Foot Locker Inc (FL) SEC Quarterly Report (10-Q) for Q3 2016

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For the quarterly p eriod ended: July 30 , 2016



OR





For the transition period from __________ to __________



Commission F ile N umber: 1-10299

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(Exact n ame of r egistrant as s pecified in i ts c harter)

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330 West 34 th Street, New York, New York 1 0001

(Address of p rincipal e xecutive o ffices, Zip Code)

(212 - 720-3700)

(Registrant's t elephone n umber, i ncluding a rea c ode)

















FOOT LOCKER, INC.

TABLE O F CONTENTS











FOOT LOCKER, INC.

CONDENSED CONSO LID ATED BALANCE SHEETS

( $   in millions, except shares)



















See Accompanying Notes to Condensed Consolidated Financial Statements.



















See Accompanying Notes to Condensed Consolidated Financial Statements.















See Accompanying Notes to Condensed Consolidated Financial Statements .



1. Summary of Signific ant 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 November 2015, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("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 early adopted this standard on a prospective basis as of the quarter ended April 30, 2016. As a result, the Company 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 revises the existing guidance related to leases by requiring 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 within those fiscal years, and requires a modified retrospective adoption, with earlier adoption permitted. The Company is currently evaluating the effects of the adoption of this ASU on its consolidated financial statements.



In March 2016, the FASB issued ASU 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. ASU 2016-09 simplifies certain aspects of the accounting for share-based payment transactions, including tax consequences, classification of awards, the option to recognize stock compensation expense with actual forfeitures as they occur, and the classifications on the statement of cash flows. ASU 2016-09 is effective for annual reporting beginning after December 15, 2016, including interim periods within that reporting period, with early adoption permitted. The manner of adoption varies, with certain provisions applied on a retrospective or modified retrospective approach, while others are applied prospectively. The Company is currently evaluating the effects of the adoption of this ASU on its consolidated financial statements.



In April 2016, the FASB issued ASU 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing. ASU 2016-10 clarifies the implementation guidance on identifying performance obligations and licensing on the previously issued ASU 2014-09, Revenue from Contracts with Customers . In May 2016, the FASB issued ASU 2016-11, Revenue Recognition (Topic 605) and Derivatives and Hedging (Topic 815): Rescission of SEC Guidance Because of Accounting Standards Updates 2014-09 and 2014-16 Pursuant to Staff Announcements at the March 3, 2016 EITF Meeting . ASU 2016-11 rescinds several SEC Staff Announcements that are codified in Topic 605, including, among other items, guidance relating to accounting for shipping and handling fees and freight services. ASU 2016-10 and ASU 2016-11 are effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. Early adoption is permitted only as of annual reporting periods beginning after December 15, 2016, including interim periods within that year. ASU 2016-10 and ASU 2016-11 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 currently evaluating the effects of the adoption of these ASUs 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, corporate expense, non-operating income, and net interest expense.











3. 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.













































4. Other Intangible Assets, net



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















Amortization of $2 million was recorded for the twenty-six week period ended July 30, 2016 . This was partially offset by $1 million of lease acquisition additions primarily related to our European businesses, which are being amortized over a weighted-average life of 10 years .





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























5. Accumulated Other Comprehensive Loss



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





The changes in AOCL for the twenty-six weeks ended July 30, 2016 were as follows:





Reclassifications from AOCL for the twenty-six weeks ended July 30, 2016 were as follows:







6 . Revolving Credit Facility



On May 19, 2016 , the Company entered into a new credit agreement with its banks (" 2016 Credit Agreement") that replace d 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 . Additionally, during the term of the 2016 Credit Agreement, the Company may 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 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 end of such 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 and the amount outstanding as of July 30, 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 at July 30, 2016 was $2 million. Interest expense including facility fees, related to the revolving credit facility was $1 million for both the thirteen and twenty-six weeks ended July 30, 2016 and August 1, 2015. 



7 . 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 inform ation is contained within Note 8 ,   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.



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, 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 o f the purchase of inventory was a $3 million gain for both the thirteen and the twenty-six weeks ended July 30, 2016, and therefore decreased AOCL. At July 30, 2016, there was a $5 million gain included in AOCL. For the thirteen weeks ended August 1, 2015, the net change in fair value was not significant, and was a $1 million loss for the twenty-six weeks ended August 1, 2015. The notional value of the foreign exchange contracts designed as hedges outstanding at July 30, 2016 was $82 million , and these contracts mature at various dates through July 2017 .



