UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

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FORM 10-Q









For the quarterly period ended: October 29, 2016



OR





For the transition period from __________ to __________



Commission File Number: 1-10299

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(Exact name of registrant as specified in its charter)

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330 West 34th Street, New York, New York 10001

(Address of principal executive offices, Zip Code)

(212-720-3700)

(Registrant’s telephone number, including area code)





 



 











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FOOT LOCKER, INC.

TABLE OF CONTENTS











 

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FOOT LOCKER, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

($  in millions, except shares)













 

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See Accompanying Notes to Condensed Consolidated Financial Statements.

 

 



 

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See Accompanying Notes to Condensed Consolidated Financial Statements.

 

 

   

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See Accompanying Notes to Condensed Consolidated Financial Statements.

 



 

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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 28, 2017 and of the fiscal year ended January 30, 2016. 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 Foot Locker, Inc.’s (the “Company”) Form 10-K for the year ended January 30, 2016, as filed with the U.S. Securities and Exchange Commission (the “SEC”) on March 24, 2016.



Recent Accounting Pronouncements



In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers. The core principle of this amendment is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09, as amended by ASU 2015-14, ASU 2016-08, ASU 2016-10 and ASU 2016-12, is effective for annual reporting periods beginning after December 15, 2017, and interim periods herein. Earlier application is permitted for annual reporting periods beginning after December 15, 2016. These ASUs can be adopted either retrospectively to each prior reporting period presented or as a cumulative-effect adjustment as of the date of adoption. The Company is evaluating the effects of the adoption of these ASUs on its consolidated financial statements, however we currently do not expect the adoption will significantly affect our consolidated financial statements, however some changes are expected regarding the timing of recognizing gift card breakage.



In November 2015, the FASB issued ASU 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes. ASU 2015-17 requires all deferred tax liabilities and assets to be presented in the balance sheet as noncurrent. The Company adopted this standard on a prospective basis as of the quarter ended April 30, 2016 and reclassified deferred tax assets and deferred tax liabilities classified as current to noncurrent. No prior periods were retrospectively adjusted.



In February 2016, the FASB issued ASU 2016-02, Leases. This ASU requires lessees to recognize a lease liability and a right-of-use asset for all leases, as well as additional disclosure regarding leasing arrangements. This standard will be effective for fiscal years beginning after December 15, 2018, including interim periods therein, and requires a modified retrospective adoption, with earlier adoption permitted. The Company does not expect to early adopt this ASU and is currently evaluating the effect of this guidance on our consolidated financial statements. The Company has historically presented a non-GAAP measure to adjust its balance sheet to present operating leases as if they were capital leases. Based upon that analysis and preliminary evaluation of the new standard, we currently estimate the adoption will result in the addition of $3 to $4 billion of assets and liabilities on our consolidated balance sheet, with no significant change to our consolidated statements of operations or cash flows.



In March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting. ASU 2016-09 simplifies the accounting for share-based payment transactions, including tax consequences, forfeitures, and classifications of the tax related items in the statement of cash flows. ASU 2016-09 is effective for annual reporting beginning after December 15, 2016 and interim periods therein, with early adoption permitted. The manner of adoption varies, with certain provisions applied on a retrospective or modified retrospective approach, with others applied prospectively. The Company has evaluated the effects of adopting this ASU on its consolidated financial statements and expects the change relating to excess tax benefits will introduce significant volatility to income tax expense as the recognition of the excess tax benefits are dependent on exercise patterns which are inherently unpredictable. The other components of this ASU are not expected to have a significant effect on our consolidated financial statements.

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In October 2016, the FASB issued ASU 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory. ASU 2016-16 requires recognition of income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. This ASU is effective for annual reporting periods after December 15, 2017, including interim periods therein, with early adoption permitted. The amendments in this update should be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. The Company does not expect to adopt this ASU until required and is currently evaluating the effects of adoption on its consolidated financial statements.



