SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended January 1, 2005
Commission File Number 1-11681
FOOTSTAR, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 22-3439443
(State of incorporation) (IRS Employer Identification No.)
933 MACARTHUR BLVD., MAHWAH, NEW JERSEY 07430
(Address of principal executive offices)
Registrant's telephone number, including area code: (201) 934-2000
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Common Stock (par value $.01 per share)
(Title of Class)
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 No X
----- -----
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in the definitive proxy statement incorporated
by reference in Part III of this Form 10-K, or any amendment to this Form 10-K.
[ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes X No
----- -----
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes No X
----- -----
The aggregate market value of the common stock held by non-affiliates of the
registrant as of July 30, 2005, was approximately $125.8 million.
Number of shares outstanding of common stock, par value $.01 per share, as of
July 30, 2005: 20,349,976.
DOCUMENTS INCORPORATED BY REFERENCE
None
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FOOTSTAR, INC.
ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
PART I.................................................................... 4
Introductory Note......................................................... 4
Item 1. Business.......................................................... 12
General................................................................... 12
The Meldisco Segment...................................................... 12
Merchandising............................................................. 13
Marketing................................................................. 13
Competitive Environment................................................... 14
Risk Factors.............................................................. 14
Trademarks and Service Marks.............................................. 20
Employees................................................................. 20
Available Information..................................................... 20
Item 2. Properties........................................................ 21
Item 3. Legal Proceedings................................................. 22
Item 4. Submission of Matters to a Vote of Security Holders............... 24
PART II................................................................... 25
Item 5. Market Prices for the Registrant's Common Equity and Related
Stockholder Matters............................................... 25
Item 6. Selected Financial Data........................................... 26
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations............................................. 28
Item 7A. Quantitative and Qualitative Disclosures About Market Risk....... 54
Item 8. Financial Statements and Supplementary Data....................... 55
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.............................................. 56
Item 9A. Controls and Procedures.......................................... 56
Item 9B. Other Information................................................ 61
PART III.................................................................. 62
Item 10. Directors and Executive Officers of the Registrant............... 62
Item 11. Executive Compensation........................................... 66
Item 12. Security Ownership of Certain Beneficial Owners and Management... 78
Item 13. Certain Relationships and Related Transactions................... 81
Item 14. Principal Accountant Fees and Services........................... 82
PART IV................................................................... 83
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K.. 83
Footstar, the Footstar logo, Just For Feet, Thom McAn, Cobbie Cuddlers, Texas
Steer and Cara Mia are, or were as of January 1, 2005, trademarks and/or service
marks of Footstar, Inc.'s subsidiaries or affiliates. All other trademarks
mentioned are the property of their respective owners.
3
PART I
INTRODUCTORY NOTE
Footstar, Inc., which may be referred to as "Footstar", the "Company", "we",
"us" or "our", is today filing this Annual Report on Form 10-K for its fiscal
year ended January 1, 2005. We have not filed our Quarterly Reports on Form 10-Q
for the fiscal quarters ended April 3, 2004, July 3, 2004 and October 2, 2004.
In lieu of filing such Quarterly Reports, this Form 10-K includes summarized
quarterly financial data and other material information that would have been
available in our 2004 Quarterly Reports on Form 10-Q. These reports were delayed
as a result of our internal investigation, the restatement of our consolidated
financial statements and our operation under protection of the bankruptcy laws,
each described below. We also intend to file our Quarterly Reports on Form 10-Q
for the fiscal quarters ended April 2, 2005 and July 2, 2005 as soon as
practicable following the filing of this fiscal 2004 Annual Report on Form 10-K.
In this Annual Report, words such as "today," "recently," "current" or
"currently," or phrases such as "as of the date hereof" or "as of the date of
this report," refer to on or about the date we are filing this report with the
Securities and Exchange Commission (the "SEC").
On November 13, 2002, we announced that management had discovered discrepancies
in the reporting of our accounts payable balances. An investigation of the
discrepancies was conducted under the oversight of the Audit Committee of the
Board of Directors and the assistance of outside legal advisors and forensic
accountants.
The investigation determined that a restatement of previously issued financial
statements over a five-and-one-half year period from the beginning of fiscal
year 1997 through June, 2002 was required. This restatement was included in our
fiscal year 2002 Annual Report on Form 10-K that was filed on September 3, 2004.
