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EX-99 - FOOT LOCKER, INC.v196049_ex99.htm

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q
______________________________________
 
(Mark One)
 

þ
 QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended:  July 31, 2010
 
o
 TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from __________ to __________
 
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 Incorporation or Organization)
(I.R.S. Employer Identification No.)
 
112 West 34th Street, New York, New York, 10120
(Address of Principal Executive Offices, Zip Code)
 
(212-720-3700)
(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  þ   No  o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   Yes  þ   No  o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer þ
Accelerated filer o
Non-accelerated filer  o
Smaller reporting company o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes  o   No  þ
 
Number of shares of Common Stock outstanding at August 28, 2010: 155,674,989
 
 
 

 

 
FOOT LOCKER, INC.

TABLE OF CONTENTS
     
Page
Part I.
 
Financial Information 
 
 
    
Item 1.
    
Financial Statements
 
       
Condensed Consolidated Balance Sheets 
3
       
Condensed Consolidated Statements of Operations 
4
       
Condensed Consolidated Statements of Comprehensive (Loss) Income
5
       
Condensed Consolidated Statements of Cash Flows 
6
       
Notes to Condensed Consolidated Financial Statements 
7
   
Item 2.
 
Management’s Discussion and Analysis of Financial Condition and Results of Operations 
14
   
Item 4.
 
Controls and Procedures 
19
Part II.
 
Other Information 
 
   
Item 1. 
 
Legal Proceedings 
19
   
Item 1A.
 
Risk Factors 
20
   
Item 2. 
 
Unregistered Sales of Equity Securities and Use of Proceeds 
20
   
Item 6. 
 
Exhibits 
20
       
Signature 
21
       
Index to Exhibits 
22
 
 
2

 

 
PART I - FINANCIAL INFORMATION

 
Item 1. Financial Statements

 
FOOT LOCKER, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS
 (in millions, except shares)

   
July 31,
   
August 1,
   
January 30,
 
   
2010
   
2009
   
2010
 
   
(Unaudited)
   
(Unaudited)
   
*
 
ASSETS
                   
Current assets
                   
Cash and cash equivalents
  $ 512     $ 402     $ 582  
Short-term investments
    7       13       7  
Merchandise inventories
    1,219       1,284       1,037  
Other current assets
    161       211       146  
      1,899       1,910       1,772  
Property and equipment, net
    376       433       387  
Deferred taxes
    351       366       362  
Goodwill
    144       145       145  
Other intangibles and other assets
    143       161       150  
    $ 2,913     $ 3,015     $ 2,816  
LIABILITIES AND SHAREHOLDERS’ EQUITY
                       
Current liabilities
                       
Accounts payable
  $ 345     $ 322     $ 215  
Accrued expenses and other current liabilities
    236       191       218  
      581       513       433  
Long-term debt
    137       138       138  
Other liabilities
    279       387       297  
      997       1,038       868  
Shareholders’ equity
                       
Common stock and paid-in capital: 161,843,666, 160,614,691 and 161,267,025 shares, respectively
    718       702       709  
Retained earnings
    1,548       1,565       1,535  
Accumulated other comprehensive loss
    (228 )     (187 )     (193 )
Less: Treasury stock at cost: 6,184,542, 4,709,020, and 4,726,237 shares, respectively
    (122 )     (103 )     (103 )
Total shareholders’ equity
    1,916       1,977       1,948  
    $ 2,913     $ 3,015     $ 2,816  

See Accompanying Notes to Condensed Consolidated Financial Statements. 
 
* The balance sheet at January 30, 2010 has been derived from the previously reported audited financial statements at that date, but does not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended January 30, 2010.
 
 
3

 

 
FOOT LOCKER, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
 (Unaudited)
 (in millions, except per share amounts)

   
Thirteen weeks ended
   
Twenty-six weeks ended
 
   
July 31,
   
August 1,
   
July 31,
   
August 1,
 
   
2010
   
2009
   
2010
   
2009
 
Sales
  $ 1,096     $ 1,099     $ 2,377     $ 2,315  
Costs and Expenses
                               
Cost of sales
    791       819       1,679       1,679  
Selling, general and administrative expenses
    268       252       548       530  
Depreciation and amortization
    26       28       52       56  
Interest expense, net
    2       3       5       5  
Other income
    (1 )     (1 )     (1 )     (2 )
      1,086       1,101       2,283       2,268  
                                 
Income (loss) from continuing operations before income taxes
    10       (2 )     94       47  
Income tax expense (benefit)
    4       (1 )     34       17  
Income (loss) from continuing operations
    6       (1 )     60       30  
                                 
Income from disposal of discontinued operations, net of tax
          1             1  
                                 
Net income
  $ 6     $     $ 60     $ 31  
                                 
Basic earnings per share:
                               
Net income
  $ 0.04     $     $ 0.39     $ 0.20  
Weighted-average common shares outstanding
    156.1       155.9       156.3       155.6  
                                 
Diluted earnings per share:
                               
Net income
  $ 0.04     $     $ 0.38     $ 0.20  
Weighted-average common shares assuming dilution
    156.9       155.9       157.1       155.8  

 
See Accompanying Notes to Condensed Consolidated Financial Statements.
 
