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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For The Quarterly Period Ended June 29, 2002
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Commission File Number 1-11681
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FOOTSTAR, INC.
--------------
(Exact Name of Registrant as specified in its charter)
Delaware 22-3439443
- -------- ----------
(State or other Jurisdiction of (I.R.S. Employer Identification Number)
Incorporation or Organization)
1 Crosfield Avenue West Nyack, New York 10994
---------------------------------------------
(Address of principal executive offices) (Zip Code)
(845) 727-6500
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(Registrant's telephone number, including area code)
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 __
Number of shares outstanding of the issuer's Common Stock:
Class Outstanding as of June 29, 2002
----- -------------------------------
Common Stock, $.01 par value 20,160,426
INDEX
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Part I. - Financial Information Page No.
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Item 1. Financial Statements
Condensed Consolidated Statements of Operations -
Three and Six Months Ended June 29, 2002 and June 30, 2001 3
Condensed Consolidated Balance Sheets -
June 29, 2002, December 29, 2001 and June 30, 2001 4
Condensed Consolidated Statements of Cash Flows -
For Six Months Ended June 29, 2002 and June 30, 2001 5
Notes to Condensed Consolidated Financial Statements 6-17
Independent Auditors' Review Report 18
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 19-26
Item 3. Quantitative and Qualitative Disclosures about Market Risk 27-28
Part II. - Other Information
Item 4. Submission of Matters to a Vote of Security Holders 29
Item 6. Exhibits and Reports on Form 8-K 30
2
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(tabular amounts in millions, except per share data)
Three Months Ended Six Months Ended
------------------------ --------------------------
June 29, June 30, June 29, June 30,
2002 2001 2002 2001
-------- -------- -------- --------
Net sales $ 593.1 $ 649.0 $1,146.9 $1,166.1
Cost of sales 408.9 443.4 808.7 813.4
------- ------- -------- --------
Gross profit 184.2 205.6 338.2 352.7
Store operating, selling, general and
administrative expenses 132.2 140.7 275.2 275.1
Bad debt expense (Note 2) 9.2 -- 9.2 --
Depreciation and amortization 11.1 12.6 21.2 24.5
Restructuring, asset impairment and other
charges (reversals), net 8.5 -- 15.0 --
------- ------- -------- --------
Operating profit 23.2 52.3 17.6 53.1
Interest expense, net 2.9 5.3 5.0 8.6
------- ------- -------- --------
Income before income taxes, minority interest
and cumulative effect of a change in
accounting principle 20.3 47.0 12.6 44.5
Income tax provision 4.6 14.1 2.3 13.3
------- ------- -------- --------
Income before minority interests and cumulative
effect of a change in accounting principle 15.7 32.9 10.3 31.2
Minority interests in net income 16.3 16.8 17.1 19.2
------- ------- -------- --------
(Loss) income before cumulative effect of a
change in accounting principle (0.6) 16.1 (6.8) 12.0
Cumulative effect of a change in accounting
principle, net of income taxes of $6.8 million -- -- 18.2 --
------- ------- -------- --------
Net (loss) income $ (0.6) $ 16.1 $ (25.0) $ 12.0
======= ======= ======== ========
Weighted average shares outstanding:
Basic: 20.4 20.2 20.4 20.2
======= ======= ======== ========
Diluted: 20.4 20.7 20.4 20.8
======= ======= ======== ========
(Loss) earnings per share:
Basic:
(Loss) income before cumulative effect of a
change in accounting principle $ (0.03) $ 0.80 $ (0.33) $ 0.59
Cumulative effect of a change in accounting
principle, net of taxes -- -- (0.89) --
------- ------- -------- --------
Net (loss) income $ (0.03) $ 0.80 $ (1.22) $ 0.59
======= ======= ======== ========
Diluted:
(Loss) income before cumulative effect of a
change in accounting principle $ (0.03) $ 0.78 $ (0.33) $ 0.58
Cumulative effect of a change in accounting
principle, net of taxes -- -- (0.89) --
------- ------- -------- --------
Net (loss) income $ (0.03) $ 0.78 $ (1.22) $ 0.58
======= ======= ======== ========
(Loss) earnings per share excluding
amortization of goodwill and intangible
asset with indefinite useful life:
Basic: $ (0.03) $ 0.82 $ (1.22) $ 0.64
======= ======= ======== =========
Diluted: $ (0.03) $ 0.80 $ (1.22) $ 0.63
======= ======= ======== =========
See accompanying notes to the condensed consolidated financial statements.
3
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(tabular amounts in millions, except for share data)
June 29, December 29, June 30,
2002 2001 2001
-------- ------------ --------
ASSETS
Current Assets:
Cash and cash equivalents $ 9.4 $ 12.4 $ 16.5
Accounts receivable, net 51.0 69.6 59.4
Inventories 426.2 368.5 498.6
Prepaid expenses and other current assets 62.4 61.2 34.6
-------- -------- --------
Total current assets 549.0 511.7 609.1
Property and equipment, net 273.5 258.6 263.8
Goodwill, net 17.4 42.4 36.8
Intangible assets, net 22.6 23.6 24.4
Deferred charges and other non-current assets 30.4 29.7 21.2
-------- -------- --------
Total assets $ 892.9 $ 866.0 $ 955.3
======== ======== ========
LIABILITIES and SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 140.5 $ 108.8 $ 161.3
Accrued expenses 133.6 144.0 101.6
Income taxes payable 10.5 12.2 0.2
Notes payable 213.8 -- --
-------- -------- --------
Total current liabilities 498.4 265.0 263.1
Long-term debt -- 146.9 234.7
Other long-term liabilities 63.4 70.7 66.7
Minority interests in subsidiaries 47.8 75.7 49.8
-------- -------- --------
Total liabilities $ 609.6 $ 558.3 $ 614.3
-------- -------- --------
Shareholders' Equity:
Common stock $.0l par value: 100,000,000
shares authorized, 30,871,995, 30,770,372 and 30,636,884
shares issued 0.3 0.3 0.3
Additional paid-in capital 347.4 347.3 347.4
Accumulated other comprehensive loss (1.0) (0.1) (0.1)
Treasury stock: 10,711,569, 10,711,569 and
10,734,241 shares at cost (310.6) (310.6) (311.2)
Unearned compensation (4.5) (5.8) (7.5)
Retained earnings 251.7 276.6 312.1
-------- -------- --------
Total shareholders' equity $ 283.3 $ 307.7 $ 341.0
-------- -------- --------
Total liabilities and shareholders' equity $ 892.9 $ 866.0 $ 955.3
======== ======== ========
See accompanying notes to the condensed consolidated financial statements.
4
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(tabular amounts in millions)
Six Months Ended
----------------------------------
June 29, 2002 June 30, 2001
------------- -------------
Cash flows from operating activities:
Net (loss) income (25.0) 12.0
Adjustments to reconcile:
Restructuring and asset impairment (reversals) charges, net 35.7 --
Bad debt expense (Note 2) 9.2 --
Minority interests in net income 17.2 20.0
Depreciation and amortization 21.2 24.4
Impairment of goodwill 25.0 --
Loss on disposal of fixed assets 0.3 1.3
Stock incentive plans (2.3) 5.8
Changes in operating assets and liabilities:
Decrease (increase) in accounts receivable, net 9.4 (5.2)
Increase in inventories (78.4) (108.3)
Increase in prepaids, deferred charges and other assets (4.4) (5.7)
Increase in accounts payable and accrued expenses 7.5 34.0
Decrease in federal income taxes payable and other liabilities (1.3) (5.0)
------- --------
Net cash provided by (used in) operating activities $ 14.1 $ (26.7)
------- --------
Cash flows (used in) provided by investing activities:
Acquisition of footwear assets of J. Baker -- (59.0)
Additions to property and equipment (43.0) (20.7)
Proceeds from sale of building 3.1 --
------- --------
Net cash used in investing activities (39.9) (79.7)
------- --------
Cash flows (used in) provided by financing activities:
Dividends paid to minority interests (45.0) (51.8)
Treasury stock issued -- 1.4
Payment on stock incentive plans (0.6) (0.5)
Net proceeds from notes payable 66.9 160.7
Payments on capital leases (0.5) (0.4)
Payments on mortgage note (0.4) (0.3)
Other 2.4 (0.5)
------- --------
Net cash provided by financing activities 22.8 108.6
------- --------
Net (decrease) increase in cash and cash equivalents (3.0) 2.2
Cash and cash equivalents, beginning of period 12.4 14.3
------- --------
Cash and cash equivalents, end of period $ 9.4 $ 16.5
======= ========
See accompanying notes to the condensed consolidated financial statements.