We have implemented an Internal Process and Control Plan designed to remediate
the material weaknesses identified in internal control over financial reporting.
We do not plan on emerging from Chapter 11 protection until we are in compliance
with SEC reporting requirements and the requirements of the Sarbanes-Oxley Act
of 2002 ("Sarbanes-Oxley".) See Item 9A - Controls and Procedures
Prior to the Company's November 13, 2002 announcement, we notified the staff of
the SEC of the discovery of the accounting discrepancies. Following that
notification, the SEC began an enforcement proceeding including an investigation
into the facts and circumstances giving rise to the restatement. The Company has
been and intends to continue cooperating fully with the SEC. We cannot predict
the outcome of this proceeding. For a further description of this and other
restatement-related litigation, see "Restatement Related Litigation" under Item
3 - Legal Proceedings.
4
On December 29, 2003, the New York Stock Exchange ("NYSE") suspended trading in
our common stock and, at a later date, our common stock was delisted. The NYSE
stated that it decided to take these actions in view of the overall uncertainty
surrounding our previous announcement that a restatement of our results for 1997
through 2002 would be required and the continued delay in fulfilling our
financial statement filing requirements.
Commencing March 2, 2004 ("Petition Date"), Footstar and substantially all of
its subsidiaries (collectively, the "Debtors") filed voluntary petitions for
relief 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 are being jointly
administered under the caption "In re: Footstar, Inc., et al. Case No. 04-22350
(ASH)" (the "Chapter 11 Cases"). The Debtors are currently operating their
businesses and managing their properties as debtors-in-possession pursuant to
Sections 1107(a) and 1108 of the Bankruptcy Code. As debtors-in-possession, we
are authorized to continue to operate as an ongoing business but may not engage
in transactions outside the ordinary course of business without the approval of
the Court.
As of the Petition Date, our operations were comprised of two distinct business
segments: the discount and family footwear segment ("Meldisco" or "Meldisco
Segment") and the athletic footwear and apparel segment ("Athletic" or "Athletic
Segment"). Meldisco sells family footwear through licensed footwear departments
and wholesale arrangements. Athletic sold athletic footwear and apparel through
various retail chains (for example, Footaction and Just For Feet), and via
catalogues and the Internet.
Meldisco has operated licensed footwear departments in discount chains since
1961, and is the only major operator of licensed footwear departments in the
United States today. As of July 30, 2005, Meldisco operated licensed footwear
departments in all 1,454 Kmart Corporation ("Kmart") stores and in 859 Rite Aid
Corporation ("Rite Aid") stores located on the West Coast. Meldisco also
supplies certain retail stores, including stores operated by Wal-Mart Stores,
Inc. ("Wal-Mart") and Rite Aid, with family footwear on a wholesale basis.
Prior to the Petition Date, Athletic specialized in the sale of branded athletic
footwear, apparel and accessories. Athletic used its three retail chains,
Footaction, Just For Feet and Uprise, to conduct retail sales. Each of the
retail chains in Athletic sold footwear and apparel from all of the major
brand-name vendors. Athletic's Consumer Direct operations conducted sales
through catalogues and the Internet to support the Footaction and Just For Feet
retail chains.
We sought bankruptcy protection after we determined we could not obtain
necessary liquidity from our lending syndicate or additional debt or equity
financing. This decline in liquidity primarily resulted from unprofitable
results in the Athletic Segment, a reduction in trade credit by certain Athletic
vendors, unprofitable results of operations from recent acquisitions and the
effect of Kmart's own bankruptcy. Other factors included intense competition in
the discount retailing industry, unsuccessful sales and marketing initiatives
and capital market volatility.
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Since the Petition Date, we have exited the Athletic Segment entirely by closing
certain underperforming stores and selling the remainder of the stores and the
other assets. Our financial statements present the Athletic Segment as a
discontinued operation for all periods presented.
In the initial stages of the Chapter 11 cases, we sought to streamline our
Meldisco business by selling or exiting selected stores. As a result, we sold or
liquidated all of our Shoe Zone stores ("Shoe Zone").We also exited the footwear
departments in 44 Gordmans, Inc. ("Gordmans") stores and the footwear
departments in 87 stores operated by subsidiaries of Federated Department
Stores, Inc. ("Federated"). Our financial statements reflect those businesses
as a discontinued operation for all periods presented.