 
4

 

 
FOOT LOCKER, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME
 (Unaudited)
 (in millions)

   
Thirteen weeks ended
   
Twenty-six weeks ended
 
   
July 31,
   
August 1,
   
July 31,
   
August 1,
 
   
2010
   
2009
   
2010
   
2009
 
Net income
  $ 6     $     $ 60     $ 31  
Other comprehensive income (loss), net of tax
                               
Foreign currency translation adjustments arising during the period
    (14 )     47       (37 )     62  
Pension and postretirement plan adjustments
    2       1       4       2  
Change in fair value of derivatives
    (1 )     (1 )     (1 )     (2 )
Unrealized gain on available-for-sale security
          2             2  
Comprehensive (loss) income
  $ (7 )   $ 49     $ 26     $ 95  

See Accompanying Notes to Condensed Consolidated Financial Statements.
 
 
5

 

 
FOOT LOCKER, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 (Unaudited)
 (in millions)

   
Twenty-six weeks ended
 
   
July 31,
   
August 1,
 
   
2010
   
2009
 
From Operating Activities:
           
Net income
  $ 60     $ 31  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Income from disposal of discontinued operations, net
          (1 )
Depreciation and amortization
    52       56  
Share-based compensation expense
    7       5  
Change in assets and liabilities:
               
Merchandise inventories
    (193 )     (138 )
Accounts payable
    132       129  
Other accruals
    27       (43 )
Qualified pension plan contributions
    (2 )     (11 )
Gain on termination of interest rate swaps
          19  
Other, net
    (20 )     36  
Net cash provided by operating activities from continuing operations
    63       83  
                 
From Investing Activities:
               
Gain from insurance recoveries
          1  
Short-term investment redemptions
          10  
Capital expenditures
    (51 )     (47 )
Net cash used in investing activities from continuing operations
    (51 )     (36 )
                 
From Financing Activities:
               
Reduction in long-term debt
          (3 )
Issuance of common stock
    1       1  
Dividends paid
    (47 )     (47 )
Treasury stock issued under employee stock plan
    3        
Purchase of treasury shares
    (20 )      
Net cash used in financing activities from continuing operations
    (63 )     (49 )
                 
Net cash used in operating activities of Discontinued Operations
          (1 )
Effect of exchange rate fluctuations on Cash and Cash Equivalents
    (19 )     20  
Net change in Cash and Cash Equivalents
    (70 )     17  
Cash and Cash Equivalents at beginning of year
    582       385  
Cash and Cash Equivalents at end of interim period
  $ 512     $ 402  
                 
Cash paid during the period:
               
Interest
  $ 6     $ 6  
Income taxes
  $ 23     $ 10  

 
See Accompanying Notes to Condensed Consolidated Financial Statements.
 
 
6

 

 
FOOT LOCKER, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 
1. Summary of Significant Accounting Policies

Basis of Presentation

The accompanying condensed consolidated financial statements contained in this report are unaudited. In the opinion of management, the condensed consolidated financial statements include all adjustments, which are of a normal recurring nature, necessary for a fair presentation of the results for the interim periods of the fiscal year ending January 29, 2011 and of the fiscal year ended January 30, 2010. Certain items included in these statements are based on management’s estimates. Actual results may differ from those estimates. The results of operations for any interim period are not necessarily indicative of the results expected for the year. The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the Notes to Consolidated Financial Statements contained in the Company’s Form 10-K for the year ended January 30, 2010, as filed with the Securities and Exchange Commission (the “SEC”) on March 29, 2010.

Recent Accounting Pronouncements

Recently issued accounting pronouncements did not have, or are not believed by management to have, a material effect on the Company’s present or future consolidated financial statements.

2. Goodwill and Other Intangible Assets

The Company reviews goodwill and intangible assets with indefinite lives for impairment annually during the first quarter of its fiscal year or more frequently if impairment indicators arise. The annual review of goodwill and assets with indefinite lives during the first quarters of 2010 and 2009 did not result in any impairment charges. The following table provides a summary of goodwill by reportable segment.  The change represents foreign exchange fluctuations.

   
July 31,
 
August 1,
 
January 30,
 
Goodwill (in millions)
 
2010
 
2009
 
2010
 
Athletic Stores
  $ 17   $ 18   $ 18  
Direct-to-Customers
    127     127     127  
    $ 144   $ 145   $ 145  

The components of finite-lived intangible assets and intangible assets not subject to amortization are as follows:

   
July 31, 2010
   
August 1, 2009
   
January 30, 2010
 
   
Gross
   
Accum.
   
Net
   
Gross
   
Accum.
   
Net
   
Gross
   
Accum.
   
Net
 
(in millions) 
 
value
   
amort.
   
value
   
value
   
amort.
   
value
   
value
   
amort.
   
value
 
Finite life
intangible assets:
                                                     
Lease acquisition costs
  $ 170     $ (137 )   $ 33     $ 184     $ (138 )   $ 46     $ 184     $ (143 )   $ 41  
                                                                         
Trademarks
    21       (7 )     14       20       (5 )     15       20       (6 )     14  
                                                                         
Loyalty program
    1       (1 )           1       (1 )           1       (1 )      
                                                                         
Favorable leases
    9       (8 )     1       9       (8 )     1       9       (8 )     1  
                                                                         
CCS customer relationships
    21       (7 )     14       21       (3 )     18       21       (5 )     16  
                                                                         
Total finite life intangible assets
    222       (160 )     62       235       (155 )     80       235       (163 )     72  
 
 
7

 

 
   
July 31, 2010
   
August 1, 2009
   
January 30, 2010
 
   
Gross
   
Accum.
   
