UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2007
Commission File Number 1-11681
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FOOTSTAR, INC.
(Exact name of registrant as specified in its charter)
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DELAWARE 22-3439443
(State or other jurisdiction (IRS Employer Identification No.)
of incorporation for organization)
933 MACARTHUR BLVD., MAHWAH, NEW JERSEY 07430
(Address of principal executive offices including zip code)
(201) 934-2000
(Registrant's telephone number, including area code)
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Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
--- ---
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer" and "large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
Large accelerated filer Accelerated filer X Non-accelerated filer
--- --- ---
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes No X
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Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Sections 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. (The registrant did not distribute new securities under
the plan confirmed by the court; there was no change to the holders of
securities as a result of the registrant's reorganization.) Yes X No
--- ---
Number of shares outstanding of common stock, par value $.01 per share, as of
July 28, 2007: 21,125,072.
1
FOOTSTAR, INC.
QUARTERLY REPORT ON FORM 10-Q
TABLE OF CONTENTS
Part I FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Statements of Operations - For the Three and
Six Months Ended June 30, 2007 (unaudited) and July 1, 2006
(unaudited).......................................................... 3
Condensed Consolidated Balance Sheets - As of June 30, 2007 (unaudited)
and December 30, 2006................................................ 4
Condensed Consolidated Statement of Shareholders' Equity and
Comprehensive Income for the Six Months Ended June 30, 2007
(unaudited).......................................................... 5
Condensed Consolidated Statements of Cash Flows - For the Six Months
Ended June 30, 2007 (unaudited) and July 1, 2006 (unaudited)......... 6
Notes to Condensed Consolidated Financial Statements.................... 7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations................................................... 15
Item 3. Quantitative and Qualitative Disclosures about Market Risk......... 21
Item 4. Controls and Procedures............................................ 22
Part II. OTHER INFORMATION
Item 1. Legal Proceedings.................................................. 22
Item 1A. Risk Factors...................................................... 22
Item 4. Submission of Matters to a Vote of Security Holders................ 26
Item 6. Exhibits........................................................... 27
SIGNATURES................................................................. 27
31.1 Certification of President and Chief Executive Officer of the Company,
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002............. 28
31.2 Certification of Chief Financial Officer - Senior Vice President of
the Company, pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.................................................................. 29
32.1 Certification of President and Chief Executive Officer and Chief
Financial Officer - Senior Vice President of the Company pursuant to
18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002............................................ 30
2
PART 1. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2007 AND JULY 1, 2006
(Unaudited)
(in millions, except per share amounts)
Three Months Ended Six Months Ended
----------------------------- ----------------------------
JUNE 30, 2007 July 1, 2006 JUNE 30, 2007 July 1, 2006
------------- ------------- ------------- ------------
Net sales $173.4 $190.6 $307.5 $324.5
Cost of sales 112.7 125.4 205.9 220.2
------ ------ ------ ------
GROSS PROFIT 60.7 65.2 101.6 104.3
Store operating, selling, general and
administrative expenses 37.1 41.8 75.9 81.2
Depreciation and amortization 2.1 2.3 4.2 4.5
Other income (0.6) -- (0.6) --
Interest expense 0.3 0.3 0.6 0.9
Interest income (0.7) (0.8) (2.0) (1.5)
------ ------ ------ ------
INCOME BEFORE REORGANIZATION ITEMS 22.5 21.6 23.5 19.2
Reorganization items -- 0.2 -- 0.1
------ ------ ------ ------
INCOME BEFORE INCOME TAXES AND DISCONTINUED OPERATIONS 22.5 21.4 23.5 19.1
Income tax provision (1.0) -- (1.2) (0.3)
------ ------ ------ ------
INCOME FROM CONTINUING OPERATIONS 21.5 21.4 22.3 18.8
Loss from discontinued operations,
net of taxes -- (0.1) -- (0.9)
Gain from disposal of discontinued
operations, net of taxes -- 0.1 -- 0.1
------ ------ ------ ------
NET INCOME $ 21.5 $ 21.4 $ 22.3 $ 18.0
====== ====== ====== ======
NET INCOME (LOSS) PER SHARE:
Basic:
Income from continuing operations $ 1.04 $ 1.04 $ 1.08 $ 0.92
Loss from discontinued operations -- -- -- (0.04)
------ ------ ------ ------
Net income $ 1.04 $ 1.04 $ 1.08 $ 0.88
Diluted:
Income from continuing operations $ 1.02 $ 1.03 $ 1.07 $ 0.91
Loss from discontinued operations -- -- -- (0.04)
------ ------ ------ ------
Net income $ 1.02 $ 1.03 $ 1.07 $ 0.87
Average common shares outstanding:
Basic 20.7 20.6 20.7 20.6
Diluted 21.0 20.7 20.9 20.7
====== ====== ====== ======
See accompanying notes to condensed consolidated financial statements.
3
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in millions, except share amounts)
JUNE 30, 2007
(UNAUDITED) December 30, 2006
------------- -----------------
ASSETS
Current Assets:
Cash and cash equivalents $ 3.2 $101.3
Accounts receivable, net 11.7 10.6
Inventories 103.4 92.0
Prepaid expenses and other current assets 7.7 7.9
------ ------
Total current assets 126.0 211.8
Property and equipment, net 22.9 25.2
Intangible assets, net 5.0 6.7
Deferred charges and other assets 1.2 1.6
------ ------
Total assets $155.1 $245.3
====== ======
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities not subject to compromise:
Accounts payable $ 47.1 $ 50.0
Accrued expenses 23.9 27.6
Income taxes payable 1.3 0.9
Liabilities of discontinued operations 1.5 2.3
Liabilities subject to compromise 0.5 1.2
------ ------
Total current liabilities 74.3 82.0
Other long-term liabilities 26.8 26.6
Amount due under Kmart Settlement 5.1 5.2
------ ------
Total liabilities 106.2 113.8
Shareholders' Equity:
Common stock $.0l par value: 100,000,000 shares authorized,
31,668,921 and 31,634,242 shares issued 0.3 0.3
Additional paid-in capital 328.4 343.7
Treasury stock: 10,711,569 shares at cost (310.6) (310.6)
Retained earnings 22.1 88.6
Accumulated other comprehensive income 8.7 9.5
------ ------
Total shareholders' equity 48.9 131.5
------ ------
Total liabilities and shareholders' equity $155.1 $245.3
====== ======
See accompanying notes to condensed consolidated financial statements.
4
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY AND COMPREHENSIVE
INCOME
(Unaudited)
(in millions, except share amounts)
Accum-
ulated
Other
Common stock Treasury Stock Add'l Compre-
------------------- -------------------- Paid-in Retained hensive
Shares Amount Shares Amount Capital Earnings Income Total
---------- ------ ---------- ------- ------- -------- ------- -------
BALANCE AS OF DECEMBER 30, 2006 31,634,242 $0.3 10,711,569 $(310.6) $343.7 $ 88.6 $ 9.5 $ 131.5
Comprehensive income:
Net income -- -- -- -- -- 22.3 -- 22.3
Amortization of prior service credit and
actuarial gain attributable to post
retirement benefit plan (0.8) (0.8)
-------
Total comprehensive income 21.5
Special cash distribution -- -- -- -- (16.0) (88.8) -- (104.8)
Common stock incentive plans 34,679 -- -- -- 0.7 -- -- 0.7
---------- ---- ---------- ------- ------ ------ ----- -------
BALANCE AS OF JUNE 30, 2007 (UNAUDITED) 31,668,921 $0.3 10,711,569 $(310.6) $328.4 $ 22.1 $ 8.7 $ 48.9
========== ==== ========== ======= ====== ====== ===== =======
See accompanying notes to condensed consolidated financial statements.