We have sold other assets, including our distribution centers in Mira Loma,
California ("Mira Loma") in July 2004 and Gaffney, South Carolina ("Gaffney") in
September 2004. The purchaser of Mira Loma, Thrifty Oil Co. ("Thrifty") has
leased Mira Loma to FMI International LLC ("FMI"), a logistics provider, which
will provide us with warehousing and distribution services through June 30, 2012
under a receiving, warehousing and distribution services agreement (the "FMI
Agreement"). Pursuant to the FMI Agreement we are obligated to pay to FMI a
minimum of $15.1 million in both 2005 and 2006.
The business relationship between Meldisco and Kmart is extremely important to
us. The licensed footwear departments in Kmart have historically provided a
significant portion of our total sales and profits, and comprise substantially
all of our sales and profits now that we have exited all of our Athletic Segment
businesses and most of our other Meldisco businesses.
Our arrangement with Kmart was governed by the Master Agreement with Kmart
effective July 1, 1995, as amended ("Master Agreement"). The Master Agreement
provided us with the non-transferable, exclusive right and license to operate a
footwear department in every Kmart store. The initial term of the Master
Agreement would have expired on July 1, 2012, and was renewable for a 15 year
term upon mutual agreement, unless either party gave notice of termination at
least four years prior to the end of the applicable term.
On August 12, 2004, we filed a motion to assume the Master Agreement (the
"Assumption Motion"). On September 30, 2004, Kmart filed an objection to this
motion (the "Assumption Objection") and cross-moved to lift the automatic stay
to enable Kmart to terminate the Master Agreement (the "Cross Motion").
In the Assumption Objection, Kmart argued that the Master Agreement was
non-assumable under section 365(c)(1) of the Bankruptcy Code because applicable
law rendered the Master Agreement non-assignable. In addition, Kmart argued that
the Master Agreement was non-assumable pursuant to section 365(b)(2)(D) of the
Bankruptcy Code because we had defaulted under the Master Agreement and such
defaults were incurable. Finally, Kmart disputed the amount of cure we would owe
Kmart should we be authorized to assume the Master Agreement. In the
Cross-Motion, Kmart argued that, because the Master Agreement is non-assumable,
Kmart should be entitled to exercise a termination provision pursuant to section
365(e)(2) of the Bankruptcy Code.
We contested the factual assertions and legal arguments contained in the
Assumption Objection and Cross-Motion. On December 17, 2004, a hearing was held
to determine whether, as a matter of law, we could assume the Master Agreement.
On February 16, 2005, the Court issued its decision on the Motion to Assume
Executory Contracts (the "Assumption Decision"). In the Assumption Decision, the
Court overruled the Assumption Objection and held that section 365(c)(1) does
not prevent assumption of the Master Agreement by us because we did not intend
to assign the Master Agreement.
Kmart moved for re-argument of the Assumption Decision and the Court held a
hearing on the argument on March 31, 2005. At this hearing the Court affirmed
the Assumption Decision. An additional hearing with respect to Kmart's Cross
Motion was held and, on May 10, 2005, the Court denied the Cross Motion. The
Court did not resolve the issue of whether the Master Agreement was assignable
under applicable nonbankruptcy law and reserved its decision on the issue of
section 365(b)(2)(D) until the completion of discovery. Nonetheless, there
continued to be no guarantee that the Court would authorize us to assume the
Master Agreement or Kmart to terminate the Master Agreement under section
365(b)(2)(D) of the Bankruptcy Code.
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Additionally, we could not be sure what cure amounts the Court would find would
be owing to Kmart if the Court authorized us to assume the Master Agreement.
In June 2004, Kmart announced the sale of 54 of its retail store locations to
Sears, Roebuck and Co. ("Sears") but agreed that Kmart would continue to operate
such stores until Sears could complete its conversion plans. Thereafter, in
November 2004, Kmart announced plans to acquire Sears (the "Sears Acquisition"),
which acquisition closed on March 24, 2005. Following the announcement of the
Sears Acquisition, we received inconsistent information from Kmart regarding its
plan to convert certain of its stores to a different retail format. Initially,
Kmart advised us of its intent to convert approximately 25 of the 54 stores to
Sears Essential stores, and that Kmart expected us to discontinue operating the
footwear departments in those stores. Kmart then informed us that only 11 of
these 25 stores were slated for a format conversion. After receiving this
inconsistent information, we filed a motion with the Court on January 28,
seeking to compel Kmart to produce certain documents relating to the proposed
Sears Acquisition and Kmart's business plans relating to the operation of
footwear departments in its stores.