Net
   
Gross
   
Accum.
   
Net
   
Gross
   
Accum.
   
Net
 
(in millions) 
 
value
   
amort.
   
value
   
value
   
amort.
   
value
   
value
   
amort.
   
value
 
Intangible assets not subject to amortization:
 
 
   
 
   
 
   
 
   
 
   
 
   
   
   
   
   
 
 
Republic of Ireland  trademark
    2             2       2             2       2             2  
CCS trade-name
    25             25       25             25       25             25  
                                                                         
Total indefinite life intangible assets
    27             27       27             27       27             27  
                                                                         
Total other intangible assets
  $ 249     $ (160 )     $ 89     $ 262     $ (155 )     $ 107     $ 262     $ (163 )     $ 99  

The weighted-average amortization period as of July 31, 2010 was 11.8 years. Amortization expense was $4 million and $5 million for the thirteen-week periods ended July 31, 2010 and August 1, 2009, respectively.  Amortization expense was $9 million and $10 million for the twenty-six week periods ended July 31, 2010 and August 1, 2009, respectively. Estimated amortization expense for finite life intangible assets is expected to approximate $9 million for the remainder of 2010, $15 million for 2011, $13 million for 2012, $9 million for 2013, and $3 million for 2014. The change in the net value of the intangible assets for the twenty-six week period ended July 31, 2010 reflects amortization of $9 million and the effect of the weakening euro as compared with the U.S. dollar of $3 million, partially offset by additions of $2 million.

3. Financial Instruments

     The Company operates internationally and utilizes certain derivative financial instruments to mitigate its foreign currency exposures, primarily related to third party and intercompany forecasted transactions.  As a result of the use of derivative instruments, the Company is exposed to the risk that counterparties will fail to meet their contractual obligations. To mitigate this counterparty credit risk, the Company has a policy of entering into contracts only with major financial institutions selected based upon their credit ratings and other financial factors. The Company monitors the creditworthiness of counterparties throughout the duration of the derivative instrument.  Additional information is contained within Note 9, Fair Value Measurements.

Derivative Holdings Designated as Hedges

     For derivatives to qualify as hedges at inception and throughout the hedged periods, the Company formally documents the nature of the hedged items and the relationships between the hedging instruments and the hedged items, as well as its risk-management objectives, strategies for undertaking the various hedge transactions, and the methods of assessing hedge effectiveness and hedge ineffectiveness. In addition, for hedges of forecasted transactions, the significant characteristics and expected terms of the forecasted transactions must be specifically identified, and it must be probable that each forecasted transaction will occur. If it were deemed probable that a forecasted transaction would not occur, the hedge gain or loss would be recognized in earnings immediately. No such gains or losses were recognized in earnings for any of the periods presented. Derivative financial instruments qualifying for hedge accounting must maintain a specified level of effectiveness between the hedging instrument and the item being hedged, both at inception and throughout the hedged period, which management evaluates periodically.

Cash Flow Hedges
      The primary currencies to which the Company is exposed are the euro, British pound, Canadian dollar, and Australian dollar. For option and forward foreign exchange contracts designated as cash flow hedges of the purchase of inventory, the effective portion of gains and losses is deferred as a component of accumulated other comprehensive loss and is recognized as a component of cost of sales when the related inventory is sold. The amount reclassified to cost of sales related to such contracts was not significant for any of the periods presented. The ineffective portion of gains and losses related to cash flow hedges recorded to earnings was also not significant for any of the periods presented. When using a forward contract as a hedging instrument, the Company excludes the time value from the assessment of effectiveness. At each quarter-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 notional value of the contracts outstanding at July 31, 2010 was $44 million and these contracts extend through July 2011. Net changes in the fair value of foreign exchange derivative financial instruments designated as cash flow hedges of the purchase of inventory was $1 million for the thirteen and twenty-six weeks ended July 31, 2010 and was $2 million and $3 million for the thirteen and twenty-six weeks ended August 1, 2009, respectively.
 
 
8

 

 
Derivative Holdings Designated as Non-Hedges

     The Company mitigates the effect of fluctuating foreign exchange rates on the reporting of foreign currency denominated earnings by entering into a variety of derivative instruments, including option currency contracts. The notional value of the contracts outstanding at July 31, 2010 was $15 million and these contracts extend through October 2010. Changes in the fair value of these foreign currency option contracts, which are designated as non-hedges, are recorded in earnings immediately within other income. The realized gains, premiums paid, and changes in the fair market value recorded in the Consolidated Statements of Operations were not significant for the thirteen and twenty-six weeks ended July 31, 2010 and August 1, 2009.