5
FOOTSTAR, INC. and SUBSIDIARY COMPANIES
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 2007 AND JULY 1, 2006
(Unaudited)
(in millions)
Six Months Ended
----------------------------
JUNE 30, 2007 July 1, 2006
------------- ------------
Net cash provided by (used in) operating activities $ 8.5 $ (34.9)
------- -------
Cash flows used in investing activities:
Additions to property and equipment (0.3) (0.6)
------- -------
Net cash used in investing activities (0.3) (0.6)
------- -------
Cash flows used in financing activities:
Special cash distribution paid (104.8) --
Payments on mortgage note (0.5) (0.5)
------- -------
Net cash used in financing activities (105.3) (0.5)
------- -------
Cash flows from discontinued operations:
Net cash used in operating activities of
discontinued operations (1.0) (92.8)
------- -------
Net decrease in cash and cash equivalents (98.1) (128.8)
Cash and cash equivalents, beginning of period 101.3 196.1
------- -------
Cash and cash equivalents, end of period $ 3.2 $ 67.3
======= =======
See accompanying notes to condensed consolidated financial statements.
6
FOOTSTAR, INC. and SUBSIDIARY COMPANIES
THE COMPANY
Footstar, Inc., ("Footstar", the "Company", "we", "us", or "our") is a holding
company that operates its businesses through its subsidiaries. We are
principally a retailer selling family footwear through licensed footwear
departments and wholesale arrangements.
As further discussed in Note 6 "Relationship with Kmart" below, the Kmart
licensed footwear departments account for substantially all of our sales and
operating profits. Our agreement with Kmart expires at the end of 2008. Unless
the Company identifies, develops and/or implements viable business alternatives
to offset this business (and to date we have not identified, developed or
implemented such viable business alternatives) we will almost certainly be
forced to liquidate when our Kmart business ends.
1. EMERGENCE FROM BANKRUPTCY
Commencing March 2, 2004 ("Petition Date"), Footstar and most of its
subsidiaries (collectively, the "Debtors") filed voluntary petitions for
reorganization under Chapter 11 of Title 11 of the United States Code
("Bankruptcy Code" or "Chapter 11") in the United States Bankruptcy Court for
the Southern District of New York in White Plains ("Court"). The Chapter 11
cases were jointly administered under the caption "In re: Footstar, Inc., et.
al. Case No. 04-22350 (ASH)" (the "Chapter 11 Cases"). The Debtors operated
their business and managed their properties as debtors-in-possession pursuant to
Sections 1107(a) and 1108 of the Bankruptcy Code. As debtors-in-possession, we
were authorized to continue to operate as an ongoing business but could not
engage in transactions outside the ordinary course of business without the
approval of the Court.
On July 2, 2005, the Company and Kmart Corporation ("Kmart") entered into an
agreement (the "Kmart Settlement") with respect to the assumption of the Master
Agreement with Kmart, effective July 1, 1995, as amended (the "Master
Agreement"), which was effective as of January 2, 2005, and allowed us to
continue operating the footwear departments in Kmart stores pursuant to an
Amended and Restated Master Agreement (the "Amended Master Agreement"). See Note
6 "Relationship with Kmart".
On November 12, 2004, we filed a proposed joint plan of reorganization with the
Court which was amended on October 28, 2005, and amended again on December 5,
2005 (the "Amended Plan"). On January 25, 2006, the Bankruptcy Court confirmed
our Amended Plan. On February 7, 2006, we successfully emerged from bankruptcy
and paid substantially all our creditors in full with interest. Pursuant to the
guidance provided by the American Institute of Certified Public Accountants in
Statement of Position 90-7, "Financial Reporting by Entities in Reorganization
Under the Bankruptcy Code" ("SOP 90-7"), the Company has not adopted fresh-start
reporting because there was no change to the holders of existing voting shares
and the reorganization value of the Company's assets was greater than its post
petition liabilities and allowed claims.
2. BASIS OF PRESENTATION
Our condensed consolidated financial statements contained herein have been
prepared in accordance with the provisions of SOP 90-7. Pursuant to SOP 90-7,
our pre-petition liabilities that were subject to compromise are reported
separately in the accompanying balance sheet as an estimate of the amount that
will ultimately be allowed by the Court. SOP 90-7 also requires separate
7
FOOTSTAR, INC. and SUBSIDIARY COMPANIES
reporting of certain expenses, realized gains and losses and provisions for
losses related to the bankruptcy filing as reorganization items.
The accompanying condensed consolidated financial statements are unaudited but,
in the opinion of management, contain all adjustments (which are of a normal
recurring nature) necessary to present fairly the financial position, results of
operations, shareholders' equity and cash flows for the periods presented. All
significant intercompany accounts and transactions have been eliminated.
The accompanying unaudited condensed financial statements have been prepared
pursuant to the rules and regulations of the Securities and Exchange Commission.
Certain information and note disclosures normally included in annual financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted pursuant to those rules and regulations. The
financial information set forth herein should be read in conjunction with the
Notes to Consolidated Financial Statements contained in our Annual Report on
Form 10-K for the period ended December 30, 2006 filed with the SEC.
The results of operations for the three and six months ended June 30, 2007 are
not necessarily indicative of results to be expected for the entire fiscal year
ending December 29, 2007.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
As of June 30, 2007, there have been no material changes to any of our
significant accounting policies, except that we adopted FASB Interpretation No.
48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB
Statement No. 109, Accounting for Income Taxes ("FIN 48"), effective December
31, 2006. FIN 48 clarifies the accounting for uncertainty in income taxes
recognized in financial statements and requires the impact of a tax position to
be recognized in the financial statements if that position is more likely than
not of being sustained by the taxing authority. As of June 30, 2007 the Company
had an insignificant amount of unrecognized tax benefits, none of which would
materially affect the effective tax rate if recognized. We do not expect that
the amount of unrecognized tax benefits will significantly increase or decrease
within the next twelve months. The Company's policy is to recognize interest and
penalties related to tax matters in income tax provision in the Condensed
Consolidated Statements of Operations. The amount of interest and penalties for
the six months ended June 30, 2007 was insignificant. Tax years beginning in
2004 are generally subject to examination by taxing authorities, although net
operating losses from all years are subject to examinations and adjustments for
at least three years following the year in which the attributes are used.
4. IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In September 2006, the FASB issued Statement No. 157, Fair Value Measurements,
which defines fair value, establishes a framework for measuring fair value under
generally accepted accounting principles followed in the United States ("GAAP"),
and expands disclosures about fair value measurements. FASB Statement No. 157
applies to other accounting pronouncements that require or permit fair value
measurements. The new guidance is effective for financial statements issued for
fiscal years beginning after November 15, 2007, and for interim periods within
those fiscal years. We are currently evaluating the potential impact, if any, of
the adoption of FASB Statement No. 157 on our consolidated financial position,
results of operations and cash flows.
8
FOOTSTAR, INC. and SUBSIDIARY COMPANIES
In February 2006, the FASB issued Statement No. 159, The Fair Value Option for
Financial Assets and Liabilities Including an Amendment of FASB Statement No.
115, which allows companies to elect to measure many financial instruments and
certain other items at fair value. The new guidance is effective for financial
statements issued for fiscal years beginning after November 15, 2007. We are
currently evaluating the potential impact, if any, of the adoption of FASB
Statement No. 159 on our consolidated financial position, results of operations
and cash flows.
5. DISCONTINUED OPERATIONS
The disposition of our Athletic Segment and certain operations within our
Meldisco Segment in fiscal year 2004, have been accounted for as discontinued
operations in accordance with FASB Statement No. 144, Accounting for the
Impairment or Disposal of Long Lived Assets. Accordingly, we have reported our
results of the discontinued operations as a separate component of operations. In
addition, we applied the provisions of FASB Statement No. 144 to the stores
closed by Kmart during the second quarter of 2007 and 2006 and determined that
these stores either did not meet the criteria to be accounted for as
discontinued operations or were not considered material to our consolidated
results of operations.
Net sales, operating loss, interest expense and loss from discontinued
operations for the three and six months ended June 30, 2007 and July 1, 2006
were as follows (in millions):
Three Months Ended Six Months Ended
---------------------------- ----------------------------
JUNE 30, 2007 July 1, 2006 JUNE 30, 2007 July 1, 2006
------------- ------------ ------------- ------------
Net sales $-- $ -- $-- $ --
Operating loss from
discontinued operations -- -- -- (0.3)
Interest expense -- 0.1 -- 0.6
Provision for income taxes -- -- -- --
--- ----- --- -----
Loss from discontinued operations $-- $(0.1) $-- $(0.9)
=== ===== === =====
6. RELATIONSHIP WITH KMART
The business relationship with Kmart is extremely important to us. The Kmart
licensed footwear departments account for substantially all of our sales and
operating profit. The loss of this operation, a significant reduction in
customer traffic in Kmart stores or the closing of a significant number of
additional Kmart stores would have a material adverse effect on us.