When Kmart announced its plan to begin the reconfiguration of some of the stores
slated for conversion to a new Sears format (the "Converting Stores"), we
believed that the Master Agreement continued to grant us the exclusive right to
operate footwear departments in the Converting Stores, whether or not Kmart
converted or operated certain of those stores under a different name, such as
the Sears Essentials name. Accordingly, after receiving notice of the
reconfigurations from Kmart, we filed a motion (the "Enforcement Motion")
requesting that the Court determine Kmart to be in contempt for violation of the
automatic stay and assess damages. Kmart replied to the Enforcement Motion by
arguing that the automatic stay did not prevent Kmart from converting stores to
a different format because our rights under the Master Agreement to sell
footwear in the Converting Stores expire upon conversion.
On February 24, 2005, the Court held a hearing with respect to the Enforcement
Motion and ruled that the automatic stay barred Kmart from taking any actions to
remove us from the Converting Stores absent relief from the automatic stay.
Accordingly, on March 4, 2005, Kmart filed a motion seeking relief from the
automatic stay. On April 6, 2005, the Court heard legal arguments concerning our
claim that we had the right to continue to operate in the Converting Stores. On
May 10, 2005, the Court granted Kmart relief from the automatic stay to effect
conversions in the Converting Stores. We filed a motion asking that the Court
reconsider its ruling on this issue (the "Reconsideration Motion"). On June 6,
2005, the Court heard legal arguments on the Reconsideration Motion and, on June
24, 2005, the Court denied the Reconsideration Motion.
On July 2, 2005, the Company and Kmart entered into an agreement (the "Kmart
Settlement") with respect to the assumption, interpretation and amendment of the
Master Agreement. On August 25, 2005, the Court approved the Kmart Settlement.
The Kmart Settlement, which takes effect beginning January 2, 2005, allows us to
continue operating the footwear departments in Kmart stores pursuant to the
Master Agreement as amended by the Kmart Settlement (the "Amended Master
Agreement"). The significant provisions of the Kmart Settlement are as follows:
- Elimination of all outstanding litigation between Kmart and us.
7
- Expiration of the Amended Master Agreement at the end of 2008 and the
requirement that Kmart will purchase our Shoemart inventory (but not
our brands) at book value, which will allow for an orderly wind down
of the business without the need for a complex liquidation and the
attendant costs.
Kmart has agreed to purchase all of the inventory (excluding inventory
that is damaged, unsaleable and seasonal inventory, as defined) that
is in our remaining stores on December 31, 2008, or that is on order
on that date pursuant to Kmart's written request, for an amount equal
to the book value of the inventory, as defined. We will vacate those
stores and the Amended Master Agreement will expire.
- Our cure obligation to Kmart is fixed at $45.0 million.
The cure amount is inclusive of all claims of Kmart, including,
without limitation, retained earnings, and retained deficit of all
stores that were no longer in operation as of January 1, 2005 and any
dividend/excess fees. This entire amount was paid to Kmart on August
26, 2005.
- Elimination of all annual fees/payments previously paid Kmart in favor
of annual payments to Kmart equal to 14.625% of gross sales plus a
miscellaneous expense fee of $23,500 per store per year; elimination
of Kmart's equity interests in the Shoemart Corporations.
Kmart's equity interests in the Shoemart Corporations have been
extinguished effective as of January 2, 2005 and accordingly Kmart
will no longer share in the profits or losses of these entities for
fiscal 2005 or subsequent years. Beginning on January 2, 2005, we were
required to begin paying Kmart 14.625% of the gross sales of the
footwear departments. Effective August 25, 2005, we are also required
to pay Kmart a miscellaneous expense fee of $23,500 per store per
year. These are the only material fees which we will be required to
pay Kmart pursuant to the Kmart Settlement.
Kmart will have a capital claim against us in the amount of $11,000
for each store that is an existing store, as defined, on August 25,
2005, which is generally payable by us to Kmart at the time a store
closes or converts to another retail format in accordance with the 550
store limitation described below. 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 capital claims not yet due
and payable will be waived for any remaining stores. If the Amended
Master Agreement is terminated as a result of our breach, capital
claims for remaining stores will not be waived and will become
immediately due and payable.