     The Company also enters into forward foreign exchange contracts to hedge foreign currency denominated merchandise purchases and intercompany transactions that are not designated as hedges. The notional value of the contracts outstanding at July 31, 2010 was $35 million and these contracts extend through January 2011. Net changes in the fair value of foreign exchange derivative financial instruments designated as non-hedges were substantially offset by the changes in value of the underlying transactions, which were recorded in selling, general and administrative expenses. The amount recorded for all of the periods presented was not significant.

The Company enters into diesel fuel forward and option contracts to mitigate a portion of the Company’s freight expense due to the variability caused by fuel surcharges imposed by our third-party freight carriers. The notional value of the contracts outstanding at July 31, 2010 was $2 million and these contracts extend through November 2010. Changes in the fair value of these contracts are recorded in earnings immediately. The effect was not significant for any of the periods presented.

In 2008, the Company terminated the European net investment hedge by amending its existing cross currency swap and entering simultaneously into a new cross currency swap, thereby fixing the amount owed to the counterparty in 2015 at $24 million. During the term of the agreement, the Company remits to its counterparty interest payments based on one-month U.S. LIBOR rates on the $24 million liability. The agreement also includes a provision that may, if exercised, require the Company to settle this transaction in August 2010, at the option of the Company or the counterparty. During the second quarter of 2010, the counterparty exercised this option, thereby resulting in a reclassification of the amount owed from non-current to current liabilities

Fair Value of Derivative Contracts

The following represents the fair value of the Company’s derivative contracts.  Many of the Company’s agreements allow for a netting arrangement. The following is presented on a gross basis, by type of contract:

   
Balance Sheet
 
July 31,
   
August 1,
   
January 30,
 
(in millions)
 
Caption
 
2010
   
2009
   
2010
 
Hedging Instruments:
                     
                             
Forward foreign exchange contracts
 
Current liability
  $ (1 )   $     $  
Total
      $ (1 )   $     $  
                             
Non-Hedging Instruments:
                           
                             
Forward foreign exchange contracts
 
Current assets
  $     $ 1     $ 1  
                             
Forward foreign exchange contracts
 
Current liability
    (1 )     (1      
European cross currency swap
 
(1)
    (24     (24     (24
Total
      $ (25 )   $ (24 )   $ (23 )

 
(1) The Company’s European cross currency swap is classified as a current liability at July 31, 2010; for all other periods presented it was classified as a non-current liability.

Interest Rate Risk Management

     The Company has from time to time employed various interest rate swaps to minimize its exposure to interest rate fluctuations. On March 20, 2009, the Company terminated its interest rate swaps for a gain of $19 million. This gain is amortized as part of interest expense over the remaining term of the debt using the effective-yield method. The amount amortized during the thirteen weeks ended July 31, 2010 and August 1, 2009 was not significant. The amount amortized during the twenty-six weeks ended July 31, 2010 and August 1, 2009 was $1 million in each respective period.

 
9

 

 
Fair Value of Financial Instruments

The carrying value and estimated fair value of long-term debt was $137 million and $132 million, respectively, at July 31, 2010, $138 million and $120 million, respectively, at August 1, 2009 and $138 million and $127 million, respectively, at January 30, 2010. The carrying values of cash and cash equivalents, short-term investments and other current receivables and payables approximate their fair value.

4. Accumulated Other Comprehensive Loss

Accumulated other comprehensive loss comprised the following:
   
July 31,
   
August 1,
   
January 30,
 
(in millions) 
 
2010
   
2009
   
2010
 
Foreign currency translation adjustments
 
$
38
   
$
72
   
$
75
 
Cash flow hedges
   
(1
   
     
 
Unrecognized pension cost and postretirement benefit
   
(263
)
   
(256
)
   
     (266
)
Unrealized loss on available-for-sale security
   
(2
)
   
(3
)
   
(2
)
   
$
(228
)
 
$
(187
)
 
$
(193
)

5. Earnings Per Share
 
      The Company accounts for and discloses net earnings per share using the treasury stock method. The Company’s basic earnings per share is computed by dividing the Company’s reported net income for the period by the weighted-average number of common shares outstanding for the period. The Company’s restricted stock awards, which contain non-forfeitable rights to dividends, are considered participating securities and are included in the calculation of basic earnings per share. Diluted earnings per share reflects the weighted-average number of common shares outstanding during the period used in the basic earnings per share computation plus dilutive common stock equivalents. The diluted earnings per share calculation includes the effect of contingently issuable share-based compensation awards with performance vesting conditions as being outstanding at the beginning of the period in which all vesting conditions are met.

 
The Company’s basic and diluted weighted-average number of common shares outstanding as of July 31, 2010 and August 1, 2009, were as follows:

   
Thirteen weeks ended
   
Twenty-six weeks ended
 
   
July 31,
   
August 1,
   
July 31,
   
August 1,
 
(in millions) 
 
2010
   
2009
   
2010
   
2009
 
Weighted-average common shares outstanding
    156.1       155.9       156.3       155.6  
Effect of Dilution: 
                               
Stock options and awards
    0.8             0.8       0.2  
Weighted-average common shares assuming dilution
    156.9       155.9       157.1       155.8  

 
      Options to purchase 4.8 million and 6.2 million shares of common stock were not included in the computation for the thirteen weeks ended July 31, 2010 and August 1, 2009, respectively. Options to purchase 4.4 million and 6.5 million shares of common stock were not included in the computation for the twenty-six weeks ended July 31, 2010 and August 1, 2009, respectively. These options were not included primarily because the exercise prices of the options were greater than the average market price of the common shares and, therefore, the effect would be antidilutive. For the thirteen weeks and twenty-six weeks ended July 31, 2010, contingently issuable shares of 0.5 million have not been included as the vesting conditions have not been satisfied. Stock option and awards totaling 0.2 million shares were not included in the computation of earnings per share for the thirteen weeks ended August 1, 2009 as the effect would have been antidilutive due to a loss from continuing operations being reported for the period.
 