We operated the footwear departments in 1,389 Kmart stores as of June 30, 2007.
The Amended Master Agreement governs our relationship with Kmart and expires at
the end of 2008 at which time Kmart is obligated to purchase all our inventory
relating to the footwear departments at Kmart (but not our brands) at book
value, as defined. Unless the Company identifies, develops and/or implements
viable business alternatives to offset this business (and to date we have
9
FOOTSTAR, INC. and SUBSIDIARY COMPANIES
not identified, developed or implemented such viable business alternatives) we
will almost certainly be forced to liquidate when our Kmart business ends.
The Amended Master Agreement provides that we pay Kmart 14.625% of the gross
sales of the footwear departments and a miscellaneous expense fee of $23,500
each year per open store.
We and Kmart each have the right to terminate the Amended Master Agreement early
if the gross sales of the footwear departments are less than $550.0 million in
any year, provided that this gross sales minimum will be reduced by $0.4 million
for each store that is closed or converted after August 25, 2005. Fifty stores
have been closed or converted from August 25, 2005 through June 30, 2007. We
also have the unilateral right to terminate the Amended Master Agreement if
either (i) the number of Kmart stores is less than 900 or (ii) the gross sales
of the footwear departments in any four consecutive quarters are less than
$450.0 million. Since August 2005, the gross sales of the footwear departments
in any four consecutive quarters have ranged from $621.2 million to $650.7
million. In the event of any such termination, Kmart is obligated to purchase
all of the inventory (including inventory that is on order but excluding
inventory that is damaged, unsaleable, and seasonal inventory, as defined) for
an amount equal to the book value of the inventory, as defined.
Pursuant to the Amended Master Agreement, Kmart must pay us the stipulated loss
value (as set forth below) if it terminates our licenses to operate the footwear
departments in up to 550 Kmart stores during the remaining term of the Amended
Master Agreement by disposing of, closing or converting those stores. The number
of stores it can dispose of, close or convert per year is capped at 85 in 2005,
150 in 2006 and 160 in each of 2007 and 2008, with any unused cap carried over
to the following year. In 2005 and 2006, 90 stores were disposed of, closed or
converted. In 2007, through June 30, 2007, three stores were disposed of, closed
or converted. For each store that is disposed of, closed or converted, Kmart
must purchase all of our in-store inventory (excluding inventory that is
damaged, unsaleable and seasonal inventory, as defined) at book value, as
defined. In addition, to the extent Kmart exceeds the annual cap or the 550
aggregate limit, Kmart must pay us a non-refundable stipulated loss value per
store equal to $40,000 for terminations occurring in 2007 and $20,000 for
terminations occurring in 2008. If the entire Amended Master Agreement is
terminated in accordance with its terms Kmart is not obligated to make any
stipulated loss value payments for such stores.
The Amended Master Agreement sets forth the parties' obligations with respect to
staffing and advertising. Specifically, we must spend at least 10% of gross
sales in the footwear departments on staffing costs, as defined, for the stores
and we must schedule the staffing in each store at a minimum of 40 hours per
week. In addition, Kmart is required to allocate at least 52 weekend newspaper
advertising insert pages per year to our products.
Kmart has a claim against us in the amount of $11,000 for each store that was an
existing store on August 25, 2005, which is generally payable by us to Kmart at
the time a store is disposed of, closed or converted to another retail format in
accordance with the 550 store limitation described above. However, upon the
expiration of the Amended Master Agreement or upon early termination of that
agreement other than as a result of our breach, all such claims not yet due and
payable will be waived for any remaining stores. If the Amended Master Agreement
is terminated as a result of
10
FOOTSTAR, INC. and SUBSIDIARY COMPANIES
our breach, such claims for remaining stores will not be waived and will become
immediately due and payable.
As set forth in the Amended Master Agreement, Kmart collects proceeds from the
sale of our inventory and remits those sales proceeds to us on a weekly basis
less any applicable fees outlined in the Kmart Settlement. Such fees were $32.6
million and $34.8 million for the three months ended June 30, 2007 and July 1,
2006, respectively, and $59.5 million and $61.9 million for the six months ended
June 30, 2007 and July 1, 2006, respectively. As of June 30, 2007 and December
30, 2006, we had outstanding accounts receivable due from Kmart of $9.0 million
and $7.9 million respectively, which were subsequently collected in July 2007
and January 2007, respectively.
7. LIABILITIES RELATED TO DISCONTINUED OPERATIONS
Liabilities related to discontinued operations not subject to compromise
consisted of the following (in millions):
JUNE 30, 2007 December 30, 2006
------------- -----------------
LIABILITIES
Accrued expenses $1.5 $2.3
---- ----
$1.5 $2.3
==== ====
8. LIABILITIES SUBJECT TO COMPROMISE
Liabilities subject to compromise represent our current estimate of the amount
of the pre-petition claims that are subject to restructuring during our
bankruptcy. Pursuant to Court orders, we were authorized to pay certain
pre-petition operating liabilities incurred in the ordinary course of business
and reject certain of our pre-petition obligations. We notified all known
pre-petition creditors of the establishment of a bar date by which creditors
must file a proof of claim, which bar date has now passed for all creditors.
Differences between liability amounts recorded by us and claims timely filed by
creditors have been substantially reconciled and paid upon our emergence on
February 7, 2006. The Court will make a final determination of allowable claims
on the remaining disputed amounts.
Liabilities subject to compromise consisted of the following (in millions):
JUNE 30, 2007 December 30, 2006
------------- -----------------
Accrued expenses $0.5 $1.2
---- ----
Total $0.5(a) $1.2(a)
==== ====
(a) Includes approximately $0 and $0.3 million of liabilities subject to
compromise from discontinued operations as of June 30, 2007 and December
30, 2006, respectively.
9. REORGANIZATION ITEMS
Reorganization items, which consist of income and expenses that are related to
our bankruptcy proceedings, were comprised of the following for the three and
six months ended June 30, 2007 and July 1, 2006 (in millions):
11
FOOTSTAR, INC. and SUBSIDIARY COMPANIES
Three Months Ended Six Months Ended
---------------------------- ----------------------------
JUNE 30, 2007 July 1, 2006 JUNE 30, 2007 July 1, 2006
------------- ------------ ------------- ------------
Professional fees $-- $ -- $-- $ 1.3
Loss (gain) on disposition of
bankruptcy claims -- 0.2 -- (0.5)
Interest income -- -- -- (0.7)
--- ---- --- -----
Total $-- $0.2 $-- $ 0.1
=== ==== === =====
10. EARNINGS PER SHARE
Basic EPS is computed by dividing net income available for common stockholders
by the weighted average number of common shares outstanding for the period.
Diluted EPS is computed by dividing net income available to common stockholders
by the weighted average shares outstanding, after giving effect to the potential
dilution that could occur if outstanding options or other contracts or
obligations to issue common stock were exercised or converted.
The following table reflects average shares outstanding used to compute basic
and diluted earnings (loss) per share (in millions):
Three Months Ended Six Months Ended
---------------------------- ----------------------------
JUNE 30, 2007 July 1, 2006 JUNE 30, 2007 July 1, 2006
------------- ------------ ------------- ------------
Average shares outstanding 20.6 20.5 20.6 20.5
Average contingently issuable shares (1) 0.1 0.1 0.1 0.1
---- ---- ---- ----
Average shares outstanding - basic 20.7 20.6 20.7 20.6
==== ==== ==== ====
Average shares outstanding - diluted (2) 21.0 20.7 20.9 20.7
==== ==== ==== ====
(1) Represents shares earned under our stock incentive plans
(2) The computation of diluted EPS does not assume conversion, exercise or
issuance of shares that would have an anti-dilutive effect on EPS. Shares
that could potentially dilute EPS in the future, but which were not
included in the calculation of diluted EPS because to do so would have been
anti-dilutive, totaled 494,415 shares for the three and six months ended
June 30, 2007 and 558,945 shares for the three and six months ended July 1,
2006. There were no shares having an anti-dilutive effect included in the
calculation of EPS in any period.