- Kmart will be prohibited from reducing the number of stores in which
we operate below specified levels, unless it pays us the stipulated
loss value for the loss of each incremental store.
Kmart will be permitted to terminate our rights to operate footwear
departments in up to 550 existing Kmart stores during the remaining
term of the Amended Master Agreement by disposing of, closing or
converting these stores. The number of such terminations per year is
8
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. For each store
that is 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, for all closings and conversions above the annual cap or the
550 aggregate limit, Kmart must pay us a nonrefundable stipulated loss
value per store equal to $100,000 for closings and conversions
occurring in 2005, $60,000 for closings and conversions occurring in
2006, $40,000 for closings and conversions occurring in 2007 and
$20,000 for closings and conversions occurring in 2008. A termination
of the entire Amended Master Agreement in accordance with its terms
does not trigger a stipulated loss value payment.
- Reduction of staffing obligations as sales decline.
We must spend at least 10% of gross sales in the footwear departments
on staffing for the stores; and we must schedule staffing in each
store at a minimum of 40 hours per week.
- Elimination of the performance standards in favor of a minimum sales
test.
The Company and Kmart will each have the right to terminate the
Amended Master Agreement if the gross sales of the footwear
departments are less than $550.0 million in any year, less $0.4
million for each store that is closed or converted after August 25,
2005. We will also have a separate, 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 fiscal quarters is less than $450.0 million. Upon
termination under either circumstance, Kmart must purchase all of the
inventory at the stores, (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.
- Kmart is required to allocate 52 weekend newspaper advertising insert
pages per year to our products.
9
Effective March 4, 2004, we entered into a two year, $300.0 million senior
secured Debtor-in-Possession Credit Agreement ("DIP Credit Agreement") with a
syndicate of lenders co-led by Fleet National Bank ("Fleet") and GECC Capital
Markets Group, Inc. The DIP Credit Agreement was subsequently amended (the "DIP
and Exit Facility"), which, among other things, reduced the amount of
commitments to $100.0 million, including a sub-limit for letters of credit with
availability determined by a borrowing base formula based upon inventory and
accounts receivable.
Pursuant to the DIP and Exit Facility, upon emergence from Chapter 11, we had
the option, subject to satisfaction of certain conditions, to convert the DIP
and Exit Facility to post-emergence financing which would have provided us with
up to $160.0 million in revolving commitments, including a $75.0 million
sub-limit for letters of credit. Borrowings under the DIP and Exit Facility bore
interest at either Fleet's prime rate plus 0.0% to 0.5% or LIBOR plus 1.75% to
2.50%, at our option, with the applicable margin based on excess availability
levels. A quarterly fee of 0.3% per annum was payable on the unutilized balance.
Effective July 1, 2005, we entered into an amendment to the DIP and Exit
Facility (the "Amended DIP and Exit Facility"). The Amended DIP and Exit
Facility, among other things, reflects a change in the maturity date for the
debtor-in-possession portion of the facility from the earlier of (a)(i) March 4,
2006 or (ii)15 days following confirmation of the Plan to the earlier of (b)(i)
October 31, 2006 or (ii) emergence from Chapter 11. The maturity date of the
exit portion of the Amended DIP and Exit Facility is the earlier of (c)(i) 36
months after our emergence from Chapter 11 or (ii) March 4, 2009. Borrowings
under the Amended DIP and Exit Facility bear interest at the same rates as under
the DIP and Exit Facility. As of July 30, 2005, there were no loans outstanding
under the Amended DIP and Exit Facility and outstanding letters of credit
thereunder totaled $16.7 million. For further information on the Amended DIP and
Exit Facility, see "Liquidity and Capital Resources; The Amended DIP and Exit
Facility" under Item 7 - Management's Discussion and Analysis of Financial
Condition and Results of Operations.
Pursuant to Court orders, we have been 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 date has now passed for all creditors. Differences between
liability amounts recorded by us and claims filed by creditors are being
reconciled and, if necessary, the Court will make a final determination of
allowable claims.
We continue to evaluate the amount of our pre-petition liabilities on an ongoing
basis and recognize any additional liabilities, which may be material.