5
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(tabular amounts in millions)
1. Basis of Presentation
In the opinion of Footstar, Inc. (the "Company"), the accompanying unaudited
condensed consolidated financial statements contain all adjustments (consisting
of only normal recurring accruals) necessary to present fairly the financial
position of the Company as of June 29, 2002 and the results of operations and
cash flows for the three-month and six-month periods ended June 29, 2002 and
June 30, 2001, respectively. The preparation of financial statements in
conformity with accounting principles generally accepted in the United States of
America, requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates. Because of
the seasonality of the specialty retailing business, operating results of the
Company on a quarterly basis may not be indicative of operating results for the
full year or any other period. The condensed consolidated financial statements
of the Company should be read in conjunction with the consolidated financial
statements of the Company included in the Company's 2001 Annual Report on Form
10-K.
2. Subsequent Events - Ames Bankruptcy Proceeding
During the third quarter of fiscal year 2001, Ames, whose footwear department
license was acquired by Footstar in the J. Baker acquisition, filed a voluntary
petition for reorganization under Chapter 11 of the U.S. Bankruptcy Code.
Footstar subsidiaries currently operate licensed footwear departments within
each of Ames' 332 stores. The Footstar subsidiaries own all footwear inventories
and certain fixtures within these departments, and are responsible for staffing
the departments.
As a result of Ames' performance and events subsequent to June 29, 2002, it is
now expected that Ames will cease operations and close all of its stores over
the next few months. Footstar management is currently in the process of
developing plans to liquidate the inventory in the related footwear departments
and exit those operations. The Company recorded a charge in the second quarter
ended June 29, 2002, of $9.2 million as an allowance for bad debt in
connection with its pre-petition receivables from Ames.
In addition to these charges, the Company now also expects to incur certain
closing and severance related costs, along with costs related to inventory
write-downs and asset impairments. These additional charges will be determined
based upon the Company's final liquidation and exit plan which will be
formulated once Ames liquidation plans are known. As of August 12, 2002 the
Company's Ames operations had post-petition receivables of approximately $3.0
million, inventory with a cost of approximately $17.3 million and fixed assets
with a net book value of $1.7 million. The Company has not recorded a reserve in
the second quarter for the potential additional losses to be incurred as a
result of Ames' liquidation and store closings. The Company will continue to
review and evaluate the impact of the liquidation and is expecting to record a
charge for this liquidation as information becomes available during the third
and fourth quarters of 2002.
The Company currently expects it will continue to operate licensed footwear
departments within Ames during the liquidation period.
The Company expects to apply to the bankruptcy court seeking an order confirming
its right to take certain actions with respect to its operation of the footwear
departments in order to protect its proceed from the sale of its inventory in
the Ames stores and to confirm its right to receive those proceeds in a timely
manner.
3. Significant Relationship with Kmart
Footstar has a significant business relationship with Kmart. Footstar operates
the licensed footwear departments in Kmart stores through its Meldisco
subsidiaries, in which Kmart owns a 49 percent equity interest. Under the
agreement with Kmart, these Meldisco subsidiaries retain title to the inventory
in each licensed footwear department up until the time the product is sold to
the consumer and are responsible for staffing the footwear departments. Kmart
collects the proceeds of each sale and, on a weekly basis, Kmart remits the
proceeds of the sales to Meldisco less applicable deductions and fees. Meldisco
has operated licensed footwear departments in Kmart stores since 1961. The
licensed footwear departments in Kmart have historically provided a significant
portion of Footstar's total annual sales and profits. For the fiscal years ended
December 29, 2001, December 30, 2000 and January 1, 2000, Kmart footwear sales
represented 49%, 58% and 64% of Footstar's net sales, respectively. Operating
profit relating to Kmart footwear departments, excluding restructuring and other
charges, reduced by Kmart's 49% equity interest in such departments, was 81%,
78% and 73% of Footstar's total operating profits in each of the fiscal years in
the three year period ended December 29, 2001, respectively.
On January 22, 2002, Kmart filed a voluntary petition for reorganization under
Chapter 11 of the U.S. Bankruptcy Code. In March 2002 Kmart secured $2 billion
in senior secured debtor-in-possession ("DIP") financing to be used to
supplement its existing cash flows to fund its reorganization and continuing
operations. Kmart stated that its decision to seek judicial reorganization was
based on a combination of factors, including a rapid decline in its liquidity
resulting from Kmart's sales and earnings performance in its fourth quarter
ending January 2002, the weakening of the surety bond market and an erosion of
supplier confidence.
6
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(tabular amounts in millions)
During March 2002, Kmart received bankruptcy court approval to close 283
under-performing stores. The 283 licensed footwear departments in those stores
generated $116.5 million of sales for Footstar for fiscal year 2001 compared
with $125.1 million for fiscal year 2000, or 4.7% and 5.6% of Footstar's total
sales in the respective years. Total operating profits for 2001 from these 283
licensed departments were $9.3 million compared with $11.5 million in 2000.
Footstar's operating profit from these 283 licensed departments reduced by
Kmart's 49% equity interest in such departments (51% of total operating profit)
was approximately $4.7 million in 2001, and $5.9 million in 2000, or 5.8% and
6.0% of Footstar's operating profits in the respective years after excluding
the Kmart equity interest. Prior to Kmart's store closing announcement, the
Company took steps to mitigate the potential effect of these store closings by
reducing inventory purchases and reducing headcount in Meldisco and at
Footstar's corporate offices. As of June 29, 2002, all 283 Kmart stores were
closed.
Note 7 below describes the charges recorded during the first quarter of 2002
relating to Kmart's store closing plan.
7
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(tabular amounts in millions, except per share data)
4. Segment Information
Statement of Financial Accounting Standards ("Statement") No. 131, Disclosures
about Segments of an Enterprise and Related Information, requires that public
business enterprises report selected information about operating segments in
interim financial reports issued to shareholders. Under Statement No. 131, the
assets of the two athletic footwear and apparel chains, Footaction and Just For
Feet, have been aggregated into the reporting segment called "Athletic" for
reporting purposes. All other footwear sales represent operating segments that
have been aggregated into the reporting segment called "Meldisco" for financial
reporting purposes.
Three Months Ended June 29, 2002
---------------------------------------------------------------------------------
Meldisco(1),(3) Athletic(3) Corporate(3) Total(3)
---------------------------------------------------------------------------------
Net sales $367.6 $225.5 $ -- $593.1
Operating profit (loss)
before restructuring 52.1 (1.1) (2.5) 48.5
and other charges
Bad debt expense 9.2 -- -- 9.2
Restructuring, asset
impairment and other 16.1 -- -- 16.1
charges (reversals)
Operating profit (loss) 26.8 (1.1) (2.5) 23.2
Six Months Ended June 29, 2002
---------------------------------------------------------------------------------
Meldisco(1),(2),(4) Athletic(1),(2),(4) Corporate(1),(2),(4) Total(1),(2),(4)
---------------------------------------------------------------------------------
Net sales $683.2 $463.7 $ -- $1,146.9
Operating profit (loss)
before restructuring 64.4 2.0 (3.9) 62.5
and other charges
Bad debt expense 9.2 -- -- 9.2
Restructuring, asset
impairment and other 30.9 4.5 0.3 35.7
charges (reversals)
Operating profit (loss) 24.3 (2.5) (4.2) 17.6
Three Months Ended June 30, 2001 Six Months Ended June 30, 2001
------------------------------------------ -------------------------------------------
Meldisco Athletic Corporate Total Meldisco Athletic Corporate Total
------------------------------------------ -------------------------------------------
Net sales $410.0 $239.0 $ -- $649.0 $686.6 $479.5 $ -- $1,166.1
Operating profit (loss) 56.5 (1.5) (2.7) 52.3 64.0 (6.8) (4.1) 53.1
(1) Operating profit (loss) before bad debt expense restructuring, asset
impairment and other charges excludes the $9.2 million allowance for bad
debt expense and excludes certain costs related to the Company's decision
to end two unprofitable footwear relationships operated by its Meldisco
segment. During the second quarter 2002, restructuring and other charges
amounted to $16.1 million, of which $7.6 million related to inventory
write-downs, which were recorded as a component of cost of sales, and $8.5
million related to asset impairment charges, lease exit costs and
severance costs.