 
10

 

 
6. Segment Information

The Company has determined that its reportable segments are those that are based on its method of internal reporting. As of July 31, 2010, the Company has two reportable segments, Athletic Stores and Direct-to-Customers. Sales and division results for the Company’s reportable segments for the thirteen weeks and twenty-six weeks ended July 31, 2010 and August 1, 2009 are presented below. Division profit reflects income from continuing operations before income taxes, corporate expense, non-operating income and net interest expense.

Sales
   
Thirteen weeks ended
 
Twenty-six weeks ended
 
   
July 31,
 
August 1,
 
July 31,
 
August 1,
 
(in millions) 
 
2010
 
2009
 
2010
 
2009
 
Athletic Stores
  $ 1,015   $ 1,018   $ 2,196   $ 2,136  
Direct-to-Customers
    81     81     181     179  
Total sales
  $ 1,096   $ 1,099   $ 2,377   $ 2,315  

Operating Results
   
Thirteen weeks ended
   
Twenty-six weeks ended
 
   
July 31,
   
August 1,
   
July 31,
   
August 1,
 
(in millions) 
 
2010
   
2009
   
2010
   
2009
 
Athletic Stores
  $ 33     $ 5     $ 134     $ 66  
Direct-to-Customers
    3       5       13       13  
Division profit
    36       10       147       79  
Corporate expense, net
    25       10       49       29  
Operating profit
    11             98       50  
Other income (1) 
    1       1       1       2  
Interest expense, net
    2       3       5       5  
Income (loss) from continuing operations before income taxes
  $ 10     $ (2 )   $ 94     $ 47  

 
(1)
Other income for the twenty-six weeks ended July 31, 2010 primarily represents royalty income and realized gains associated with foreign currency option contracts. Other income for the twenty-six weeks ended August 1, 2009 primarily represents gains from insurance proceeds, gain on the purchase and retirement of bonds, and royalty income.

 
 7. Pension and 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 medical and life insurance plans are contributory and are not funded.

The following are the components of net periodic pension benefit cost and net periodic postretirement benefit income:

   
Pension Benefits
   
Postretirement Benefits
 
   
Thirteen weeks
   
Twenty-six weeks
   
Thirteen weeks
   
Twenty-six weeks
 
   
Ended
   
Ended
   
Ended
   
ended
 
   
July 31,
   
August 1,
   
July 31,
   
August 1,
   
July 31,
   
August 1,
   
July 31,
   
August 1,
 
   
2010
   
2009
   
2010
   
2009
   
2010
   
2009
   
2010
   
2009
 
Service cost
  $ 3     $ 3     $ 6     $ 6     $     $     $     $  
Interest cost
    9       9       17       18                          
Expected return on plan assets
    (10 )     (11 )     (20 )     (21 )                        
Amortization of net loss (gain)
    4       3       9       6       (1 )     (1 )     (3 )     (3 )
Net benefit expense (income)
  $ 6     $ 4     $ 12     $ 9     $   (1 )   $   (1 )   $   (3 )   $   (3 )
 
 
11

 

 
During the twenty-six weeks ended July 31, 2010 the Company made a $2 million contribution to its Canadian qualified plan.  No further pension contributions to its U.S. or Canadian qualified plans are required in 2010; however, the Company currently expects to make a $30 million contribution by mid September to its U.S. qualified plan.

8. Share-Based Compensation

On May 19, 2010, the Foot Locker 2007 Stock Incentive Plan was amended to increase the number of shares of the Company’s common stock reserved for all awards to twelve million shares.

The Company uses a Black-Scholes option-pricing model to estimate the fair value of share-based awards. The Black-Scholes option-pricing model incorporates various and highly subjective assumptions, including expected term and expected volatility.  Total compensation expense related to the Company’s share-based plans was $3.9 million and $3.0 million and $6.9 million and $5.4 million for the thirteen and twenty-six weeks ended July 31, 2010 and August 1, 2009, respectively.