In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash. ASU 2016-18 requires that a statement of cash flows explain the change during the period in the total cash, cash equivalents, and amounts generally described as restricted cash and restricted cash equivalents when reconciling the beginning-of-period and end-of-period total amounts. This ASU is effective for annual reporting periods after December 15, 2017 including interim periods therein, with early adoption permitted. The amendments in this update should be applied using a retrospective transition method to each period presented. The Company is currently evaluating the effects of the adoption of this ASU on its consolidated financial statements.

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



2. Segment Information



The Company has determined that its reportable segments are those that are based on its method of internal reporting. The Company has two reportable segments, Athletic Stores and Direct-to-Customers. The Company evaluates performance based on several factors, of which the primary financial measure is division results. Division profit reflects income before income taxes, pension litigation charge, corporate expense, non-operating income, and net interest expense.







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3. Impairment and Litigation Charges





Due to the continued underperformance of our Runners Point and Sidestep stores, management determined during the third quarter of 2016 that a triggering event had occurred and, therefore, an impairment review was conducted. This evaluation resulted in a non-cash charge of $6 million to write-down store fixtures and leasehold improvements of 116 stores. The Company quantified the amount of the impairment by estimating the fair value of the assets reviewed by determining the cash flows expected from the use of the assets. If the carrying value of the assets exceeded the estimated undiscounted future cash flows, an impairment charge was recorded representing the difference between the discounted future cash flow, using the Company’s weighted-average cost of capital, and the carrying value. The Company also performed an impairment review of other intangible assets related to Runners Point and Sidestep. The Company calculated the fair value using a relief from royalty concept and compared the fair value to the carrying value to determine if the asset was impaired. As a result of this review, no impairment charge of these assets was required.



During the third quarter of 2015, the Company recorded a $100 million pension litigation charge. Please see Note 13, Legal Proceedings for further information.





4. Goodwill



Annually during the first quarter, or more frequently if impairment indicators arise, the Company reviews goodwill and intangible assets with indefinite lives for impairment. The annual review of goodwill and intangible assets with indefinite lives performed during the first quarter of 2016 did not result in the recognition of impairment. The following table provides a summary of goodwill by reportable segment.











5. Other Intangible Assets, net



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







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During the thirty-nine week period ended October 29, 2016, the Company recorded  $1 million of lease acquisition additions, primarily related to our European businesses. These additions are being amortized over a weighted-average life of 8 years.  Amortization expense recorded is as follows:





Estimated future amortization expense for finite life intangible assets is as follows:









6. Accumulated Other Comprehensive Loss



Accumulated other comprehensive loss (“AOCL”), net of tax, is comprised of the following:





The changes in AOCL for the thirty-nine weeks ended October 29, 2016 were as follows:





Reclassifications from AOCL for the thirty-nine weeks ended October 29, 2016 were as follows:



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7. Revolving Credit Facility



On May 19, 2016, the Company entered into a new credit agreement with its banks (“2016 Credit Agreement”) that replaced the Company’s prior credit agreement (“2011 Restated Credit Agreement”). The 2016 Credit Agreement provides for a $400 million asset-based revolving credit facility maturing on May 19, 2021.  During the term of the 2016 Credit Agreement, the Company may also increase the commitments by up to $200 million, subject to customary conditions. Interest is determined, at the Company’s option, by the federal funds rate plus a margin of 0.125 percent to 0.375 percent, or a Eurodollar rate, determined by reference to LIBOR, plus a margin of 1.125 percent to 1.375 percent depending on availability under the 2016 Credit Agreement. In addition, the Company will pay a commitment fee of 0.20 percent per annum on the unused portion of the commitments.



The 2016 Credit Agreement provides for a security interest in certain of the Company’s domestic store assets, including inventory assets, accounts receivable, cash deposits, and certain insurance proceeds. The Company is not required to comply with any financial covenants unless certain events of default have occurred and are continuing, or if availability under the 2016 Credit Agreement does not exceed the greater of $40 million and 10 percent of the Loan Cap (as defined in the 2016 Credit Agreement). There are no restrictions relating to the payment of dividends and share repurchases, as long as no default or event of default has occurred and the aggregate principal amount of unused commitments under the 2016 Credit Agreement is not less than 15 percent of the lesser of the aggregate amount of the commitments and the Borrowing Base, determined as of the preceding fiscal month and on a proforma basis for the following six fiscal months. 