(2) Operating profit (loss) before restructuring, asset impairment and other
charges, excludes certain costs related to the Company's restructuring
plan and Kmart's store closing action. During first quarter 2002,
restructuring, asset impairment and other charges amounted to $19.6
million, of which $13.1 million related to inventory write-downs, which
were recorded as a component of cost of sales, and $6.5 million related to
severance and building exit costs. Meldisco, Athletic and Corporate
recorded $14.8 million, $4.4 million and $0.4 million of these charges,
respectively.
(3) Amortization expense included in the three months ended June 30, 2001, but
no longer required in 2002 as a result of the Company's adoption of
Statement 142 totaled $0.6 million, of which Meldisco, Athletic and
Corporate recorded $0.3 million, $0.2 million and $0.1 million,
respectively.
(4) Amortization expense included in the six months ended June 30, 2001 but no
longer required in 2002 as a result of the Company's adoption of Statement
142, totaled $1.0 million, of which Meldisco, Athletic and Corporate
recorded $0.5 million, $0.3 million and $0.2 million, respectively.
8
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(tabular amounts in millions, except per share data)
5. Comprehensive Income (Loss)
Statement No. 130, Reporting Comprehensive Income, requires that items defined
as other comprehensive income, such as foreign currency translation adjustments
and unrealized gain (loss) in the fair value of derivatives, be separately
classified in the financial statements and that the accumulated balance of other
comprehensive income be reported separately from retained earnings and
additional paid-in capital in the equity section of the balance sheet. The
components of comprehensive income for the three and six months ended June 29,
2002 and June 30, 2001 are as follows:
Three Months Ended Six Months Ended
-------------------------------------- -------------------------------------
June 29, 2002 June 30, 2001 June 29, 2002 June 30, 2001
----------------- ----------------- ----------------- ----------------
Comprehensive (Loss) Income:
Net (loss) income $ (0.6) $ 16.1 $ (25.0) $ 12.0
Other comprehensive loss --
Unrealized loss on interest rate
swap agreement (1.0) -- (1.0) --
------ ------ ------- ------
Comprehensive (loss) income $ (1.6) $ 16.1 $ (26.0) $ 12.0
====== ====== ======= ======
9
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(tabular amounts in millions, except share and per share data)
6. Earnings per Share
The table below shows the reconciliation of the earnings available to common
stockholders and the shares used in calculating basic and diluted earnings per
common share.
Three Months Ended Six Months Ended
---------------------------- -------------------------------
June 29, June 30, June 29, June 30,
2002 2001 2002 2001
----------- ----------- ----------- ------------
Numerator for Basic and Diluted EPS -
Net income (loss) $ (0.6) $ 16.1 $ (25.0) $ 12.0
=========== =========== =========== ============
Denominator:
Shares outstanding at beginning of period 20,112,831 19,887,868 20,058,803 19,854,778
Weighted average deferred compensation
shares earned not issued 278,239 322,928 291,565 304,552
Weighted average shares issued/(repurchased) 40,939 10,356 56,420 26,690
----------- ----------- ----------- ------------
Denominator for Basic EPS - Weighted average
common shares outstanding 20,432,009 20,221,152 20,406,788 20,186,020
----------- ----------- ----------- ------------
Dilutive effect of stock options(1) -- 487,000 -- 578,770
----------- ----------- ----------- ------------
Denominator for Diluted EPS -
Adjusted weighted average common shares outstanding 20,432,009 20,708,152 20,406,788 20,764,790
----------- ----------- ----------- ------------
Basic EPS $ (0.03) $ 0.80 $ (1.22) $ 0.59
=========== =========== =========== ============
Diluted EPS $ (0.03) $ 0.78 $ (1.22) $ 0.58
=========== =========== =========== ============
(1) The computation of diluted EPS does not assume conversion, exercise, or
issuance of shares that would have an anti-dilutive effect on earnings per
share. During the three and six months ended June 29, 2002, the Company
had a net loss; as a result, any assumed conversions would result in
reducing the loss per share and therefore are not included in the
calculation.
10
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(tabular amounts in millions, except share and per share data)
7. Restructuring, Asset Impairment and Other Charges (Reversals)
During the second quarter of 2002, the Company adopted a restructuring plan in
connection with its decision to end two unprofitable licensed footwear
relationships operated by its Meldisco segment (the "Second Quarter Plan"). The
Company exited the Variety Wholesale Distributors ("Variety") operation during
the second quarter 2002, and will cease operating the footwear departments in
Stein Mart stores ("Stein Mart") no later than February 2003, when that contract
expires. The Company recorded pre-tax restructuring and other charges ("Second
Quarter Charges") totaling $16.1 million ($10.3 million after taxes) for the
write-down of inventory, asset impairment costs, lease exit costs and severance
costs.
The Second Quarter Charges include the write-down of certain inventory, which
totaled $7.6 million and has been recorded as a component of cost of sales. The
Second Quarter Charges also contain approximately $1.3 million relating
primarily to costs to exit its Variety operation, which the Company will settle
through the transfer of inventory to Variety. Additionally, the Second Quarter
Charges contain an asset impairment charge of $4.7 million recorded pursuant to
the requirements of Statement No. 144. These charges relate to certain fixed
assets, leasehold improvements and intangible assets associated with the exit
from Variety, and Stein Mart.
In connection with the Second Quarter Plan, the Company established reserves
within the Meldisco segment for severance costs totaling $1.5 million. The
Company also established a reserve of $1.0 million for exit costs, which are
anticipated to be paid in cash (store exit costs). Costs are being charged
against the reserves as incurred and the reserves will be reviewed periodically
to determine their adequacy.
During the first quarter of 2002, the Company approved a restructuring plan in
connection with its Athletic reorganization and incurred other charges relating
to Kmart's store closing plan (the "First Quarter Charges"). In connection with
these First Quarter Charges, the Company recorded pre-tax restructuring and
other charges totaling $20.4 million ($8.5 million after tax and minority
interest) for the write-down of inventory, building exit costs and severance
costs. In addition, the Company reversed approximately $0.8 million ($0.6
million after taxes) of the charge recorded in 2001 relating to exit costs
associated with a landlord relationship assumed in the J. Baker acquisition as
the Company did not exit the relationship.
The charges recorded in the first quarter cover costs related to inventory
write-downs and severance costs in connection with Kmart's announcement of its
plan to close 283 stores, as well as costs to shut down the Company's Irving,
Texas Footaction offices, including building exit costs and severance costs in
connection with the Company's plan to combine the marketing, planning, finance
and human resources functions of its two athletic chains, Footaction and Just
For Feet.
The most significant component of the First Quarter Charges included the
write-down of certain inventory in the Meldisco segment related to the Kmart
store closings, which totaled $13.1 million and has been recorded as a component
of cost of sales.
11
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(tabular amounts in millions, except share and per share data)
Additionally, in connection with the first quarter consolidation of the
Company's athletic divisions, the Company established reserves within the
athletic segment for costs to exit its Footaction headquarters building of $2.3
million and severance costs of $2.1 million. In connection with Kmart's 283
store closings, Meldisco established reserves for various exit costs and
severance costs totaling $0.6 million and $1.9 million, respectively. Costs are
being charged against the reserves as incurred and the reserves will be reviewed
periodically to determine their adequacy.