11. INCOME TAXES
The effective tax rate for the three and six months ended June 30, 2007 was
lower than the expected rate and the applicable U.S. statutory rate because the
Company is utilizing net operating losses available to reduce the annual
provision. The 2007 income tax provision relates to the estimated income tax
obligation of our stores located in Puerto Rico, Guam and the Virgin Islands,
which do not have net operating losses available to offset current income. Also
included in the income tax provision for the three and six months ended June 30,
2007 is a provision for alternative minimum tax. The 2006 income tax provision
relates to the estimated income tax obligation of our stores located in Puerto
Rico, Guam and the Virgin Islands.
As of June 30, 2007, all of the Company's deferred tax assets, net of deferred
tax liabilities, continue to be subject to a full valuation allowance, including
the net operating losses available to offset future taxable income.
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FOOTSTAR, INC. and SUBSIDIARY COMPANIES
12. COMMITMENTS AND CONTINGENCIES
Kmart Relationship
The Amended Master Agreement expires at the end of December 2008. Unless the
Company identifies, develops and/or implements viable business alternatives to
offset this business (and to date we have not identified, developed or
implemented such viable business alternatives) we will almost certainly be
forced to liquidate when our Kmart business ends. In addition, should we fail to
meet the minimum sales tests, staffing requirements or other provisions provided
in the Amended Master Agreement, after the expiration of applicable cure
periods, termination of our business could occur prior to December 2008. Kmart
has been in communication with us concerning its view that we have not been in
compliance with our obligation to schedule a minimum of 40 hours per week in
each store. We have provided Kmart with specific information on this issue
which we believe demonstrates we are in material compliance with our scheduling
requirements. We plan to continue to provide information to Kmart concerning
this issue and will continue to monitor this matter.
Litigation Matters
On or about March 3, 2005, a first amended complaint was filed against us in the
U.S. District Court for the District of Oregon, captioned Adidas America, Inc.
and Adidas -Salomon AG v. Kmart Corporation and Footstar, Inc. The first amended
complaint and subsequent amendments, seek injunctive relief and unspecified
monetary damages for alleged trademark infringement, trademark dilution, unfair
competition, deceptive trade practices and breach of contract arising out of our
use of four stripes as a design element on footwear which Adidas claims
infringes on its registered three stripe trademark. While it is too early to
predict the outcome of the litigation, we believe that we have meritorious
defenses and we have filed an answer denying the allegations asserted by Adidas.
At each balance sheet date, or more frequently as conditions warrant, the
Company reviews the status of this claim, as well as its potential insurance
coverage for such claim with due consideration given to potentially applicable
deductibles and reservations of rights under its insurance policies. While the
ultimate outcome of any litigation cannot be predicted, management believes that
adequate provision has been made with respect to such claim and does not believe
that an amount of loss in excess of recorded amounts is reasonably possible.
Based on the information presently available and the availability of insurance,
the Company does not expect that the outcome of such claim will have a material
adverse effect on the Company's financial condition, results of operations or
liquidity. There can be no assurance, however, that future events will not
require the Company to increase the amount it has accrued for this matter.
NAFTA Traders, Inc. ("NAFTA"), a salvage company which previously did business
with our former Footaction division, filed a proof of claim in our bankruptcy
proceeding alleging that NAFTA is owed the amount of $3.8 million. In July,
2006, NAFTA amended its claim to $9.1 million plus legal fees and expenses. We
objected to their initial and amended claim and reserved all rights to continue
to object to and challenge any claim by NAFTA on the basis that we owe
relatively minimal amounts, if any, to NAFTA. In November, 2006, NAFTA further
amended its proof of claim to $4.5 million. Following a summary judgment
hearing, this claim, which was an adversary proceeding in the U. S. Bankruptcy
Court in the Southern District of New York, was expunged in its entirety by a
court order dated June 1, 2007.
A former employee of the Company filed a proof of claim in our bankruptcy
proceeding alleging he is owed $2 million based on services rendered and
agreements entered into during his employment. Following a trial, this claim was
disallowed and expunged in its entirety by a court order dated July 25, 2007.
13
FOOTSTAR, INC. and SUBSIDIARY COMPANIES
We are involved in various other claims and legal actions arising in the
ordinary course of business. We do not believe that any of them will have a
material adverse effect on our financial position.
FMI Agreement
During our bankruptcy, we sold certain assets, including, among other things,
our distribution center in Mira Loma, California ("Mira Loma"). We sold Mira
Loma to Thrifty Oil Co. ("Thrifty") for approximately $28.0 million. Thrifty has
leased Mira Loma to FMI International LLC ("FMI"), a logistics provider, which
is obligated to provide us with warehousing and distribution services through
June 30, 2012 under a receiving, warehousing and distribution services
agreement, as amended (the "FMI Agreement"). Pursuant to the FMI Agreement, FMI
is the Company's exclusive provider of receiving, warehousing and physical
distribution services for (a) imported product where the Company or its
subsidiaries are the importer of record or (b) landed or domestic shipments
controlled within the Company's supply chain. In 2006, we were obligated to pay
FMI a minimum of $15.1 million. Commencing with calendar year 2007, there were
originally no specified minimum payments due under the FMI Agreement. Payments
to FMI in 2007, and subsequent years, were to be based on transactional pricing.
With respect to each calendar year commencing with 2007 through the end of the
term of the FMI Agreement, the Company was originally obligated to provide FMI
with an estimated total unit volume, if any, prior to the start of such year. In
order to resolve disagreements regarding the application of transactional
pricing under the FMI Agreement, on June 25, 2007 the Company and FMI entered
into the Third Amendment to the FMI Agreement (the "Third Amendment"), which
among other things, provides for an aggregate minimum revenue commitment equal
to $17,750,000 for the two-year period of 2007 and 2008 payable $10,400,000 in
2007 and $7,350,000 in 2008 and clarifies the pricing schedule contained in the
FMI Agreement. The Company will recognize the expense over a straight line basis
through December 2008. The provisions of the Third Amendment apply commencing
with the first day of the Company's 2007 fiscal year.
13. SPECIAL CASH DISTRIBUTION
On March 27, 2007, the Company announced that its Board of Directors declared a
special cash distribution to shareholders in the amount of $5.00 per common
share. The Company recorded this distribution effective the date the declaration
was made by the Board of Directors. As such, the Company recorded a special cash
distribution which reduced retained earnings by the amount available on the date
of declaration ($88.8 million) and reduced additional paid-in capital for the
amount in excess of retained earnings ($16.0 million). The special cash
distribution was paid on April 30, 2007.
14. DEBT
The Company maintains a $100 million senior-secured revolving credit facility
(the "Credit Facility") (containing a sub-limit for issuance of letters of
credit). The amount the Company may borrow under the Credit Facility is
determined by a borrowing base formula, based upon eligible inventory and
accounts receivable, and other terms of the facility. Revolving loans under the
Credit Facility bear interest, at the Company's option, either at the prime rate
plus a variable margin of 0.0% to 0.5% or the London Interbank Offered Rate
("LIBOR") plus a variable margin of 1.75% to
14
FOOTSTAR, INC. and SUBSIDIARY COMPANIES
2.50%. The variable margin is based upon quarterly excess availability levels
specified in the Credit Facility. A quarterly fee of 0.3% per annum is payable
to the lenders on the unused balance. The Credit Facility has a maturity date of
the earlier of November 30, 2008 and thirty days prior to the termination of the
Amended Master Agreement.