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 was not significant for the thirteen weeks ended July 30, 2016 and resulted in expense of $1 million for the twenty-six weeks ended July 30, 2016. The net change in fair value resulted in income of $1 million and $2 million for the thirteen and twenty-six weeks ended August 1, 2015, respectively. The notional value of the foreign exchange contracts not designed as he dges outstanding at July 30, 2016 was $14 million, and these contracts mature at various dates through December 2016 .



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 July 30, 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 July 30, 2016.



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:





















8 . 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:



Securities classified as available-for-sale are recorded at fair value with unrealized gains and losses reported, net of tax, in other comprehensive income, unless unrealized losses are determined to be other than temporary. The fair value of the auction rate security is determined by using quoted prices for similar instruments in active markets and accordingly is classified as a Level 2 instrument.



The Company's derivative financial instruments are valued using market-based inputs to valuation models. These valuation models require a variety of inputs, including contractual terms, market prices, yield curves, and measures of volatility and, therefore, are classified as Level 2 instruments.

There were no transfers into or out of Level 1, Level 2, or Level 3 assets and liabilities for any of the periods presented.



The carrying value and estimated fair value of long-term debt and obligations under capital leases were as follows:







The fair value of long-term debt is determined by using model-derived valuations in which all significant inputs or significant value drivers are observable in active markets and, therefore, are classified as Level 2. The carrying values of cash and cash equivalents and other current receivables and payables approximate their fair value.



9 . Earnings Per Share

The Company accounts for and discloses earnings per share using the treasury stock method. Basic earnings per share is computed by dividing net income for the period by the weighted-average number of common shares outstanding. Restricted stock awards, which contain non-forfeitable rights to dividends, are considered participating securities and are included in the calculation of basic earnings per share. Diluted earnings per share reflects the weighted-average number of common shares outstanding during the period used in the basic earnings per share computation plus dilutive common stock equivalents.

The computation of basic and diluted earnings per share is as follows:







Options to purchase 1.1 million and 0.7 million shares of common stock were not included in the computation of diluted earnings per share for the thirteen weeks ended July 30, 2016 and August 1, 2015, respectively. Options to purchase 1.0 million and 0. 6 million shares of common stock were not included in the computation of diluted earnings per share for the twenty-six weeks ended July 30 , 2016 and August 1, 2015, respectively. These options were not included because the effect would have been antidilutive. Contingently issuable shares of 0.3 million and 0.4 million have not been included as the vesting conditions have not been satisfied as of July 30, 2016 and August 1, 2015 , respectively .  

10 . Pension and Postretirement Plans



The Company has defined benefit pension plans covering certain of its North American employees, which are funded in accordance with the provisions of the laws where the plans are in effect. In addition, the Company has a defined benefit pension plan covering certain employees of the Runners Point Group.



In addition to providing pension benefits, the Company sponsors postretirement medical and life insurance plans, which are available to most of its retired U.S. employees. These medical and life insurance plans are contributory and are not funded.



The following are the components of net periodic pension benefit cost and net periodic postretirement benefit income, which is recognized as part of SG&A expense:





During the first quarter of 2016 , the Company made a contribution of $25 million to the U.S. qualified plan. The Company continually evaluates the amount and timing of any future contributions. The Company contributed $8 million to the U.S. qualified plan on August 31, 2016. The Company currently expects to contribute $4 million to the Canadian qualified plan during the fourth quarter of 2016. Actual contributions are dependent on several factors, including the outcome of the ongoing pension litigation. See No te 12 ,   Legal Proceedings, for further information.



1 1 . Share-Based Compensation



Total compensation expense included in SG&A, and the associated tax benefits recognized related to the Company's share-based compensation plans were as follows:





Valuation Model and Assumptions



The Company uses a Black-Scholes option-pricing model to estimate the fair value of share-based awards. The Black-Scholes option-pricing model incorporates various and highly subjective assumptions, including expected term and expected volatility. The following table shows the Company's assumptions used to compute the share-based compensation expense for awards granted during the twenty-six weeks ended July 30, 2016 and August 1, 2015 :





The information in the following table covers options granted under the Company's stock option plans for the twenty-six weeks ended July 30, 2016:





The total fair value of options vested as of July 30, 2016 and August 1, 2015 was $8 million and $14 million , respectively. The cash received from option exercises for the thirteen and twenty-six weeks ended July 30, 2016 was $7 million and $14 million , respectively. The cash received from option exercises for the thirteen and twenty-six weeks ended August 1, 2015 was $15 million and $38 million, respectively.