The following table displays a rollforward of the activity for the six-month
period ended June 29, 2002, the significant components of the first and second
quarter restructuring, and other charges and the related reserves remaining as
of June 29, 2002. The balance at December 29, 2001 primarily relates to
severance and lease termination costs associated with the Company's 2001 and
1998 restructuring, asset impairment and other charges.
Balance Three months ended Three months ended
December 29, March 30, 2002 June 29, 2002 Remaining at
2001 Charge/(Reversal), net Charge Usage June 29, 2002
---- ---------------------- ------ ----- --------------
Non-cash components:
- --------------------
Inventory write-downs $ -- $ 13.1 $ 7.6 20.7 $ --
Lease exit costs -- -- 1.3 1.3 --
Asset Impairment -- -- 4.7 4.7 --
Cash components:
- ----------------
Severance costs 1.5 4.4 1.5 3.1 4.3
Store, building and
lease exit costs 29.1 2.1 1.0 5.4 26.8
------ ------ ------ ------ ------
Total $ 30.6 $ 19.6 $ 16.1 $ 35.2 $ 31.1
====== ====== ====== ====== ======
The 2002 usage primarily consists of permanent markdowns of inventory, asset
impairment charges, various lease costs, severance payments and the payments
relating to exiting the stores, building and leases.
8. Supplemental Cash Flow Information
Six Months Ended
-------------------------------------
June 29, June 30,
2002 2001
---------------- ----------------
Cash paid for
income taxes $ 7.5 $22.6
Cash paid for interest $ 4.4 $ 7.8
12
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(tabular amounts in millions, except per share data)
9. Long-term Debt
Effective May 25, 2000, the Company entered into a three-year, $325 million
revolving credit facility with a syndicate of banks. This facility replaced a
$300 million revolving credit facility, which was due to expire September 18,
2000. As of June 29, 2002, there was $213.8 million outstanding under the credit
facility and the weighted average interest rate on the outstanding balance was
3.9%. As of December 29, 2001 and June 30, 2001, there was $146.9 million and
$234.7 million, respectively, outstanding under the credit facility with an
average interest rate of 3.6% and 6.1%, respectively. The Company's credit
facility expires in May 2003; therefore, the borrowings under the credit
facility are classified within current liabilities on the balance sheet at June
29, 2002.
10. Commitments and Contingencies
The Company is involved in various claims and legal actions arising in the
ordinary course of business. In the opinion of management, the ultimate
disposition of these matters will not have a material adverse effect on the
Company's combined financial position, results of operations or liquidity.
The Company continues the expansion of its distribution center located in Mira
Loma, California. The Company spent $2.9 million and $10.4 million on this
project during the three- and six-months periods ended June 29, 2002,
respectively, and expects to spend approximately $7 million to complete this
project.
See Note 2, "Subsequent Events," for information with respect to certain
contingencies in connection with the Company's relationship with Ames.
13
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(tabular amounts in millions, except per share data)
11. Goodwill and Other Intangible Assets
In July 2001, the FASB issued Statement No. 142, Goodwill and Other Intangible
Assets. Statement No. 142 requires that goodwill and intangible assets with
indefinite useful lives no longer be amortized, but instead be tested for
impairment annually in accordance with the provisions of Statement No. 142.
Statement No. 142 also requires that intangible assets with definite useful
lives be amortized over their respective estimated useful lives to their
estimated residual values. Intangible assets with definite useful lives are
reviewed for impairment in accordance with Statement No. 144. See the "Impact of
Recently Issued Accounting Standards" Note 13 for more information.
The Company adopted the provisions of Statement No. 142 effective the first day
of fiscal 2002. The Company ceased the amortization of all unamortized goodwill
and ceased the amortization of $9.9 million of an unamortized intangible asset,
which has an indefinite useful life. Amortization expense related to goodwill
was $0.6 million and $1.1 million for the three- and six-month period ended June
30, 2001, respectively. Amortization expense related to the intangible asset
with an indefinite useful life was $0.1 million and $0.3 million for the three-
and six-month periods ended June 30, 2001, respectively.
Statement No. 142 requires the annual testing for the impairment of goodwill at
a reporting unit level. The Standard also required a goodwill impairment test as
of the adoption date. The Company identified its reporting units under Statement
No. 142 as the operating segments within the Meldisco and Athletic reportable
segments. The Company maintained goodwill at the Footaction operating segment in
Athletic in the amount of $17.4 million and at the Meldisco segment relating to
the assets acquired from J. Baker in the amount of $25.0 million. The fair value
of these reporting units was estimated using the expected present value of
associated future cash flows and market values of related businesses, where
appropriate. The Company completed its impairment test during the second quarter
of 2002 and determined that the $25.0 million of goodwill of the Meldisco
segment relating to the assets acquired from J. Baker was impaired under the
fair value test. This impairment was the result of sequential periods of
decreased operating profit. Accordingly, the Company has recognized a charge for
the cumulative change of adopting the accounting standard as shown in the
condensed consolidated statements of operations.
The Company has established the first day of its fourth fiscal quarter as the
Company's annual impairment test date and will test its athletic segment
goodwill on that date each year unless circumstances arise prior to that date
indicating that impairment may exist.
In connection with the adoption of Statement No. 142, the Company reassessed the
useful lives of its amortizable intangible assets to be as noted in the table
below, which did not change from previous years.
14
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(tabular amounts in millions, except per share data)
Additionally, the unamortizable tradename is determined to have an indefinite
useful life due to its expected ability to generate cash flows indefinitely.
During the first quarter of 2002, the Company reevaluated the fair value of the
unamortizable tradename and determined that there was no impairment of the
intangible asset.
The following table shows information regarding intangible assets that are
deemed to have a finite life and are, therefore, currently amortized in
accordance with Statement No. 142 and intangibles with indefinite life, which
are no longer being amortized.
As of June 29, 2002 As of December 29, 2001 As of June 30, 2001
- -----------------------------------------------------------------------------------------------------------------------
Gross Gross Gross
Amortizable Carrying Accumulated Carrying Accumulated Carrying Accumulated
lives Amount Amortization Amount Amortization Amount Amortization
Amortizable assets
- ------------------
Tradenames 5-20 $13.9 $2.9 $13.9 $2.2 $13.1 $1.2
Customer Database 5 3.1 1.4 3.1 1.1 3.1 0.8
Unamortizable asset
- -------------------
Tradenames 10.5 0.6 10.5 0.6 10.5 0.3
- -----------------------------------------------------------------------------------------------------------------------
Total $27.5 $4.9 $27.5 $3.9 $26.7 $2.3
- -----------------------------------------------------------------------------------------------------------------------
The following schedule shows the reconciliation between net income and the net
income excluding amortization of goodwill and amortization of tradename with an
indefinite life at June 30, 2001, as well as the related impact on basic and
diluted earnings per share.
For the three months For the six months
ended June 30, 2001 ended June 30, 2001
-------------------- -------------------
Net income reported $16.1 $12.0
Add back: Goodwill amortization 0.5 0.8
Add back: Tradename amortization 0.1 0.2
----- ------
Adjusted net income $16.7 $13.0
===== ======
Basic earnings per share:
Net income $ 0.80 $0.59
Goodwill amortization $ 0.02 $0.04
Tradename amortization -- $0.01
Adjusted net income $ 0.82 $0.64
Diluted earnings per share:
Net income $ 0.78 $0.58
Goodwill amortization $ 0.02 $0.04
Tradename amortization -- $0.01
Adjusted net income $ 0.80 $0.63
15
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(tabular amounts in millions, except per share data)
The following table lists amortization expense relating to amortizable
intangible assets for the quarter ended June 29, 2002 and projected amortization
expense for the next five years.
Quarter ended June 29, 2002 $0.5
Fiscal year 2002 2.1
Fiscal year 2003 2.1
Fiscal year 2004 2.1
Fiscal year 2005 1.4
Fiscal year 2006 1.2
12. Interest Rate Swap Agreements
The Company incurs variable rate debt through its Credit Facility. This debt
exposes the Company to variability in interest expense due to changes in
interest rates. In order to limit the variability of a portion of its interest
expense, effective January 8, 2002, the Company entered into four interest rate
swap agreements with a total notional amount of $60 million, which fixes the
rate at 3.6% on the notional amount of $60 million. For the quarter ended June
29, 2002, interest rate cash flow hedges resulted in immaterial ineffectiveness.