10
The following is an overview of the pre-petition claims filed against us (for
which our estimated liability is approximately $154.0 million) as of July 5,
2005:
STATUS CLAIMS (#) CLAIMS ($)
------ ---------- ------------
Total claims received from Creditors 6,658 657,926,899
Claims officially withdrawn by Creditors (through Court) (193) (1,981,184)
Claims objected to which were subsequently expunged by
the Court (1,693) (377,902,173)
Other Claims formally objected to (450) (136,694,219)
Claims agreed to "As Submitted" (772) (12,738,995)
Claims reviewed, not yet objected to (331) (28,597,828)
------ ------------
Claims still to be reconciled(1) 3,219 100,012,500
====== ============
(1) The remaining 3,219 claims consist of:
Expenses payable 57 1,478,967
Landlord lease rejection claims 221 55,292,621
Claims involving litigation 8 553,481
Payroll tax 174 908,001
Income/sales/all other tax 2,668 30,807,850
Miscellaneous (2) 91 10,971,580
----- -----------
3,219 100,012,500
===== ===========
(2) Includes $10.0 million claim for mortgage on MacArthur building.
Under the Bankruptcy Code, we have the ability to reject executory contracts,
including leases, subject to the approval of the Court and certain other
conditions. Parties affected by the rejection of a contract may file claims
against us in the Court in accordance with the Bankruptcy Code. We have rejected
a number of executory contracts and unexpired leases, and the claims made
against us with respect to those rejected contracts and unexpired leases on or
prior to July 5, 2005 are included in the tables above. We expect that as a
result of our rejection of additional executory contracts and unexpired leases,
including leases of nonresidential real property, additional claims will be
filed. Under the Bankruptcy Code, we may choose to assume executory contracts
and unexpired leases subject to the approval of the Court and certain other
conditions, including our payment or "cure" of all outstanding liabilities
thereunder. Due to the uncertain nature of many of the claims which have been or
may be asserted against us, we are unable to project the total magnitude of all
such claims with certainty. We have incurred, and will continue to incur,
significant costs associated with the Chapter 11 Cases. In order to exit Chapter
11 successfully, we will need to obtain Court confirmation of a Chapter 11 plan
that satisfies the requirements of the Bankruptcy Code.
On November 12, 2004, we filed a proposed joint plan of reorganization with the
Court. Following the Kmart Settlement, we anticipate filing an amended plan with
the Court (the "Amended Plan"). The Amended Plan is expected to provide for an
orderly reorganization of the Company and certain cash distributions and be
subject to a vote by eligible ballot holders. The Amended Plan is also expected
to provide for some flexibility in the timing of its confirmation and our
emergence from bankruptcy. The Amended Plan is also expected to provide that we
will not emerge from bankruptcy until we file with the SEC those periodic
reports required by the SEC. Although we expect that creditors in the bankruptcy
will be paid in full, the timing of such payments is currently subject to
negotiation and is expected to be specified in the Amended Plan.
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ITEM 1. BUSINESS
GENERAL
We are a holding company and operate our businesses through our subsidiaries. We
are principally a retailer conducting business through our Meldisco Segment and,
prior to our sale of certain stores to Foot Locker on May 2, 2004 and the
closing of underperforming stores, our Athletic Segment. Meldisco sells family
footwear through licensed footwear departments and wholesale arrangements.
Athletic sold athletic footwear and apparel through various retail chains (for
example, Footaction and Just For Feet), and via catalogs and the Internet.
See "Introductory Note" for a description of certain important events which have
occurred including our restatement, our Chapter 11 filing, the exit from the
footwear departments of Federated and Gordmans stores and the closing and sale
of the Shoe Zone stores within the Meldisco Segment and the closing of certain
stores, the sale of all remaining stores within the Athletic Segment and the
Kmart Settlement.
MELDISCO
Meldisco sells family footwear through licensed footwear departments and
wholesale arrangements. Meldisco has operated licensed footwear departments
since 1961 and is the only major operator of licensed footwear departments in
the United States today.
As of January 1, 2005, Meldisco operated licensed footwear departments in 1,482
Kmart stores and in 856 Rite Aid drugstores. As of July 30, 2005, Meldisco
operated licensed footwear departments in 1,454 Kmart stores and in 859 Rite Aid
drugstores located on the West Coast. In October 2002, Meldisco began selling
family footwear on a wholesale basis to Wal-Mart.