As of June 30, 2007, the Company had no loans outstanding, standby letters of
credit totaling $8.1 million and $60.2 million available for additional
borrowings under the Credit Facility. The special distribution to shareholders
on April 30, 2007 temporarily depleted the Company's cash balances and caused
the Company to incur loans under its Credit Facility, which have since been
repaid.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD-LOOKING STATEMENTS
This report contains forward-looking information within the meaning of The
Private Securities Litigation Reform Act of 1995. These statements may be
identified by the use of words such as "anticipate," "estimates," "should,"
"expect," "guidance," "project," "intend," "plan," "believe" and other words and
terms of similar meaning, in connection with any discussion of our financial
statements, business, results of operations, liquidity and future operating or
financial performance. Factors that could affect our forward-looking statements
include, among other things:
- if the Company identifies, develops and/or implements viable business
alternatives (which it has not developed to date) to replace the loss
of its Kmart business at the end of December 2008;
- whether the Company will be able to continue to operate the footwear
departments in Kmart stores through December 2008;
- impact of the declaration and payment of the $5.00 per share special
distribution on April 30, 2007 on our future cash requirements and
liquidity needs, both for our expected operations as well as other
future needs, contingencies, obligations or operating plans;
- the affect on the Company should Kmart significantly reduce the number
of or eliminate Kmart footwear departments, between now and December
31, 2008;
- the Company's ability to obtain and maintain adequate terms with
vendors and service providers;
- the ability to maintain contracts that are critical to the Company's
operations;
- the Company's ability to successfully implement and maintain internal
controls and procedures that ensure timely, effective and accurate
financial reporting;
- the Company's ability to reduce overhead costs commensurate with any
decline in sales;
- any adverse developments in existing commercial disputes or legal
proceedings;
- the Company's ability to manage and plan for the disposal of, closing
or conversion of Kmart stores; and
- intense competition in the markets in which the Company competes.
The Company's operation of the footwear departments in Kmart stores accounts for
substantially all of the Company's net sales and profits. The Company's
agreement with Kmart provides for the termination of this business by no later
than the end of December 2008 and permits earlier termination, after the
expiration of applicable cure periods, if we fail to meet the minimum sales
tests, staffing obligations or other provisions of
15
FOOTSTAR, INC. and SUBSIDIARY COMPANIES
such agreement. Kmart has been in communication with us concerning its view that
we have not been in compliance with our obligation to schedule a minimum of 40
hours per week in each store. We have provided Kmart with specific information
on this issue which we believe demonstrates we are in material compliance with
our scheduling requirements. We plan to continue to provide information to Kmart
concerning this issue and will continue to monitor this matter.
In addition, unless the Company identifies, develops and/or implements viable
business alternatives to offset this business (and to date we have not
identified, developed or implemented such viable business alternatives) we will
almost certainly be forced to liquidate when our Kmart business ends.
Because the information in this Quarterly Report on Form 10-Q is based solely on
data currently available, it is subject to change and should not be viewed as
providing any assurance regarding our future performance. Actual results and
performance may differ from our current projections, estimates and expectations
and the differences may be material, individually or in the aggregate, to our
business, financial condition, results of operations, liquidity and prospects.
Additionally, we do not plan to update any of our forward looking statements
based on changes in assumptions, changes in results or other events subsequent
to the date of this Quarterly Report on Form 10-Q, other than as included in our
future required SEC filings.
OVERVIEW
The following points highlight the first six months of operations of 2007 as
compared to the first six months of 2006 for the Company and our financial
condition as of June 30, 2007:
- As of June 30, 2007 we operated in 1,389 Kmart stores compared with 1,395
stores on July 1, 2006, and as of June 30, 2007 we operated in 854 Rite Aid
stores in the western region of the United States, compared with 851 stores
on July 1, 2006;
- Operating profit increased to $21.5 million for the six month period ended
June 30, 2007 as compared to an operating profit of $18.6 million for the
six month period ended July 1, 2006 primarily due to an increase in gross
profit percentage and a reduction in expenses;
- The Company provided $7.5 million in cash from operating activities (from
continuing and discontinued operations) during the first six months of 2007
as compared to $127.7 million for the first six months of 2006;
- As of June 30, 2007, the Company had $3.2 million in cash and cash
equivalents with no loans outstanding under the Credit Facility and standby
letters of credit thereunder totaling $8.1 million. The Company had $60.2
million available for additional borrowing under the Credit Facility as of
June 30, 2007;
- On April 30, 2007, the Company paid a special cash distribution of $5.00
per common share totaling $104.8 million.
KMART RELATIONSHIP
Our business relationship with Kmart is extremely important to us. The licensed
footwear departments in Kmart provide substantially all of our sales and
profits.
PRODUCT SOURCING
Product sourcing in the family footwear business is driven by relationships with
foreign manufacturers. Approximately 96% of our products are imported by us and
manufactured in China where the cost of labor has increased. A portion of our
footwear product is comprised of petrochemical products where prices have
fluctuated dramatically over the past year. Furthermore, higher product prices
could result from China's July 2005 currency revaluation which allows the value
of the Yuan to link to a trade-weighted basket of currencies rather than being
pegged to the
16
FOOTSTAR, INC. and SUBSIDIARY COMPANIES
U.S. dollar at a fixed rate. Although we pay for finished goods in U.S. dollars,
it is possible that these costs could be passed on to us through higher product
costs. As a result of these issues, the Company has begun to shift manufacturing
production to lower cost regions of China. It is possible that the Company could
experience lower product quality and/or late shipments in these new factories
which could unfavorably impact the Company's financial results.
RESULTS OF OPERATIONS - THREE MONTHS ENDED JUNE 30, 2007 VERSUS THREE MONTHS
ENDED JULY 1, 2006
The following is a discussion of the results of operations for the three months
ended June 30, 2007 compared with the three months ended July 1, 2006 (in
millions):
SECOND QUARTER 2007 VERSUS SECOND QUARTER 2006
% OF SALES - % of Sales -
2007 2006 2007 2006
------ ------ ------------ ------------
Net Sales $173.4 $190.6 100.0 100.0
------ ------ ----- -----
Gross Profit 60.7 65.2 35.0 34.2
SG&A Expenses 37.1 41.8 21.4 21.9
Depreciation/Amortization 2.1 2.3 1.2 1.2
------ ------ ----- -----
Operating Profit $ 21.5 $ 21.1 12.4 11.0
------ ------ ----- -----
NET SALES
Net sales decreased $17.2 million, or 9.0%, to $173.4 million in 2007 compared
with $190.6 million in 2006. Shoemart sales were approximately $166.9 million in
2007 and $182.2 million in 2006. Shoemart comparable store sales decreased 7.9%
in second quarter due to a poor month of sales in April which included a weak
Easter selling season. Shoemart store counts were down on average by 0.7% during
the quarter as there were 1,389 open at the end of second quarter 2007 versus
1,395 at the end of second quarter 2006. The balance of the sales decrease was
due to a 14.5% comparable store sales decline at Rite Aid and lower wholesale
shipments to Wal-Mart.
GROSS PROFIT
Gross profit decreased $4.5 million or 6.9% to $60.7 million in 2007 compared
with $65.2 million in 2006. The gross profit decrease was largely the result of
the 9.0% decline in sales during the second quarter partially offset by the $1.7
million decrease in our fixed minimum revenue commitment with our third party
logistics provider, FMI. The gross profit rate improved from 34.2% to 35.0%
primarily due to the decrease in the fixed minimum revenue commitment with FMI.
(See Note 12 to our Condensed Consolidated Financial Statements for additional
information regarding our relationship with FMI.)
SG&A EXPENSES
SG&A expenses decreased $4.7 million, or 11.2%, to $37.1 million in 2007
compared with $41.8 million in 2006. The decrease in SG&A expenses was due to
lower store selling costs and lower
17
FOOTSTAR, INC. and SUBSIDIARY COMPANIES
home office compensation costs. The overall SG&A rate as a percentage of sales
decreased to 21.4% versus 21.9% in 2006.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization decreased $0.2 million to $2.1 million in 2007
compared with $2.3 million in 2006.
OPERATING PROFIT
Operating profit increased $0.4 million to $21.5 million in 2007 compared with
$21.1 million in 2006 primarily for the reasons described above.
RESULTS OF OPERATIONS - SIX MONTHS ENDED JUNE 30, 2007 VERSUS SIX MONTHS ENDED
JULY 1, 2006
The following is a discussion of the results of operations for the six months
ended June 30, 2007 compared with the six months ended July 1, 2006 (in
millions):
FIRST SIX MONTHS 2007 VERSUS FIRST SIX MONTHS 2006
% OF SALES - % OF SALES -
2007 2006 2007 2006
------ ------ ------------ ------------
Net Sales $307.5 $324.5 100.0 100.0
------ ------ ----- -----
Gross Profit 101.6 104.3 33.0 32.1
SG&A Expenses 75.9 81.2 24.7 25.0
Depreciation/Amortization 4.2 4.5 1.4 1.4
------ ------ ----- -----
Operating Profit $21.5 $18.6 7.0 5.7
------ ------ ----- -----
NET SALES
Net sales decreased $17.0 million, or 5.2%, to $307.5 million in 2007 compared
with $324.5 million in 2006. Shoemart sales were approximately $295.2 million in
2007 and $310.6 million in 2006 for a 5.0% decrease during the first six months
of 2007. The Shoemart sales decrease was the result of comparable store sales
that were down 4.4% and store counts that were down 0.9% on average throughout
the first six months of 2007. The balance of the sales decrease was due to a
6.9% comparable store sales decline at Rite Aid and lower wholesale shipments to
Wal-Mart.