As of June 29, 2002, the fair value of each interest rate swap (the net interest
receivable/payable) is reflected in the consolidated balance sheet as a current
payable in accrued expenses and other comprehensive loss totaling $1.0 million.
Since the interest rate swaps qualified as a cash flow hedge and were determined
to be highly effective, the changes in the fair value were recorded in other
comprehensive income. The Company does not expect to charge any net derivative
losses included in other comprehensive income as of June 29, 2002 to earnings
during the next twelve months. The Company does not enter into derivative
instruments for any purpose other than to manage its interest rate exposure. The
Company does not hold derivative financial investments for trading or
speculative purposes.
13. Impact of Recently Issued Accounting Standards
Effective fiscal 2002, the Company adopted the provision of Statement No. 144,
Accounting for the Impairment or Disposal of Long-Lived Assets to Be Disposed
Of. This statement addresses accounting and reporting for the impairment or
disposal of long-lived assets. The statement superseded FASB Statement No. 121,
while retaining many of the fundamental provisions covered by that statement.
Statement No. 144 differs fundamentally from Statement No. 121 in that goodwill
and other intangible assets that are not amortized are excluded from the scope
of Statement No. 144. Additionally Statement No. 144 addresses and clarifies
implementation and estimation issues arising from Statement No. 121.
16
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(tabular amounts in millions, except per share data)
Statement No. 144 also superseded the accounting and reporting provisions of APB
Opinion No. 30, Reporting the Results of Operations--Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions, for the disposal of a segment of a business.
Statement No. 144 retains the basic provisions of APB Opinion No. 30 for the
presentation of discontinued operations in the income statement but broadens
that presentation to apply to a component of an entity rather than a segment of
a business. The application of Statement No. 144 in 2002 did not have a material
impact on the Company's consolidated financial statements as the impairment
assessment under Statement No. 144 is predominantly unchanged from Statement No.
121 and as the stores closed during the six months ended June 29, 2002 did not
meet all of the requirements to be reported as discontinued operations under
Statement No. 144.
During April 2002, the FASB issued Statement No. 145, Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections. This Statement rescinds FASB Statement No. 4, Reporting Gains and
Losses from Extinguishment of Debt and FASB Statement No. 44, Accounting for
Intangible Assets of Motor Carriers. This Statement amends FASB Statement No.
13, Accounting for Leases, so that certain lease modifications that have
economic effects that are similar to sale-leaseback transactions are accounted
for the same way as sale-leaseback transactions. Additionally, Statement No. 13
is amended so that the original lessee under an operating lease agreement that
becomes secondarily liable shall recognize the fair value of the guarantee
obligation. This Statement also amends other existing authoritative
pronouncements to make various technical corrections, clarify meanings, or
describe their applicability under changed conditions. The amendment to
Statement No. 13 is effective for transactions occurring after May 15, 2002 and
the remainder of Statement 145 is effective for fiscal years beginning after May
15, 2002. The application of Statement No. 145 did not have a material impact on
the Company's consolidated financial statements.
On July 30, 2002, the FASB issued Statement No. 146, Accounting for Costs
Associated with Exit or Disposal Activities. This Statement nullifies EITF Issue
No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and
Other Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring)." Statement 146 is different from EITF Issue No. 94-3 in that
Statement No. 146 requires that a liability be recognized for a cost associated
with an exit or disposal activity only when the liability is incurred, that is
when it meets the definition of a liability in the FASB's conceptual framework.
Statement 146 also establishes fair value as the objective for initial
measurement of liabilities related to exit or disposal activities. In contrast,
under EITF Issue 94-3, a company recognized a liability for an exit cost when it
committed to an exit plan. Statement No. 146 is effective for exit or disposal
activities that are initiated after December 31, 2002. The application of this
statement did not have an impact on the Company's exit activity initially
applied prior to the adoption of Statement 146, however the adoption of
Statement 146 can be expected to impact the timing of liability recognition
associated with any future exit activities.
17
Independent Auditors' Review Report
The Board of Directors and Shareholders
Footstar, Inc.
We have reviewed the condensed consolidated balance sheets of Footstar, Inc. and
subsidiary companies as of June 29, 2002 and June 30, 2001 and the related
condensed consolidated statements of operations for the three-month and
six-month periods ended June 29, 2002 and June 30, 2001, respectively and
condensed cash flows for the six-month periods ended June 29, 2002 and June 30,
2001, respectively. These condensed consolidated financial statements are the
responsibility of the Company's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with generally accepted auditing standards, the objective of which is the
expression of an opinion regarding the financial statements taken as a whole.
Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to the condensed consolidated financial statements referred to above for
them to be in conformity with accounting principles generally accepted in the
United States of America.
We have previously audited, in accordance with auditing standards generally
accepted in the United States of America, the consolidated balance sheet of
Footstar, Inc. and subsidiary companies as of December 29, 2001 and the related
consolidated statements of operations, shareholders' equity and comprehensive
income, and cash flows for the year then ended (not presented herein); and in
our report dated February 5, 2002, except as to the third paragraph of the
"Business Risk" note which was as of March 15, 2002, we expressed an unqualified
opinion on those consolidated financial statements. In our opinion, the
information set forth in the accompanying condensed consolidated balance sheet
as of December 29, 2001 is fairly stated, in all material respects, in relation
to the consolidated balance sheet from which it has been derived.
/S/ KPMG LLP
New York, New York
August 12, 2002
18
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Unaudited)
The following discussion should be read in conjunction with the Condensed
Consolidated Financial Statements of the Company and notes thereto appearing
elsewhere in this report.
General
- -------
Three Months Ended
------------------------------------
June 29, June 30,
($ in millions) 2002 2001
----------------- -----------------
Company:
Net sales $593.1 $649.0
Net sales % change from prior year (8.6%) 10.1%
Same store sales % change (5.6%) (1.3%)
Meldisco:
Net sales $367.6 $410.0
Net sales % change from prior year (10.3%) 14.8%
Same store sales % change (7.1%) (2.0%)
% of consolidated net sales 62.0% 63.2%
Athletic:
Net sales $225.5 $239.0
Net sales % change from prior year (5.6%) 2.9%
Same store sales % change (3.3%) (0.1%)
% of consolidated net sales 38.0% 36.8%
Consolidated net sales for the three months ended June 29, 2002 were $593.1
million, a decrease of 8.6% from net sales of $649.0 million for the same period
of 2001. Same store sales for the three-month period decreased 5.6% compared to
the year-ago period. Total sales for Meldisco decreased 10.3% from $410.0
million in the second quarter of 2001 to $367.6 million in the second quarter of
2002. Meldisco's same store sales declined by 7.1% compared to the year-ago
period. The decrease was primarily due to fewer stores in operation and the
shift in Easter from April in 2001 to March in 2002, cooler than normal weather
in May and lower sales in the footwear departments outside of Kmart which faced
comparisons with heavy liquidations during the initial phase-in of the J. Baker
acquisition in 2001. In the Athletic segment, total sales decreased 5.6% to
$225.5 million and athletic same store sales decreased 3.3% compared to the
year-ago period due to the Easter shift from the second quarter in 2001 to the
first quarter in 2002, fewer stores in operation and a heavy promotional
environment. Strong sales of basketball footwear were offset by lower sales in
other categories.