Compensation expense related to the Company’s stock option and stock purchase plans was $1.5 million and $1.0 million for the thirteen weeks ended July 31, 2010 and August 1, 2009, respectively, and was $3.0 million and $1.7 million for the twenty-six weeks ended July 31, 2010 and August 1, 2009, respectively. The following table shows the Company’s assumptions used to compute the share-based compensation expense:

 
 
Stock Option Plans
Twenty-six weeks ended
 
Stock Purchase Plan
Twenty-six weeks ended
 
 
July 31,
 
August 1,
 
July 31,
 
August 1,
 
 
2010
 
2009
 
2010
 
2009
 
Weighted-average risk free rate of interest
  2.34 %   1.76 %   1.03 %   1.91 %
Expected volatility
  45 %   53 %   39 %   39 %
Weighted-average expected award life
5.0 years
 
4.8 years
 
1.0 year
 
1.0 year
 
Dividend yield
  4.0 %   6.0 %   5.1 %   4.2 %
Weighted-average fair value
$ 4.47   $ 2.87   $ 2.36   $ 4.74  

The information set forth in the following table covers options granted under the Company’s stock option plans for the twenty-six weeks ended July 31, 2010:

(in thousands, except price per share)
 
Shares
   
Weighted-
Average
Term
   
Weighted-
Average 
Exercise 
Price
 
Options outstanding at the beginning of the year
    7,002           $ 16.88  
Granted
    1,309             15.10  
Exercised
    (151 )           11.00  
Expired or cancelled
    (105 )           20.59  
Options outstanding at July 31, 2010
    8,055       5.47     $ 16.65  
Options exercisable at July 31, 2010
    5,637       3.87     $ 18.26  
Options available for future grant at July 31, 2010
    10,336                  

The total intrinsic value of options exercised (the difference between the market price of the Company’s common stock on the exercise date and the price paid by the optionee to exercise the option) for the thirteen and twenty-six weeks ended July 31, 2010 was $0.1 million and $0.6 million, respectively, and was not significant for the thirteen and twenty-six weeks ended August 1, 2009. The aggregate intrinsic value for stock options outstanding and exercisable (the difference between the Company’s closing stock price on the last trading day of the period and the exercise price of the options, multiplied by the number of in-the-money stock options) as of July 31, 2010 was $8.9 million and $5.3 million, respectively. The aggregate intrinsic value for stock options outstanding and exercisable as of August 1, 2009 was $1.7 million and $0.6 million, respectively.

The cash received from option exercises for the thirteen and twenty-six weeks ended July 31, 2010 was $0.2 million and $1.2 million, respectively. There were no option exercises for the thirteen weeks ended August 1, 2009. The cash received from option exercises for the twenty-six weeks ended August 1, 2009 was $0.1 million. The tax benefit realized from option exercises was not significant for any of the periods presented.
 
 
12

 

 
The following table summarizes information about stock options outstanding and exercisable at July 31, 2010:

     
Options Outstanding
         
Options Exercisable
 
Range of Exercise Prices
   
Number
Outstanding
   
Weighted-
Average
Remaining
Contractual
Life
   
Weighted-
Average
Exercise Price
   
Number
Exercisable
   
Weighted-
Average
Exercise Price
 
(in thousands, except price per share)
 
$ 9.51     $ 10.25       1,832       7.01     $ 10.05       915     $ 10.09  
$ 10.31     $ 15.10       2,864       6.22     $ 13.45       1,370     $ 12.11  
$ 15.41     $ 23.92       2,014       4.10     $ 20.66       2,007     $ 20.67  
$ 24.04     $ 27.10       922       3.50     $ 25.70       922     $ 25.70  
$ 28.16     $ 28.16       423       4.50     $ 28.16       423     $ 28.16  
$ 9.51     $ 28.16       8,055       5.47     $ 16.65       5,637     $ 18.26  

Changes in the Company’s non-vested options for the twenty-six weeks ended July 31, 2010 are summarized as follows:
(in thousands, except price per share)
 
Number of
Shares
 
Weighted-
Average Grant
Date Fair Value
per Share
 
Non-vested at January 30, 2010
   
1,918
 
$
11.67
 
Granted
   
1,309
   
15.10
 
Vested
   
(704
)
 
12.45
 
Expired or cancelled
   
(105
)
 
20.59
 
Non-vested at July 31, 2010
   
2,418
   
12.92
 

As of July 31, 2010, there was $5.1 million of total unrecognized compensation cost, related to non-vested stock options, which is expected to be recognized over a weighted-average period of 1.3 years.

Restricted Stock and Units

Restricted shares of the Company’s common stock and restricted stock units may be awarded to certain officers and key employees of the Company. The Company also issues restricted stock units to its non-employee directors. Each restricted stock unit represents the right to receive one share of the Company’s common stock provided that the vesting conditions are satisfied. As of July 31, 2010, 678,535 restricted stock units were outstanding. Compensation expense is recognized using the fair market value at the date of grant and is amortized over the vesting period, provided the recipient continues to be employed by the Company. Generally, awards fully vest after the passage of time, typically three years. However, restricted stock unit grants made after May 19, 2010 in connection with the Company’s long-term incentive program vest after the passage of time and the attainment of certain performance metrics. Restricted stock is considered outstanding at the time of grant and the holders have voting rights.  Dividends are paid to holders of restricted stock that vest with the passage of time; for performance-based restricted stock granted after May 19, 2010, dividends will be accumulated and paid after the performance criteria are met.

