.79 | % | 3.72 | % | 3.53 | % | |||||||||||||||||||||
Expected
long-term rate of return on assets |
8.89 | % | 8.88 | % | 8.87 | % | |||||||||||||||||||||
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.
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 2002, based on historical experience, the drop out rate assumption was increased for the medical plan,
thereby shortening the expected amortization period, which decreased the accumulated postretirement benefit obligation at February 1, 2003 by
approximately $6 million, and increased postretirement benefit income by approximately $3 million in 2002.
49
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. In May 2004, the FASB issued FASB Staff Position No. 106-2, “Accounting and Disclosure
Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003” (“FSP 106-2”). FSP 106-2 requires
companies to account for the effect of the subsidy on benefits attributable to past service as an actuarial experience gain and as a reduction of the
service cost component of net postretirement health care costs for amounts attributable to current service, if the benefit provided is at least
actuarially equivalent to Medicare Part D. Management has concluded that the health care benefits that it provides to retirees is not actuarially
equivalent to Medicare Part D and, therefore, the Company will not be eligible to receive the Federal subsidy.
The Company’s pension plan weighted-average
asset allocations at January 29, 2005 and January 31, 2004, by asset category are as follows:
| 2004 |
2003 |
|||||||||
|---|---|---|---|---|---|---|---|---|---|---|
Asset
Category |
||||||||||
Equity
securities |
63 | % | 63 | % | ||||||
Foot Locker,
Inc. common stock |
2 | % | 2 | % | ||||||
Debt
securities |
33 | % | 33 | % | ||||||
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 January 29, 2005 and January 31, 2004. 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.
The Company currently expects to contribute $22
million to its pension plans during 2005 to the extent that the contributions are tax deductible. However, this is subject to change, and is based upon
the Company’s overall financial performance as well as plan asset performance significantly above or below the assumed long-term rate of
return.
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) |
|||||||||||
2005 |
$63 | $5 | |||||||||
2006 |
62 | 4 | |||||||||
2007 |
60 | 3 | |||||||||
2008 |
58 | 3 | |||||||||
2009 |
58 | 2 | |||||||||
2010–2014 |
266 | 8 | |||||||||
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 $1.3 million, $1.6 million and $1.4 million in 2004, 2003 and 2002, respectively.