19
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Unaudited)
Six Months Ended
------------------------------------
June 29, June 30,
($ in millions) 2002 2001
----------------- -----------------
Company:
Net sales $1,146.9 $1,166.1
Net sales % change from prior year (1.6%) 13.3%
Same store sales % change 0.3% (2.5%)
Meldisco:
Net sales $ 683.2 $ 686.6
Net sales % change from prior year (0.5%) 8.7%
Same store sales % change 0.5% (5.0%)
% of consolidated net sales 59.6% 58.9%
Athletic:
Net sales $ 463.7 $ 479.5
Net sales % change from prior year (3.3%) 20.6%
Same store sales % change (0.1%) 1.6%
% of consolidated net sales 40.4% 41.1%
Consolidated net sales for the six months ended June 29, 2002 totaled $1,146.9
million, a 1.6% decrease from net sales of $1,166.1 million for the same period
of 2001. Same store sales for the six-month period increased 0.3% compared to
the year-ago period. Total sales for Meldisco decreased 0.5% to $683.2 million
due to improved performance in the first quarter of 2002 and in June 2002,
offset by poor sales performance in May, primarily attributed to cooler than
expected weather. Meldisco's same store sales increased 0.5% compared to the
year-ago period. In the Athletic segment, total sales decreased 3.3% to $463.7
million primarily due to fewer athletic stores in operation this year compared
with 2001, and a same store sales decrease of 0.1%.
Restructuring, Asset Impairment and Other Charges (Reversals), Net
During the second quarter of 2002, the Company adopted a restructuring plan in
connection with its decision to end two unprofitable licensed footwear
relationships operated by its Meldisco segment (collectively the "Second Quarter
Plan"). The Company exited the Variety Wholesale Distributors ("Variety")
operation during the second quarter 2002, and will cease operating the footwear
departments in Stein Mart stores ("Stein Mart") no later than February 2003,
when that contract expires. The Company recorded pre-tax restructuring and other
charges ("Second Quarter Charges") totaling $16.1 million ($10.3 million after
taxes) for the write-down of inventory, asset impairment costs, lease exit costs
and severance costs. In connection with these Second Quarter Charges,
20
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Unaudited)
the Company recorded inventory write-downs of $7.6 million, which were included
as a component of cost of sales, and asset impairment costs, lease exit costs
and severance costs amounting to $8.5 million, which were included in operating
costs and expenses. (See Note 7 for a further discussion of these charges.)
During the first quarter of 2002, the Company adopted a restructuring plan in
connection with its athletic reorganization, and incurred other charges relating
to Kmart's store closing plan. Charges recorded included pre-tax restructuring
and other charges totaling $20.4 million ($8.5 million after tax and minority
interest) for the write-down of inventory, building exit costs and severance
costs. In addition, the Company reversed approximately $0.8 million ($0.6
million after taxes) of the charge recorded in 2001 relating to exit costs
associated with a landlord relationship assumed in the J. Baker acquisition. In
connection with the charges, $13.1 million of inventory write-downs were
included as a component of cost of sales, and $6.5 million in severance costs
and net building exit costs were included in operating costs and expenses. (See
Note 7 for a further discussion of these charges.)
Cost of Sales and Expenses
Three Months Ended Six Months Ended
---------------------------------------- --------------------------------------------
($ in millions, % are
percent of net sales) June 29, 2002 June 30, 2001 June 29, 2002 June 30, 2002
---------------------------------------- --------------------------------------------
Sales $593.1 100.0% $649.0 100.0% $1,146.9 100.0% $1,166.1 100.0%
Cost of sales 401.3 67.7% 443.4 68.3% 788.0 68.7% 813.4 69.8%
Cost of sales-other charges 7.6 1.3% -- -- 20.7 1.8% -- --
---------------------------------------- --------------------------------------------
Total cost of sales 408.9 69.0% 443.4 68.3% 808.7 70.5% 813.4 69.8%
Gross Margin 184.2 31.0% 205.6 31.7% 338.2 29.5% 352.7 30.2%
Store operating, selling,
general, and
administrative expenses 132.2 22.3% 140.7 21.7% 275.2 24.0% 275.1 23.6%
Bad debt expense 9.2 1.6% -- -- 9.2 0.8% -- --
Restructuring, asset
impairment and other
charges 8.5 1.4% -- -- 15.0 1.3% -- --
Depreciation and
amortization 11.1 1.9% 12.6 1.9% 21.2 1.9% 24.5 2.1%
Cost of Sales
Cost of sales for the second quarter of 2002 versus the same year-ago period
increased 70 basis points to 69% of net sales due to other charges consisting of
$7.6 million in inventory write-downs in the Meldisco Segment; excluding those
other charges, cost of sales declined 70 basis points. Gross profit decreased 70
basis points to $184.2 million due to lower margins in the Athletic segment and
inventory write-downs at Meldisco. Excluding the $7.6 million
21
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Unaudited)
inventory write-down, Footstar's second quarter 2002 gross margin as a percent
of net sales increased 60 basis points; the gross margin at Meldisco improved
with a reduction in clearance sales, the gross margin at Just For Feet improved
as a result of a reduction in promotional sales, while higher markdowns in a
promotional retail environment lowered the gross margin at Footaction.
For the six months ended June 29, 2002, cost of sales as a percent of net sales
increased by 70 basis points versus the same year-ago period; cost of sales in
the first half of 2002 included $20.7 million in other charges representing
inventory write-downs in connection with Kmart's announcement of its plan to
close 283 stores and with the termination of two unprofitable licensed footwear
relationships operated by Meldisco. Excluding the $20.7 million in other
charges, Footstar's gross margin as a percent of net sales increased 110 basis
points for the first six months of 2002.
Store Operating, Selling, General and Administrative Expenses
Store operating, selling, general and administrative ("SG&A") expenses, as a
percent of net sales, increased 60 basis points from 21.7% in the second quarter
of 2001 to 22.3% in the second quarter of 2002 as a result of the decreased
leverage of selling and occupancy expenses from lower than expected sales.
For the six months ended June 29, 2002, SG&A expenses as a percent of net sales,
increased 40 basis points as a result of the decreased leverage of selling and
occupancy expenses from lower than expected sales.
Bad Debt Expense
The Company recorded an allowance for bad debt of $9.2 million during the second
quarter of 2002 in connection with its pre-petition Ames receivable. (See Note
2, Subsequent Events).
The Company currently expects it will continue to operate licensed footwear
departments within Ames during the liquidation period and is currently taking
actions to limit future financial exposure.
The Company expects to apply to the bankruptcy court seeking an order confirming
its right to take certain actions with respect to its operation of the footwear
departments in order to protect its proceed from the sale of its inventory in
the Ames stores and to confirm its right to receive those proceeds in a timely
manner.
Operating Profit (Loss)
Operating profit for each segment is presented below before restructuring, asset
impairment and other charges and bad debt expense, which are recorded on a
separate line.
Three Months Ended Six Months Ended
--------------------------------------------------- -----------------------------------------------------
June 29, 2002 June 30, 2001 June 29, 2002 June 30, 2001
--------------------------------------------------- -----------------------------------------------------
($ in millions) Amount % of Net Sales Amount % of Net Sales Amount % of Net Sales Amount % of Net Sales
--------------------------------------------------- -----------------------------------------------------
Meldisco $52.1 14.2% $56.5 13.8% $64.4 9.4% $64.0 9.3%
Athletic (1.1) (0.5%) (1.5) (0.6%) 2.0 0.4% (1.4%)
(6.8)
Corporate overhead (2.5) -- (2.7) -- (3.9) -- (4.1) --
Bad debt expense 9.2 -- -- -- 9.2 -- -- --
Restructuring, asset
impairment and other
charges/(reversals) 16.1 -- -- -- 35.7 -- -- --
--------------------------------------------------- -----------------------------------------------------
Total 23.2 3.9% $52.3 8.1% $17.6 1.5% $53.1 4.6%
Note: Percentages represent percent of net sales of the respective entities.
22
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Unaudited)
During the second quarter ended June 29, 2002, operating profit after
restructuring, asset impairment and other charges and bad debt expense as a
percent of net sales decreased versus the same period of 2001 due to the second
quarter 2002 restructuring, asset impairment and other charges within Meldisco
relating primarily to exiting various underperforming landlord relationships,
which were acquired in the J. Baker acquisition and bad debt expense relating to
Ames. Excluding these charges and bad debt expense, operating profit would have
been $48.5 million for the second quarter 2002. At Meldisco, operating profit as
a percentage of sales increased 40 basis points due to improved gross margins,
partially offset by higher SG&A expenses due to the underabsorption of expenses
resulting from lower sales. In the Athletic segment, operating profit as a
percentage of sales increased 10 basis points.