Restricted shares and units activity for the twenty-six weeks ended July 31, 2010 and August 1, 2009 is summarized as follows:

   
Number of Shares and Units
 
(in thousands)
 
July 31, 2010
   
August 1, 2009
 
Outstanding at the beginning of the year
   
1,680
     
844
 
Granted
   
651
     
615
 
Vested
   
(457
)
   
(39
)
Cancelled or forfeited
   
(70
   
 
Outstanding at end of period
   
1,804
     
1,420
 
Aggregate value (in millions)
 
$
21.1
   
$
21.8
 
Weighted-average remaining contractual life
 
1.90 years
   
1.42 years
 
 
 
13

 

 
The weighted-average grant-date fair value per share was $13.75 and $9.74 for the twenty-six weeks ended July 31, 2010 and August 1, 2009, respectively. The total value of awards for which restrictions lapsed during the twenty-six weeks ended July 31, 2010 and August 1, 2009 was $9.5 million and $0.9 million, respectively. As of July 31, 2010, there was $12.8 million of total unrecognized compensation cost related to non-vested restricted awards. The Company recorded compensation expense related to restricted stock awards, net of forfeitures, of $3.9 million and $3.7 million for the twenty-six weeks ended July 31, 2010 and August 1, 2009, respectively.

9. Fair Value Measurements

The following tables provide a summary of the Company’s recognized assets and liabilities that are measured at fair value on a recurring basis:

   
At July 31, 2010
   
At August 1, 2009
   
At January 30, 2010
 
(in millions)
 
Level 1
   
Level 2
   
Level 3
   
Level 1
   
Level 2
   
Level 3
   
Level 1
   
Level 2
   
Level 3
 
Assets
                                                     
Short-term investment
  $     $     $ 7     $     $     $ 13     $     $     $ 7  
Auction rate security
          5                   4                   5        
Forward foreign exchange contracts
                            1                   1        
Total Assets
  $     $ 5     $ 7     $     $ 5     $ 13     $     $ 6     $ 7  
                                                                         
Liabilities
                                                                       
European net investment hedge
  $     $ 24     $     $     $ 24     $     $     $ 24     $  
Forward foreign exchange contracts
          2                   1                          
Total Liabilities
  $     $ 26     $     $     $ 25     $     $     $ 24     $  

The Company’s auction rate security is classified as available-for-sale and, accordingly, is reported at fair value. The fair value of the security is determined by review of the underlying security at each reporting period. The Company’s derivative financial instruments are valued using market-based inputs to valuation models. These valuation models require a variety of inputs, including contractual terms, market prices, yield curves, and measures of volatility.

The Company’s Level 3 assets represent the Company’s investment in the Reserve International Liquidity Fund, Ltd. (the “Fund”), a money market fund classified in short-term investments. The Company assesses the fair value of its investment in the Fund, which includes a quarterly impairment evaluation. There were no further redemptions for this investment during the twenty-six weeks ended July 31, 2010.

Item 2. 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, Footaction, and CCS.

The Direct-to-Customers segment is multi-branded and multi-channeled. This segment sells, through its affiliates, directly to customers through catalogs and its Internet websites. Eastbay, one of the affiliates, is among the largest direct marketers of athletic footwear and apparel in the United States.  This segment also operates websites aligned with the brand names of the retail store banners (footlocker.com, ladyfootlocker.com, kidsfootlocker.com, footaction.com, champssports.com, and ccs.com).

STORE COUNT

At July 31, 2010, the Company operated 3,476 stores as compared with 3,500 and 3,615 stores at January 30, 2010 and August 1, 2009, respectively. During the twenty-six weeks ended July 31, 2010, the Company opened 27 stores, remodeled or relocated 94 stores and closed 51 stores.

A total of 20 franchised stores were operating at July 31, 2010, as compared with 22 stores at January 30, 2010 and 19 stores at August 1, 2009. Revenue from the franchised stores was not significant for the thirteen and twenty-six weeks ended July 31, 2010 and August 1, 2009. These stores are not included in the Company’s operating store count above.
 
 
14

 

 
SALES AND OPERATING RESULTS

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. Accordingly, stores opened and closed during the period are not included. Sales from the Direct-to-Customers segment are included in the total Company calculation of comparable-store sales for all periods presented. Sales from acquired businesses that include the purchase of inventory are included in the computation of comparable-store sales after 15 months of operations. Accordingly, effective with the first quarter of 2010, CCS sales have been included in the computation of comparable-store sales. Division profit reflects income from continuing operations before income taxes, corporate expense, non-operating income and net interest expense.

The following table summarizes results by segment:
Sales
   
Thirteen weeks ended
   
Twenty-six weeks ended
 
   
July 31,
   
August 1,
   
July 31,
   
August 1,
 
(in millions)
 
2010
   
2009
   
2010
   
2009
 
Athletic Stores
  $ 1,015     $ 1,018     $ 2,196     $ 2,136  
Direct-to-Customers
    81       81       181       179  
Total sales
  $ 1,096     $ 1,099     $ 2,377     $ 2,315  

Operating Results
   
Thirteen weeks ended
   
Twenty-six weeks ended
 
   
July 31,
   
August 1,
   
July 31,
   
August 1,
 
(in millions)
 
2010
   
2009
   
2010
   
2009
 
Athletic Stores
  $ 33     $ 5     $ 134     $ 66  
Direct-to-Customers
    3       5       13       13  
Division profit
    36       10       147       79  
Corporate expense, net
    25       10       49       29  
Operating profit
    11             98       50  
Other income (1) 
    1       1       1       2  
Interest expense, net
    2       3       5       5  
Income (loss) from continuing operations before income taxes
  $ 10     $ (2 )   $ 94     $ 47  

(1)
Other income for the twenty-six weeks ended July 31, 2010 primarily represents royalty income and realized gains associated with foreign currency option contracts. Other income for the twenty-six weeks ended August 1, 2009 primarily represents gains from insurance proceeds, gain on the purchase and retirement of bonds, and royalty income.