In April 2003, the licensed footwear agreement between the Company and Rite Aid
covering approximately 2,500 Rite Aid drugstores located in the eastern half of
the United States changed to a wholesale arrangement.
Meldisco's core licensed footwear operation sells family footwear and
lower-priced basic and seasonal footwear in Kmart and Rite Aid stores.
In its licensed footwear departments, Meldisco generally sells a wide variety of
family footwear, including men's, women's and children's dress, casual and
athletic footwear, work shoes and slippers.
In October 2002, we began supplying Thom McAn family footwear on a wholesale
basis to 300 Wal-Mart stores. In February 2003, we expanded our arrangement with
Wal-Mart to supply Thom McAn family footwear on a wholesale basis to up to 1,500
Wal-Mart stores in the United States. As of July 30, 2005, we were supplying
Thom McAn family footwear to 1,500 Wal-Mart stores in the United States and 13
stores in Puerto Rico. In 2004, we sold approximately $28.6 million of Thom McAn
products to Wal-Mart stores. Wal-Mart has advised us that, beginning in January
2006, it will no longer be purchasing Thom McAn product for any of its stores in
the United States.
12
Wal-Mart has advised us that it will continue to buy Thom McAn footwear for
Wal-Mart stores in Puerto Rico and will continue to source footwear from us for
Wal-Mart stores under Wal-Mart's proprietary brands.
Merchandising
Meldisco's merchandising strategy is to continue to build upon its position in
family footwear. The essence of this strategy is to satisfy Meldisco's customers
with high in-stock availability of its footwear products and a wide selection of
well-known national brands such as Thom McAn and Cobbie Cuddlers (which are
Company-owned) and Everlast.
In its licensed footwear operations, Meldisco seeks to attract non-footwear
shoppers into the footwear departments from other areas of the stores. Its
branded products are also intended to differentiate Meldisco merchandise from
that of its competitors. Brands currently available at Meldisco's operations
include Thom McAn, Cobbie Cuddlers and Texas Steer (which are Company-owned) and
Route 66, Thalia and Joe Boxer. Meldisco conducts consumer research on an
ongoing basis to gauge new opportunities for brand extensions and to determine
price and positioning of new brands. Our strategy is to leverage our expertise
in branded products to expand our sales in existing licensed departments as well
as in our wholesale operations.
Meldisco's traditional strength has been in quality leather footwear which it
currently offers under the Thom McAn brand, as well as seasonal, work,
value-priced athletic, women's casual and children's shoes. Meldisco builds on
its strength in these segments by focusing on customer satisfaction. Meldisco's
"narrow and deep" merchandising strategy and its merchandise planning systems
are designed to ensure that each store is well stocked in product lines that are
particularly popular with Meldisco's core customers. Meldisco's demand-driven
merchandise replenishment system has been designed to permit inventory
management at the store, style and size levels.
We are also exploring ways to leverage some of our core competencies, among
which is our direct sourcing. There may be opportunities for us to use direct
sourcing capabilities to provide sourcing for certain branded lines. We are
investigating new channels of distribution for our proprietary brands, possibly
internationally. Also, we have demonstrated proficiency in assortment planning
and inventory management and are currently investigating how these competencies
might be leveraged in the future.
Marketing
We offer a wide range of quality, value-priced footwear. Key strengths include
style development, quality control and competitive pricing. Coupled with
planning and inventory management, these strengths provide us the opportunity to
explore additional wholesale initiatives as well as being a producer of sourcing
and retail management in the international arena.
Meldisco believes that the typical footwear customer in its licensed footwear
departments in Kmart generally resembles the average Kmart softlines shopper: a
25 to 49 year-old mother with children, who is employed at least part-time, has
at least one child under the age of 18 and reports a total annual household
income between $25,000 and $65,000. Meldisco's marketing initiatives are
designed to support its overall business strategy of increasing purchases among
traditional footwear
13
shoppers, as well as appealing to the growing customer segments that include
African Americans and Hispanics.
Meldisco's marketing strategy in its Kmart footwear departments is designed to
convey to prospective customers that Kmart carries the right value combination
of brands, product selection, quality, comfort and price to make Kmart footwear
departments their footwear destination of choice. This message is communicated
primarily through weekly advertising in newspaper inserts and in-store
presentations. Kmart's weekly newspaper inserts had a weekly circulation of
approximately 43 million as of July 30, 2005.