GROSS PROFIT
Gross profit decreased $2.7 million to $101.6 million in 2007 compared with
$104.3 million in 2006. The 2.6% decrease in gross profit dollars was the result
of decreased sales partially offset by higher gross margin rates primarily due
to the decrease in the fixed minimum revenue commitment with our third party
logistics provider, FMI, of $3.1 million.
SG&A EXPENSES
SG&A expenses decreased $5.3 million, or 6.5%, to $75.9 million in 2007 compared
with $81.2 million in 2006. The decrease in SG&A expenses was due to lower store
selling costs, lower costs
18
FOOTSTAR, INC. and SUBSIDIARY COMPANIES
as a result of not being in bankruptcy in 2007 and lower home office
compensation costs. The overall SG&A rate as a percentage of sales decreased to
24.7% in 2007 versus 25.0% in 2006.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization decreased $0.3 million to $4.2 million in 2007
compared with $4.5 million in 2006.
OPERATING PROFIT
Operating profit increased $2.9 million to $21.5 million in 2007 compared with
$18.6 million in 2006 primarily due to the reasons noted above.
LIQUIDITY AND CAPITAL RESOURCES
Our principal sources of liquidity used in funding short-term operations are our
operating cash flows and borrowings available under our revolving credit
facility (the "Credit Facility"). The Credit Facility is structured to support
general corporate borrowing requirements.
Subsequent to our emergence from Chapter 11 through June 30, 2007, we made
payments to creditors totaling $127.5 million, including interest where
applicable. These payments exclude claims for approximately $0.5 million which
we currently expect will be paid, with interest where applicable, upon final
resolution.
Net cash provided by operating activities (from continuing and discontinued
operations) for the first six months of 2007 was $7.5 million compared to cash
used in operating activities (from continuing and discontinued operations) of
$127.7 million for the first six months of 2006. Cash provided by operating
activities for the first six months of 2007 consisted of net income of $22.3
million and other miscellaneous items totaling $3.7 million, partially offset by
an increase in inventories of $11.4 million and a decrease in accounts payable
and accrued expenses of $7.1 million. In the first six months of 2006, the
Company used $123.0 million in cash from operating activities of continuing and
discontinued operations to pay pre-petition claims and related interest upon our
emergence from bankruptcy.
Cash used in investing activities was $0.3 million and cash used in financing
activities was $105.3 million in the first six months of 2007 compared to using
$0.6 million in cash in investing activities and $0.5 million in cash in
financing activities in the first six months of 2006. Cash outflows from
financing activities in the 2007 period reflect the Company's special cash
distribution of $5.00 per common share totaling $104.8 million paid in April
2007. All conditions within our Credit Facility with respect to such
distribution were satisfied.
On March 27, 2007, the Company announced that its Board of Directors declared a
special cash distribution to shareholders in the amount of $5.00 per common
share. This distribution totaling $104.8 million was paid on April 30, 2007. All
conditions within our Credit Facility with respect to such distributions were
satisfied.
Factors that could affect our short and long term liquidity include, among other
things, maintaining
19
FOOTSTAR, INC. and SUBSIDIARY COMPANIES
the support of our key vendors and lenders, retaining key personnel, the payment
of further dividends or distributions, the impact of subsequent financial
results and the timing of the wind-down and ultimate liquidation of our Kmart
business, many of which are beyond our control. If the Company does not
identify, develop and implement viable business alternatives (which we have not
to date) to offset the termination of its Kmart business, it is expected that
the Company will be required to liquidate its business by no later than the end
of 2008. Although we cannot reasonably assess the impact of these or other
uncertainties, we believe that our cash generated from operations and borrowings
available under our Credit Facility will be sufficient to fund our currently
expected operating expenses and current operating business plan, capital
expenditures and working capital needs during the next 12 to 18 months.
We maintain a $100 million senior-secured revolving Credit Facility (containing
a sub-limit for issuance of letters of credit). The amount we may borrow under
the Credit Facility is determined by a borrowing base formula, based upon
eligible inventory and accounts receivable, and other terms of the facility.
Revolving loans under the Credit Facility bear interest, at our option, either
at the prime rate plus a variable margin of 0.0% to 0.5% or the London Interbank
Offered Rate ("LIBOR") plus a variable margin of 1.75% to 2.50%. The variable
margin is based upon quarterly excess availability levels specified in the
Credit Facility. A quarterly fee of 0.3% per annum is payable to the lenders on
the unused balance. The Credit Facility has a maturity date of the earlier of
November 30, 2008 and thirty days prior to the termination of the Amended Master
Agreement.
The Credit Facility is secured by substantially all of the assets of the Company
and contains various affirmative and negative covenants, representations,
warranties and events of default to which we are subject, including certain
financial covenants and restrictions such as limitations on additional
indebtedness, other liens, dividends, distributions, stock repurchases and
capital expenditures. The Company is required to maintain a minimum excess
availability level equal to at least 10% of the borrowing base. In addition, if
minimum excess availability falls below 20% of the calculated borrowing base, we
will be subject to a fixed charge coverage covenant. The Company is currently in
compliance with all of its covenants under the Credit Facility.
As of June 30, 2007, the Company had no loans outstanding, standby letters of
credit totaling $8.1 million and $60.2 million available for additional
borrowings under the Credit Facility. Our special distribution to shareholders
on April 30, 2007 temporarily depleted our cash balances and caused us to incur
loans under our Credit Facility, which have since been repaid.
As of July 28, 2007 we had no loans outstanding, standby letters of credit
totaling $8.1 million and $56.2 million available for additional borrowings
under the Credit Facility.
CRITICAL ACCOUNTING ESTIMATES
Our discussion of results of operations and financial condition relies on our
condensed consolidated financial statements that are prepared based on certain
critical accounting estimates that require management to make judgments and
estimates that are subject to varying degrees of uncertainty. We believe that
investors need to be aware of these estimates and how they impact our financial
statements as a whole, as well as our related discussion and analysis presented
herein. While we believe that these accounting estimates are based on sound
measurement criteria, actual future
20
FOOTSTAR, INC. and SUBSIDIARY COMPANIES
events can and often do result in outcomes that can be materially different from
these estimates or forecasts.
The accounting estimates and related risks described in our Annual Report on
Form 10-K for the fiscal year ended December 30, 2006 are those that depend most
heavily on these judgments and estimates. As of June 30, 2007, there have been
no material changes to any of the critical accounting estimates contained in our
2006 Annual Report on Form 10-K.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
DERIVATIVES
As of June 30, 2007, we were not materially exposed to changes in the underlying
values of our assets or liabilities nor were we materially exposed to changes in
the value of expected foreign currency cash flows. We historically have not
entered into derivative instruments for any purpose other than to manage our
interest rate exposure. We do not hold derivative financial investments for
trading or speculative purposes.
INTEREST RATES
Revolving loans under our Credit Facility bear interest at rates that are tied
to the LIBOR and the Prime Rate and therefore our condensed consolidated
financial statements could be exposed to changes in interest rates. Although we
did incur short term borrowings under the Credit Facility as a result of our
special cash distribution in the second quarter of fiscal 2007, which was repaid
prior to June 30, 2007, the Company has not considered this exposure to be
material. We assess interest rate cash flow risk by identifying and monitoring
changes in interest rate exposures that may adversely impact expected future
cash flows and by evaluating hedging opportunities. The Company has engaged in
interest rate hedging agreements in the past for purposes of limiting portions
of interest rate expense in connection with outstanding variable rate debt. The
Company is not currently engaged in interest rate hedging activities.