For the six months ended June 29, 2002, operating profit excluding restructuring
charges, asset impairment and other charges and bad debt expense would have been
$62.5 million, or 5.4% of net sales, an 80 basis point increase versus the same
year-ago period. This increase was driven by positive comp store sales and
reduced markdowns at Meldisco, and the elimination of under-performing stores in
the Athletic segment.
New Business Relationship
On July 11, 2002 the Company announced that it reached an agreement with
Wal-Mart Stores, Inc. to supply Thom McAn brand value family footwear to 300
Wal-Mart stores for a six-month test period beginning in October of this year.
Liquidity and Financial Condition
The Company's inventories at the end of the second quarter decreased by $72.4
million or 14.5% versus the same quarter of 2001. The decrease is attributable
to lower inventory levels in Meldisco and at both athletic chains. The Company's
accounts receivable balance as of June 29, 2002, decreased by $8.4 million or
14.1% versus the prior year. Other current assets were higher than last year due
to deferred taxes related to the restructuring charges. Accounts payable
balances were lower than last year due to the lower overall level of
inventories.
Net cash provided by operating activities totaled $14.1 million during the first
six months of 2002, compared with net cash used in operating activities of $26.7
million during the first six months of 2001. The Company's principal sources of
liquidity used in funding its short-term operations are its operating cash flows
and bank borrowings. The Company has a $325 million 3-year revolving credit
facility with a syndicate of banks, which was effective May 25, 2000
(collectively, with all amendments, the "Credit Facility"). The Credit Facility
contains various operating covenants, which, among other things, impose certain
limitations on the Company's ability to incur liens, incur indebtedness, merge,
consolidate, make capital expenditures or declare and make dividend payments.
Under the Credit Facility, the Company is also required to comply with financial
covenants relating to debt and interest coverage. As of June 29, 2002 the
Company was in compliance with all covenants.
23
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Unaudited)
The Credit Facility expires on May 24, 2003. The Company is currently in
discussions with its banks about replacing the current facility with a new
3-year secured facility. The new facility is expected to be fully secured and
availability will be subject to a borrowing base formula based on eligible
inventory and accounts receivable. The amount of eligible inventory will be
determined based on the liquidation value of inventory and will be subject to
the lender's ability to secure a first priority lien on that inventory. The
Company currently expects to have a new facility in place by the end of 2002.
However, this is subject to further review and final determination.
As of June 29, 2002, the Company had $213.8 million in borrowings, classified as
notes payable in the balance sheet. Since the Company's Credit Facility expires
on May 24, 2003, the borrowings are classified within current liabilities on the
balance sheet as of June 29, 2002. At June 30, 2001, the Company had $234.7
million in borrowings classified as long-term debt. Net interest expense for the
six months ended June 29, 2002, was $4.9 million compared to $8.6 million for
the same period of 2001. This decline in interest expense was due to lower
interest rates during 2002.
During the third quarter of fiscal year 2001, Ames whose footwear department
license was acquired by Footstar in the J. Baker acquisition, filed a voluntary
petition for reorganization under Chapter 11 of the U.S. Bankruptcy Code.
Footstar subsidiaries currently operate licensed footwear departments within
each of Ames' 332 stores. The Footstar subsidiaries own all footwear inventories
and certain fixtures within these departments and are responsible for staffing
the departments.
As a result of Ames' performance and events subsequent to June 29, 2002, it is
now expected that Ames will cease operations and close all of its stores over
the next few months. Footstar management is currently in the process of
developing plans to liquidate the inventory in the Ames footwear departments and
exit those operations. The Company recorded a charge in the second quarter ended
June 29, 2002, of $9.2 million as bad debt expense and setup an allowance in
connection with its pre-petition receivables from Ames. These 332 licensed
departments generated $43.9 million or 4% of Footstar's total sales of $1.1
billion for the six months ended June 29, 2002. These licensed departments had
an operating loss of approximately $0.5 million before bad debt expense for the
six month period ended June 29, 2002, as compared to Footstar's consolidated
operating profit of $62.5 million before restructuring, bad debt expense and
other charges for the same period.
In addition to these charges, the Company now also expects to incur certain
closing and severance related costs, along with costs related to inventory
write-downs and asset impairments. These additional charges will be determined
based upon the Company's final liquidation and exit plan which will be
formulated once Ames liquidation plans are known. As of August 12, 2002 the
Company's Ames operations had post-petition receivables of approximately $3.0
million, inventory with a cost of approximately $17.3 million and fixed assets
with a net book value of $1.7 million. The Company has not recorded a reserve in
the second quarter for the potential additional loss to be incurred as a result
of Ames' liquidation and store closings. The Company will continue to review and
evaluate the impact of the liquidation and is expecting to record a charge for
this liquidation during the third and fourth quarter's of 2002.
The Company currently expects it will continue to operate licensed footwear
departments within Ames during the liquidation period, and is currently taking
actions to limit future financial exposure.
The Company expects to apply to the bankruptcy court seeking an order confirming
its right to take certain actions with respect to its operation of the footwear
departments in order to protect its proceed from the sale of its inventory in
the Ames stores and to confirm its right to receive those proceeds in a timely
manner.
On March 8, 2002, Kmart announced that it would close 283 underperforming
stores. These 283 licensed departments generated $116.5 million of Footstar's
total sales of $2.5 billion for fiscal year 2001. Total operating profit from
these licensed departments was $9.3 million. While the store closings are
expected to negatively affect earnings, the Company believes the effect on 2002
cash flows to be minimal. The cash generated from the inventory liquidations,
lower ongoing working capital requirements and reduced accounts receivable will
offset most of the reduced cash flows from lower earnings. Until Kmart provides
information about its future plans, it is premature to predict the impact of
those plans, including the impact of any potential future Kmart store closings,
on the Company or its Credit Facility. However, if Kmart were to elect to close
additional stores, those store closings may have a negative effect on the
Company's cash flows from operations. Store closings will also reduce the
Company's total working capital requirements, and thus have a positive effect on
the Company's liquidity, as Footstar's Meldisco division owns the related
inventory and has a receivable balance for sales receipts from each Kmart
licensed footwear department. The Company continues to monitor the Kmart
bankruptcy proceedings.
24
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Unaudited)
The Company's businesses are seasonal in nature and, therefore, are impacted by
weather conditions. Peak selling periods coincide with Christmas, the Easter
holiday and the back-to-school selling seasons. Working capital requirements
vary with seasonal business volume and inventory buildups, which occur prior to
the peak selling periods. The Company expects that its current cash, together
with cash generated from operations and its credit facilities, will be
sufficient to fund its expected operating expenses, working capital needs,
capital expenditures and projected internal growth for the foreseeable future.
The Company believes its current borrowing capacity will allow it to take
advantage of new growth and investment opportunities.
The Company expects that it will retain all available funds for the operation
and expansion of its business and does not anticipate paying any cash dividends
to shareholders in the foreseeable future.
Capital expenditures for the six months ended June 29, 2002 were $43.0 million.
Total capital expenditures for the entire 2002 fiscal year are estimated to be
between $75 and $80 million. Capital projects include the expansion of the
Company's distribution center in Mira Loma, California, 20 to 30 new stores in
the Athletic segment, new landlord growth in the Meldisco segment and several
projects to support the Company's information systems infrastructure.
Under the Company's arrangement with Kmart, Meldisco distributes annually to
Kmart a portion of profits representing Kmart's 49% minority interest in
Meldisco subsidiaries and an excess rent payment which is contingent upon
profits above certain levels. In April 2002, the Company distributed
approximately $45.0 million and approximately $25.5 million, respectively,
representing Kmart's dividend for its minority interest in the net earnings of
each of the Kmart licensed footwear department and excess rent for the fiscal
year 2001.
Effective fiscal 2002, the Company adopted the provision of Statement No. 144,
Accounting for the Impairment or Disposal of Long-Lived Assets to Be Disposed
Of. This statement addresses accounting and reporting for the impairment or
disposal of long-lived assets. The statement superseded FASB Statement No. 121,
while retaining many of the provisions covered by that statement. Statement No.