     Sales decreased by $3 million, or 0.3 percent, to $1,096 million for the thirteen weeks ended July 31, 2010, from $1,099 million for the thirteen weeks ended August 1, 2009. For the twenty-six weeks ended July 31, 2010 sales of $2,377 million increased 2.7 percent from sales of $2,315 million for the twenty-six week period ended August 1, 2009. Excluding the effect of foreign currency fluctuations, total sales for the thirteen-week and twenty-six week periods increased 1.3 percent and 2.2 percent, respectively, as compared with the corresponding prior-year periods. Comparable-store sales increased by 2.5 percent and 3.7 percent, for the thirteen and twenty-six weeks ended July 31, 2010, respectively.

     Gross margin, as a percentage of sales, increased to 27.8 percent for the thirteen weeks ended July 31, 2010 as compared with 25.5 percent in the corresponding prior-year period. Gross margin, as a percentage of sales, of 29.4 percent for the twenty-six weeks ended July 31, 2010 increased as compared with 27.5 percent in the corresponding prior-year period. The cost of merchandise rate for the thirteen and twenty-six weeks ended July 31, 2010 decreased by 210 and 140 basis points, respectively, as compared with the corresponding prior-year periods, reflecting a lower markdown rate as the Company was less promotional during the current year, coupled with lower inventory shortages. The thirteen weeks ended July 31, 2010 also reflected a favorable shift toward higher margin apparel. The effect of lower vendor allowances during the current year negatively affected gross margin by 40 and 20 basis points for the thirteen and twenty-six weeks ended July 31, 2010, respectively, as compared with the corresponding prior-year periods. For the thirteen and twenty-six weeks ended July 31, 2010, the occupancy and buyers’ salary expense rate decreased by 20 and 50 basis points, respectively, as a percentage of sales, as compared with the corresponding prior-year periods reflecting expense reductions and improved leverage.
 
 
15

 

Segment Analysis

Athletic Stores

     Athletic Stores sales decreased by 0.3 percent and increased by 2.8 percent for the thirteen and twenty-six weeks ended July 31, 2010, respectively, as compared with the corresponding prior-year periods. Excluding the effect of foreign currency fluctuations, sales from athletic stores increased 1.3 percent and 2.3 percent for the thirteen and twenty-six weeks ended July 31, 2010, respectively, as compared with the corresponding prior-year periods. Comparable-store sales increased by 2.6 percent and 3.9 percent for the thirteen and twenty-six weeks ended July 31, 2010, respectively. The increase in domestic comparable-store sales for the thirteen and twenty-six weeks ended July 31, 2010 reflect an improved in-stock position and new receipts of more compelling assortments of athletic footwear, including expanded offerings of toning, as well as technical and light-weight running styles. International sales increased in Europe reflecting gains in both athletic footwear and apparel. Sales declined in Canada, Australia and New Zealand. The decline in Australia reflects the effect of the prior-year government stimulus program.

     Athletic Stores division profit for the thirteen weeks ended July 31, 2010 increased to $33 million, or 3.3 percent, as a percentage of sales, from a division profit of $5 million or 0.5 percent, as a percentage of sales, for the thirteen weeks ended August 1, 2009. Athletic Stores division profit for the twenty-six weeks ended July 31, 2010 increased to $134 million, or 6.1 percent, as a percentage of sales, from a division profit of $66 million, or 3.1 percent, as a percentage of sales, for the twenty-six weeks ended August 1, 2009. The increase in division profit was mainly attributable to improved sales, as well as a higher gross margin rate as the Company was less promotional during the current year and inventories were better positioned. The Athletic Stores division profit reflects higher incentive compensation, offset by lower operating expenses as this segment benefited from initiatives implemented during late 2009 to reduce overhead costs.

Direct-to-Customers

     Direct-to-Customers sales of $81 million for the thirteen weeks ended July 31, 2010 were flat as compared with the thirteen weeks ended August 1, 2009. Direct-to-Customers sales increased by 1.1 percent to $181 million for the twenty-six weeks ended July 31, 2010, as compared with the corresponding prior-year period of $179 million. Internet sales increased by 2.9 percent to $71 million and by 2.6 percent to $156 million for the thirteen and twenty-six weeks ended July 31, 2010, respectively, as compared with the corresponding prior-year periods. This increase was primarily a result of the strong sales performance through the Company’s store banner websites, which benefited from improved functionality and style.

     Direct-to-Customers division profit decreased 40 percent to $3 million, and was flat at $13 million, for the thirteen and twenty-six weeks ended July 31, 2010, as compared with the corresponding prior-year periods. Division profit, as a percentage of sales, decreased to 3.7 percent and 7.2 percent for the thirteen and twenty-six weeks ended July 31, 2010, respectively, as compared with 6.2 percent and 7.3 percent, respectively, in the corresponding prior-year periods. The decrease primarily reflects a lower gross margin rate as a result of increased free shipping offers.

Corporate Expense