FOREIGN EXCHANGE
A significant percentage of the Company's products are sourced or manufactured
offshore, with China accounting for approximately 96% of all sources. Our
offshore product sourcing and purchasing activities are currently, and have been
historically, denominated in U.S. dollars, and, therefore, we do not currently
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
reporting periods presented in this report.
Historically, China's national currency, the Yuan, was pegged to the U.S. dollar
at a fixed rate. However, in July 2005, the Chinese government revalued the Yuan
allowing its value to now link to a trade-weighted basket of currencies. If the
exchange rate of the Chinese Yuan were to continue increasing versus the U.S.
dollar, the Company may experience higher product costs with regards to
inventory purchased from China.
21
FOOTSTAR, INC. and SUBSIDIARY COMPANIES
ITEM 4. CONTROLS AND PROCEDURES
The Company's management, with the participation of our President and Chief
Executive Officer and Chief Financial Officer - Senior Vice President, conducted
an evaluation of the effectiveness of the design and operation of our disclosure
controls and procedures (as such term is defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange
Act")) as of the end of the period covered by this report (the "Evaluation
Date"). There are inherent limitations to the effectiveness of any system of
disclosure controls and procedures, including the possibility of human error and
the circumvention or overriding of the controls and procedures. Accordingly,
even effective disclosure controls and procedures can only provide reasonable
assurance of achieving their control objectives. Based on such evaluation, the
President and Chief Executive Officer and Chief Financial Officer - Senior Vice
President concluded that, as of the Evaluation Date, our disclosure controls and
procedures were effective at a reasonable assurance level.
No changes in the Company's internal control over financial reporting have
occurred during the quarterly period covered by this report that have materially
affected, or are reasonably likely to materially affect, the Company's internal
controls over financial reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The information set forth on page 13 under the caption "Litigation Matters" in
Note 12 to the Condensed Consolidated Financial Statements is incorporated
herein by reference.
ITEM 1A. RISK FACTORS
The Risk Factors included in the Company's Annual Report on Form 10-K for the
fiscal year ended December 30, 2006, have not materially changed, but given the
termination of the Company's principal business relationship with Kmart no later
than December 31, 2008 and the difficulty of the Company's ability to manage and
plan for the disposal of, conversion, or closing of additional Kmart stores, we
are repeating these factors below. In addition, we have included a Risk Factor
concerning the impact of our declaration and payment of a special cash
distribution on April 30, 2007 on our future cash requirements and liquidity
needs for our expected operations.
OUR OPERATION OF THE FOOTWEAR DEPARTMENTS IN KMART STORES ACCOUNTS FOR
SUBSTANTIALLY ALL OF OUR NET SALES AND PROFITS. OUR AGREEMENT WITH KMART
PROVIDES FOR THE TERMINATION OF THIS BUSINESS BY NO LATER THAN THE END OF
DECEMBER 2008 AND PERMITS EARLIER TERMINATION IF WE FAIL, AFTER THE EXPIRATION
OF APPLICABLE CURE PERIODS, TO MEET THE MINIMUM SALES TESTS, STAFFING
OBLIGATIONS OR OTHER PROVISIONS OF SUCH AGREEMENT. SEE MANAGEMENT'S DISCUSSION
AND ANALYSIS - FORWARD-LOOKING STATEMENTS ABOVE. IN ADDITION, UNLESS THE COMPANY
IDENTIFIES, DEVELOPS AND/OR IMPLEMENTS VIABLE BUSINESS ALTERNATIVES TO OFFSET
THIS BUSINESS (AND TO DATE WE HAVE NOT IDENTIFIED, DEVELOPED OR IMPLEMENTED
SUCH VIABLE BUSINESS ALTERNATIVES) WE WILL ALMOST CERTAINLY BE FORCED TO
LIQUIDATE WHEN OUR KMART BUSINESS ENDS.
OUR APRIL 30, 2007 DECLARATION AND PAYMENT OF A SPECIAL CASH DISTRIBUTION MAY
IMPACT OUR FUTURE CASH REQUIREMENTS AND LIQUIDITY NEEDS.
On March 27, 2007, we announced the declaration of a $5.00 per common share cash
distribution, paid on April 30, 2007. The Board considered, among other factors,
our cash position, our expected
22
FOOTSTAR, INC. and SUBSIDIARY COMPANIES
future operating results, our future cash needs and cash position, our liquidity
needs and available capital resources, and our strategic options.
This special cash distribution reduced cash available for future operations, and
for future cash needs and liquidity, by a total of $104.8 million. It is likely
that the Company will be required to periodically borrow under its Credit
Facility to support normal operating needs. If our future operating results or
cash needs or obligations differ in any material respect from our expectations,
or other changes occur in our business or operations, which we have not
anticipated, our cash needs could be greater than our cash generated from
operations and funds available under our Credit Facility, which would have a
material adverse impact on our financial condition. There can be no assurance
that we will have sufficient available cash and available cash resources
(including funds available under our Credit Facility and credit available from
our vendors) to satisfy all of our future cash needs.
In addition, the payment of this special cash distribution may likely limit our
ability to consider or implement other potential business operating plans or
strategic options such as a merger or sale, acquisition of one or more other
businesses, or entry into or expansion of any particular lines of business.
WE MAY BE UNABLE TO ATTRACT AND RETAIN TALENTED PERSONNEL.
Our success is dependent upon our ability to attract and retain qualified and
talented individuals. We have instituted several retention programs designed to
retain key executives and employees and will seek to implement additional
programs to retain key executives and employees if and when necessary. However,
if we are unable to attract or retain key executives and employees, including
senior management, and qualified accounting and finance, marketing, and
merchandising personnel, or put in place additional retention programs, it could
adversely affect our businesses. This risk is acute given the anticipated
liquidation of our Kmart business no later than the end of 2008 as a result of
the Kmart Settlement.
WE RELY ON KEY VENDORS AND THIRD PARTIES TO MANUFACTURE, WAREHOUSE AND
DISTRIBUTE OUR PRODUCTS.
Product sourcing in the family footwear business is driven by relationships with
foreign manufacturers. If the terms under which these vendors deal with us,
including payment terms, change adversely, there could be a material adverse
impact on our operations and financial condition. Also, if these foreign
manufacturers are unable to secure sufficient supplies of raw materials or
maintain adequate manufacturing capacity, they may be unable to provide us with
timely delivery of products of acceptable quality. In addition, if manufacturing
costs increase, our cost of acquiring merchandise could increase. Although we
pay for finished goods in U.S. dollars, it is possible that higher costs could
be passed on to us through higher product costs. If we cannot recover these cost
increases with increased pricing to our customers, it could have a material
adverse effect on our operations and financial condition.
The Company manages against possible product cost increases by shifting
manufacturing production to lower cost regions of China. It is possible that the
Company could experience lower product quality and/or late shipments from these
new factories which could unfavorably impact the Company's financial results.
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FOOTSTAR, INC. and SUBSIDIARY COMPANIES
We also depend on third parties to receive, warehouse, transport and deliver our
products. If these third parties are unable to perform for any reason, or if
they increase the price of their services, there could be a material adverse
effect on our operations and financial performance.
WE MAY BE UNABLE TO ADJUST TO CONSTANTLY CHANGING FASHION TRENDS.
Our level of current sales depends, in large part, upon our ability to gauge the
evolving fashion tastes of our customers and potential customers and to provide
merchandise that satisfies those fashion tastes in a timely manner. The
retailing industry fluctuates according to changing fashion tastes and seasons,
and merchandise usually must be ordered well in advance of the season,
frequently before consumer fashion tastes are evidenced by consumer purchases.
In addition, in order to ensure sufficient quantities of footwear in the desired
size, style and color for each season, we are required to maintain substantial
levels of inventory, especially prior to peak selling seasons when we build up
our inventory levels.
As a result, if we fail to properly gauge the fashion tastes of consumers or to
respond to changes in fashion tastes in a timely manner, this failure could
adversely affect retail and consumer acceptance of our merchandise and leave us
with substantial unsold inventory. If that occurs, we may be forced to rely on
markdowns or promotional sales to dispose of excess, slow-moving inventory,
which may harm our business and financial results.
WE MUST PROVIDE CONSUMERS WITH SEASONALLY APPROPRIATE MERCHANDISE, MAKING OUR
SALES HIGHLY DEPENDENT ON SEASONAL WEATHER CONDITIONS.