144 differs fundamentally from Statement No. 121 in that goodwill and other
intangible assets that are not amortized are excluded from the scope of
Statement No. 144. Additionally Statement No. 144 addresses and clarifies
implementation and estimation issues arising from Statement No. 121.
Statement No. 144 also superseded the accounting and reporting provisions of APB
Opinion No. 30, Reporting the Results of Operations--Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions, for the disposal of a segment of a business.
Statement No. 144 retains the basic provisions of APB Opinion No. 30 for the
presentation of discontinued operations in the income statement but broadens
that presentation to apply to a component of an entity rather than a segment of
a business. The application of Statement No. 144 in 2002 did not have a material
impact on the Company's consolidated financial statements as the impairment
assessment under Statement No. 144 is predominantly unchanged from Statement No.
121 and as the stores closed during the six months ended June 29, 2002 did not
meet all of the requirements to be reported as discontinued operations under
Statement No. 144.
25
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Unaudited)
Forward-Looking Statements
This Report on Form 10-Q contains statements, which constitute forward-looking
statements within the meaning of The Private Securities Litigation Reform Act of
1995. These statements appear in a number of places in this report as well as
the documents incorporated herein by reference and can be identified by the use
of forward-looking terminology such as "believe," "expect," "outlook," "look
forward," "estimate," "plans," "projects," "may," "will," "should,"
"anticipates," or similar statements, or the negative thereof or other
variations. Such forward-looking statements include, without limitation,
statements relating to revenue projections, cost savings, capital expenditures,
potential write-offs and other charges, future cash needs, improvements in
infrastructure, and operating efficiencies and other future results of operation
or financial position. Such forward-looking statements involve significant
material known and unknown risks, uncertainties and other factors which may
cause the actual results, performance or achievements to be materially different
from any future results, performance or achievements expressed or implied by
such forward-looking statements, including the possible substantial impact on
the Company's business of the bankruptcy proceedings commenced by Kmart
Corporation (at which the Company currently has approximately 1,831 licensed
footwear departments) and potential adverse developments in such proceedings
including: failing to successfully reorganize the chain, any significant store
closings effected by Kmart as part of such proceedings, rights of the debtor to
seek rejection of agreements in such bankruptcy proceedings, and the impact of
any other plans or activities effected by Kmart in such proceedings. Certain
other risks and uncertainties include but are not limited to: uncertainties
related to Ames liquidation and cessation of business, uncertainties related to
the integration of new businesses, the continued independence and financial
health of the Company's other significant licensors and customers, consumer
demand for the Company's products; unseasonable weather; risks associated with
foreign global sourcing, global liquidity, the occurrence of catastrophic events
or acts of terrorism, consumer acceptance of the Company's merchandise mix,
availability of favorable retail locations, product availability; the effect of
competitive products and pricing; and existing retail economic conditions,
including the impact on consumer spending and consumer confidence from a slowing
economy and the impact of a highly promotional retail environment and going out
of business sales. In such case, actual results may differ materially from such
forward-looking statements. Certain other information that may cause actual
results to differ from such forward-looking statements are contained in this and
other Company filings with the Securities and Exchange Commission. In light of
the uncertainty inherent in such forward-looking statements you should not
consider the inclusion to be a representation that such forward-looking matters
are achievable. The Company undertakes no obligation to update forward-looking
statements to reflect actual results, changes in assumptions or changes in other
factors affecting such forward-looking statements.
26
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
DERIVATIVES
As of June 29, 2002, the Company was not materially exposed to changes in the
underlying values of its assets or liabilities nor was it materially exposed to
changes in the value of expected foreign currency cash flows. Therefore, the
Company has not engaged in the purchase or sale of any derivative instruments,
except as described below.
INTEREST RATES
The Company's debt portfolio is subject to variable rates and primarily seasonal
in nature. The Company, from time to time, undertakes borrowings to finance
working capital, acquisitions and other corporate borrowing requirements. The
Company's peak borrowing periods coincide with peak inventory purchases. As of
June 29, 2002, the Company had $213.8 million outstanding under its Credit
Facility. The Company incurs variable rate debt through its Credit Facility.
This debt exposes the Company to variability in interest expense due to changes
in interest rates. In order to limit the variability of a portion of its
interest expense, effective January 8, 2002, the Company entered into four
interest rate swap agreements with a total notional amount of $60 million, which
fix the rate on the notional amount.
The interest rate swaps change the variable-rate cash flow exposure on the notes
to fixed-rate cash flows by entering into receive-variable, pay-fixed interest
rate swaps. Under the interest rate swaps, the Company receives variable
interest rate payments and makes fixed interest rate payments, thereby creating
the effect of fixed-rate notes. On the date the derivative was entered into, the
Company designated the derivative as a cash flow hedge of a forecasted
transaction related to a recognized liability. The Company formally documents
the relationship between the hedged instrument and the hedged items, as well as
its risk management objective and strategy for undertaking the hedge
transaction. The Company also formally assessed, at the hedge's inception, and
will assess on an ongoing basis, whether the derivatives that are used in
hedging transactions are highly effective in offsetting changes in fair values
or cash flows of hedged items. For the quarter ended June 29, 2002, interest
rate cash flow hedges resulted in immaterial ineffectiveness. The fair value of
each interest rate swap (the net interest receivable/payable) is reflected in
the consolidated balance sheet as a current payable in accrued expenses and
other comprehensive loss totaling $1.0 million at June 29, 2002. Since the
interest rate swaps qualified as a cash flow hedge and were determined to be
highly effective, the changes in the fair value are recorded in other
comprehensive income. The Company does not expect to charge any net derivative
gains included in other comprehensive income as of June 29, 2002 to earnings
during the next twelve months. The Company does not enter into derivative
instruments for any purpose other than to manage its interest rate exposure.
That is, the Company does not hold derivative financial investments for trading
or speculation purposes.
The Company assesses interest rate cash flow risk by continually identifying and
monitoring changes in interest rate exposures that may adversely impact expected
future cash flows and by evaluating hedging opportunities. Credit risk of
derivative instruments is considered minimal as the Company maintains risk
management control
27
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
systems to monitor the financial condition of the counterparties to the contract
and interest rate cash flow risk attributable to both the Company's outstanding
or forecasted debt obligations, as well as the Company's offsetting hedge
positions.
FOREIGN EXCHANGE
The Company's offshore product sourcing and purchasing activities are
denominated in US dollars and therefore the Company does not have material
exposure to cash flows denominated in foreign currencies nor have net foreign
exchange gains or losses been material to operating results in the past 3
reporting periods.
28
Part II. - OTHER INFORMATION
Item 4. - Submission of Matters to a Vote of Security Holders
The Company's Annual Meeting of Stockholders was held on May 14, 2002. The
stockholders elected all of management's nominees for the Board of Directors to
serve until the Annual Meeting of Stockholders in 2005 and ratified the
appointment of KPMG LLP as the Corporation's independent auditors for fiscal
2002.
The voting results are as follows:
Election of Directors
- ---------------------
Broker
For Withheld Non-Votes
------------------------------------------------------
George S. Day 14,940,925 3,320,181 --
Bettye Martin Musham 15,119,609 3,141,497 --
Kenneth S. Olshan 14,940,806 3,320,300 --
Ratification of Auditors
- ------------------------
Broker
For Against Abstain Non-Votes
-------------------------------------------------------------------------
17,885,209 362,952 12,946 --
29
Part II. - OTHER INFORMATION
Item 6. - Exhibits and Reports on Form 8-K
a) EXHIBIT INDEX
Exhibit
- -------
10.9(a) Amended and Restated Supplemental Retirement Plan for
Senior Management of Footstar, Inc.
15 Accountants' Acknowledgment
b) Reports -
Reports on Form 8-K - None
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FOOTSTAR, INC.
By: /s/ STEPHEN R. WILSON
----------------------------
Stephen R. Wilson
Executive Vice President and
Chief Financial Officer
Date: August 13, 2002
30