The Company uses the credit facility to support standby letters of credit in connection with insurance programs. The amount outstanding as of October 29, 2016 was not significant. The Company’s management does not currently expect to borrow under the facility in 2016. The Company paid approximately $2 million in fees relating to the new credit facility. Deferred financing fees are amortized over the life of the facility on a straight-line basis, which is comparable to the interest method. The unamortized balance as of October 29, 2016 was $2 million. Interest expense including facility fees, related to the revolving credit facility was $1 million for the thirty-nine weeks ended October 29, 2016 and October 31, 2015. 



8. 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 practice 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 a derivative to qualify as a hedge at inception and throughout the hedged period, 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 ineffectiveness. In addition, for hedges of forecasted transactions, the significant characteristics and expected terms of a forecasted transaction must be specifically identified, and it must be probable that each forecasted transaction would occur. If it were deemed probable that the forecasted transaction would not occur, the gain or loss on the derivative instrument 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.

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The primary currencies to which the Company is exposed are the euro, British pound, Canadian dollar, and Australian dollar. For the most part, merchandise inventories are purchased by each geographic area in their respective local currency. The most significant exception to this is the United Kingdom, whose merchandise inventory purchases are denominated in euros. For option and foreign exchange forward contracts designated as cash flow hedges of the purchase of inventory, the effective portion of gains and losses is deferred as a component of AOCL 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 effective portion of gains or losses associated with other forward contracts is deferred as a component of AOCL until the underlying transaction is reported in earnings. 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 of the contract from the assessment of effectiveness. At quarter-end, substantially all of the Company’s hedged forecasted transactions were less than twelve months, and the Company expects all derivative-related amounts reported in AOCL to be reclassified to earnings within twelve months.



The net change in the fair value of the foreign exchange derivative financial instruments designated as cash flow hedges of the purchase of inventory was a $1  million and $4 million gain for the thirteen and the thirty-nine weeks ended October 29, 2016, and therefore decreased AOCL. At October 29, 2016, there was a  $6 million gain included in AOCL. For the thirteen weeks and thirty-nine weeks ended October 31, 2015, the net change in fair value was a gain of $2 million and $1 million, respectively. The notional value of the foreign exchange contracts designed as hedges outstanding at October 29, 2016 was $105 million, and these contracts mature at various dates through January 2018. 



Derivative Holdings Not Designated as Hedges



The Company enters into foreign exchange forward contracts that are not designated as hedges in order to manage the costs of foreign-currency denominated merchandise purchases and intercompany transactions. Changes in the fair value of these foreign exchange forward contracts are recorded in earnings immediately within selling, general and administrative expenses. The net change in fair value resulted in income of $1 million for the thirteen weeks ended October 29, 2016 and was not significant for the thirty-nine weeks ended October 29, 2016. The net change in fair value resulted in expense of $3 million and $1 million for the thirteen and thirty-nine weeks ended October 31, 2015, respectively. The notional value of the foreign exchange contracts not designed as hedges outstanding at October 29, 2016 was $12 million, and these contracts mature at various dates through December 2016.



From time to time, the Company mitigates the effect of fluctuating foreign exchange rates on the reporting of foreign-currency denominated earnings by entering into currency option contracts. Changes in the fair value of these foreign currency option contracts, which are not designated as hedges, are recorded in earnings immediately within other income. The realized gains, premiums paid, and changes in the fair market value recorded were not significant for any of the periods presented. No such contracts were outstanding at October 29, 2016. 



Additionally, 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. Changes in the fair value of these contracts are recorded in earnings immediately. The effect was not significant for any of the periods presented. No such contracts were outstanding at October 29, 2016.



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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:















9. Fair Value Measurements



The Company’s financial assets recorded at fair value are categorized as follows:









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