If the weather conditions for a particular period vary significantly from those
typical for that period, such as an unusually cold spring or an unusually warm
winter, consumer demand for seasonally appropriate merchandise that we have
available in our footwear departments will be lower, and our net sales and
margins will be adversely affected. Lower sales may leave us with excess
inventory of our basic products and seasonally appropriate products, forcing us
to sell both types of our products at significantly discounted prices and,
thereby, adversely affecting our net sales and margins.
DECLINES IN OUR SALES WILL HAVE A MAGNIFIED IMPACT ON PROFITABILITY BECAUSE OF
OUR FIXED COSTS.
A significant portion of our operating expenses are fixed costs that are not
dependent on our sales performance, as opposed to variable costs, which vary
proportionately with sales performance. These fixed costs include, among other
things, the costs associated with operating as a public company and a
substantial portion of our labor expenses. If our sales decline we may not be
able to reduce our operating expenses proportionately. If our sales fall below
certain minimums set forth in our agreement with Kmart, our right to operate in
Kmart stores may be terminated, forcing us to liquidate.
WE OPERATE IN THE HIGHLY COMPETITIVE FOOTWEAR RETAILING INDUSTRY.
The family footwear industry, where our business is concentrated, is highly
competitive. Competition is concentrated among a limited number of retailers and
discount department stores,
24
FOOTSTAR, INC. and SUBSIDIARY COMPANIES
including Payless ShoeSource, Kmart, Wal-Mart, Kohl's, Sears and Target, with a
number of traditional mid-tier and value-priced retailers such as Shoe Carnival,
Famous Footwear and Rack Room also selling lower-priced footwear. The events
that caused us to seek bankruptcy put us at a disadvantage with respect to our
competitors. In addition, our agreement with Kmart which provides that we will
no longer operate the footwear departments in Kmart stores beyond December 31,
2008, at the latest, puts us at a disadvantage with respect to our competitors,
many of which are growing rapidly and have substantial financial and marketing
resources which are unavailable to us. If we are unable to overcome these
disadvantages and our sales fall below certain minimums set forth in our
agreement with Kmart, our right to operate in Kmart stores may be terminated,
forcing us to liquidate prior to December 31, 2008.
THERE ARE RISKS ASSOCIATED WITH OUR IMPORTATION OF PRODUCTS.
Approximately 96% of the Company's products are directly imported by us and
manufactured in China. Substantially all of this imported merchandise is subject
to customs duties and tariffs imposed by the United States. Penalties may be
imposed for violations of labor and wage standards by foreign contractors.
In addition, China and other countries in which our merchandise is manufactured
may, from time to time, impose additional new quotas, tariffs, duties, taxes or
other restrictions on its merchandise or adversely change existing quotas,
tariffs, duties, taxes or other restrictions. Any such changes could adversely
affect our ability to import our products and, therefore, our results of
operations.
Any deterioration in the trade relationship between the United States and China
or any other disruption in our ability to import products from China could
adversely affect our business, financial condition or results of operations.
Other risks inherent in sourcing products from foreign countries include
economic and political instability, social unrest and the threat of terrorism,
each of which risks could adversely affect our business, financial condition or
results of operations. In addition, we incur costs as a result of security
programs designed to prevent acts of terrorism such as those imposed by
government regulations and our participation in the Customs-Trade Partnership
Against Terrorism implemented by the United States Bureau of Customs and Border
Protection. Significant increases in such costs could adversely affect our
business, financial condition or results of operations.
Our ability to successfully import merchandise into the United States from
foreign sources is also dependent on stable labor conditions in the major ports
of the United States. Any instability or deterioration of the domestic labor
environment in these ports could result in increased costs, delays or disruption
in merchandise deliveries that could cause loss of revenue, damage to customer
relationships and have a material adverse effect on our business operations and
financial condition.
THE FOOTWEAR RETAILING INDUSTRY IS HEAVILY INFLUENCED BY GENERAL ECONOMIC
CYCLES.
Footwear retailing is a cyclical industry that is heavily dependent upon the
overall level of consumer spending. Purchases of footwear, apparel and related
goods tend to be highly correlated with the cycles of the levels of disposable
income of our customers. As a result, any substantial deterioration in general
economic conditions could have a material adverse effect on our operations
25
FOOTSTAR, INC. and SUBSIDIARY COMPANIES
and financial condition.
INTERNAL CONTROL OVER FINANCIAL REPORTING
DURING FISCAL 2004 WE HAD "MATERIAL WEAKNESSES" IN INTERNAL CONTROL OVER
FINANCIAL REPORTING AS DEFINED BY THE PUBLIC COMPANY ACCOUNTING OVERSIGHT
BOARD'S AUDIT STANDARD NO. 2 WHICH IN PART RELATED TO OUR RESTATEMENT AND
RELATED PROCEEDINGS AND CANNOT ASSURE YOU THAT MATERIAL WEAKNESSES WILL NOT BE
IDENTIFIED IN THE FUTURE. OUR FAILURE TO EFFECTIVELY MAINTAIN INTERNAL CONTROL
OVER FINANCIAL REPORTING CAN RESULT IN MATERIAL MISSTATEMENTS IN OUR FINANCIAL
STATEMENTS WHICH COULD REQUIRE US TO RESTATE FINANCIAL STATEMENTS, CAUSE
INVESTORS TO LOSE CONFIDENCE IN OUR REPORTED FINANCIAL INFORMATION AND HAVE A
NEGATIVE EFFECT ON OUR STOCK PRICE.
Although these material weaknesses identified in fiscal 2004 have been
remediated, we cannot assure you that additional other material weaknesses in
our internal control over financial reporting will not be identified in the
future. Any failure to maintain or implement required new or improved controls,
or any difficulties we encounter in their implementation, could result in other
material weaknesses, cause us to fail to meet our periodic reporting obligations
or result in material misstatements in our financial statements. Any such
failure could also adversely affect the results of periodic management
evaluations and annual auditor attestation reports regarding the effectiveness
of our internal control over financial reporting required under Section 404 of
the Sarbanes-Oxley Act of 2002 and the rules promulgated under Section 404. The
existence of a material weakness could also cause investors to lose confidence
in our reported financial information, leading to a decline in our stock price.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The following matters were submitted to a vote of security holders at the
Company's Annual Meeting of Shareholders held on May 9, 2007.
ELECTION OF DIRECTORS
NOMINEE FOR WITHHELD
------- ---------- --------
Michael O'Hara 14,211,887 141,933
Steven D. Scheiwe 14,212,795 141,025
Alan I. Weinstein 14,212,791 141,029
All three directors listed above were elected as Class I directors to a
three-year term expiring in 2010 by the vote indicated.
The following proposal was adopted by the vote indicated:
BROKER
DESCRIPTION OF PROPOSALS FOR AGAINST ABSTAIN NON-VOTES
------------------------ ---------- ------- ------- ---------
Ratification of appointment of Amper Politziner and Mattia,
P.C. as independent registered public accounting firm 14,203,237 143,682 6,901 N/A
26
FOOTSTAR, INC. and SUBSIDIARY COMPANIES
ITEM 6. EXHIBITS
Exhibit 10.2 Third Amendment dated as of June 25, 2007 to the Receiving,
Warehousing and Physical Distribution Services Agreement dated as of July 8,
2004, as amended by First Amendment to Warehousing and Physical Distribution
Services Agreement dated as of July 19, 2004 and a letter agreement dated
January 7, 2005 by and between Footstar Corporation and FMI International LLC.
Exhibit 31.1 Certification of President and Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
Exhibit 31.2 Certification of Chief Financial Officer - Senior Vice President
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
Exhibit 32.1 Certifications pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
SIGNATURES
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.
Date: August 9, 2007 By: /s/ Jeffrey A. Shepard
------------------------------------
Jeffrey A. Shepard
President and Chief Executive
Officer
Date: August 9, 2007 By: /s/ Michael J. Lynch
------------------------------------
Michael J. Lynch
Chief Financial Officer - Senior
Vice President
Date: August 9, 2007 By: /s/ Craig M. Haines
------------------------------------
Craig M. Haines
Vice President, Controller,
Principal Accounting Officer
27