The total intrinsic value of options exercised (the difference between the market price of the Company's common stock on the exercise date and the price paid by the optionee to exercise the option) is presented below:





The total tax benefit realized from option exercises was $5 million and $10 million for the thirteen and twenty-six weeks ended July 30, 2016, respectively, and was $11 million and $25 million for the corresponding prior-year periods.

The aggregate intrinsic value for stock options outstanding, outstanding and exercisable, and vested and expected to vest (the difference between the Company's closing stock price on the last trading day of the period and the exercise price of the options, multiplied by the number of in-the-money stock options) is presented below:





As of July 30, 2016 there was $9 million of total unrecognized compensation cost, net of estimated forfeitures, relate d to nonvested stock options, which is expected to be recognized over a remaining weighted-average period of 1.6 years . The following table summarizes information about stock options outstanding and exercisable at July 30, 2016:





Restricted Stock and Restricted Stock Units



Restricted shares of the Company's common stock and restricted stock units ("RSU") may be awarded to certain officers, key employees of the Company, and to nonemployee directors. Additionally, RSU awards are made to employees in connection with the Company's long-term incentive program. Each RSU represents the right to receive one share of the Company's common stock provided that the performance and vesting conditions are satisfied. There were 671,690  a nd 581,713 RSU awards outstanding as of July 30, 2016 and August 1, 2015, respectively.



Generally, awards fully vest after the passage of time, typically three years. However, RSU awards made in connection with the Company's long-term incentive program are earned after the attainment of certain performance metrics and vest after the passage of time. Restricted stock is c onsidered outstanding at the time of grant and the holders have voting rights. Dividends are paid to holders of restricted stock that vest with the passage of time. With regard to performance-based restricted stock, dividends will be accumulated and paid after the performance criteria are met. No dividends are paid or accumulated on RSU awards. Compensation expense is recognized using the market value at the date of grant and is amortized over the vesting period, provided the recipient continues to be employed by the Company.

Restricted stock and RSU activity for the thirteen weeks ended July 30, 2016 is summarized as follows:





The total value of awards for which restrictions lapsed during the twenty-six weeks ended July 30, 2016 and August 1, 2015 was $8 million and $10 million, respectively. As of July 30, 2016, there was $19 million of total unrecognized compensation cost net of forfeitures related to nonvested restricted awards.



1 2 . Legal Proceedings



Legal proceedings pending against the Company or its consolidated subsidiaries consist of ordinary, routine litigation, including administrative proceedings, incidental to the business of the Company or businesses that have been sold or disposed of by the Company in past years. These legal proceedings include commercial, intellectual property, customer, environmental, and employment-related claims.



The Company and the Company's U.S. retirement plan are defendants in a class action ( Osberg v. Foot Locker Inc. et ano., filed in the U.S. District Court for the Southern District of New York) in which the plaintiff alleges that, in connection with the 1996 conversion of the retirement plan to a defined benefit plan with a cash balance formula, the Company and the retirement plan failed to properly advise plan participants of the "wear-away" effect of the conversion. Plaintiff's claims were for breach of fiduciary duty under the Employee Retirement Income Security Act of 1974, as amended, and violation of the statutory provisions governing the content of the Summary Plan Description. The trial was held in July 2015 and the court issued a decision in September 2015 in favor of the class on the foregoing claims. The court ordered that the Plan be reformed. The Company is appealing the court's decision, and the judgment has been stayed pending the outcome of the appeal. As a result of this development, the Company determined that it is probable a liability exists. The Company's reasonable estimate of this liability is a range between $100 million and $200 million, with no amount within that range more probable than any other amount. Therefore, in accordance with U.S. GAAP, the Company recorded a charge of $100 million pre-tax ($ 61 million after-tax) in the third quarter of 2015. This amount has been classified as a long-term liability. The Company will continue to vigorously defend itself in this case. In light of the uncertainties involved in this matter, there is no assurance that the ultimate resolution will not differ from the amount currently accrued by the Company. 



Management does not believe that the outcome of any such legal proceedings pending against the Company or its consolidated subsidiaries, as described above, would have a material adverse effect on the Company's consolidated financial position, liquidity, or results of operations, taken as a whole, based upon current knowledge and taking into consideration current accruals. Litigation is inherently unpredictable, and judgments could be rendered or settlements entered into that could adversely affect the Company's operating results or cash flows in a particular period.