Competitive Environment
The family footwear business, where the majority of Meldisco's business is
generated, is highly competitive.
Competition is concentrated among a limited number of retailers and discount
department stores, including Kmart, Wal-Mart, Payless ShoeSource, Kohl's, Target
and Sears, with a number of traditional off-price and value retailers such as
Shoe Carnival, Famous Footwear and Rack Room also selling lower-priced footwear.
The events that caused us to seek bankruptcy and the terms of the Kmart
Settlement put us at a distinct disadvantage with respect to our competitors,
many of which are growing rapidly and have substantial financial and marketing
resources which are unavailable to us.
RISK FACTORS
Set forth below are certain important risks and uncertainties that could
adversely affect our results of operations or financial condition and cause our
actual results to differ materially from those expressed in forward-looking
statements made by the Company or its management. See "Forward-Looking
Statements" in Item 7 for additional risk factors.
MELDISCO IS OUR ONLY CONTINUING BUSINESS AND SUBSTANTIALLY ALL OF OUR CONTINUING
NET SALES AND PROFITS RESULT FROM MELDISCO'S BUSINESS IN KMART STORES. THE KMART
SETTLEMENT WILL RESULT IN THE ORDERLY LIQUIDATION OF OUR KMART BUSINESS NO LATER
THAN THE END OF DECEMBER 2008. IF WE FAIL TO DEVELOP VIABLE BUSINESS
ALTERNATIVES TO OFFSET THIS BUSINESS WE WILL ALMOST CERTAINLY BE FORCED TO
LIQUIDATE OUR BUSINESS WHEN THE KMART RELATIONSHIP ENDS.
IF WE ARE UNABLE TO SUCCESSFULLY REORGANIZE OUR CAPITAL STRUCTURE AND OPERATIONS
AND IMPLEMENT OUR BUSINESS PLAN THROUGH THE CHAPTER 11 PROCESS, WE MAY NEVER
EMERGE FROM BANKRUPTCY AND MAY BE REQUIRED TO LIQUIDATE OUR ASSETS.
Commencing March 2, 2004, the Company and most of its subsidiaries filed
voluntary petitions for relief under Chapter 11 of the Bankruptcy Code.
14
Risk factors involving the Chapter 11 filing include the following:
- The Chapter 11 cases may adversely affect our business. We believe
that any such adverse effects may worsen if confirmation of the
Amended Plan is protracted.
- There can be no assurance that the Court will confirm our Amended
Plan.
- There can be no assurance regarding any adverse actions that creditors
or equity holders of the Company or other parties in interest in the
Chapter 11 Cases may take that may have the effect of preventing or
unduly delaying confirmation of the Amended Plan.
- There can be no assurance as to the overall long-term viability of our
operational reorganization and Amended Plan.
- There can be no assurance as to our ability to maintain sufficient
financing sources to fund our Amended Plan and meet future
obligations.
- We may be unable to retain top management and other key personnel
through confirmation of our Amended Plan and emergence from bankruptcy
protection.
In addition, the uncertainty regarding the eventual outcome of our
restructuring, and the effect of other unknown adverse factors, could threaten
our existence as a going concern.
We have continued to manage our business and property as debtors-in-possession,
subject to the supervision of the Court and in accordance with the provisions of
the Bankruptcy Code. An immediate effect of the filing of the Chapter 11 Cases
was the imposition of the automatic stay which, with limited exceptions, enjoins
the commencement or continuation of all collection efforts by creditors,
enforcement of liens against any assets of the Company and litigation against
us. However, the automatic stay is applicable only to litigation against us, and
not against our officers and directors. We may request the Court to extend the
stay to cover our officers and directors, but absent Court approval, such
litigation may proceed.
Continuing on a going concern basis is dependent upon, among other things, the
success and Court approval of our Amended Plan, maintaining the support of key
vendors, retaining key personnel, along with financial, business, and other
factors, many of which are beyond our control.
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 through the end of the term of
the Amended Master Agreement. 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 orderly liquidation of the Shoemart business at the end of
2008 as a result of the Kmart Settlement.
15
WE RELY ON KEY VENDORS AND THIRD PARTIES TO MANUFACTURE 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 the prices
charged by these manufacturers increase, our cost of acquiring merchandise would
increase. A portion of our footwear product is comprised of petrochemical
products which have risen in price dramatically over the past year. It is very
possible that these raw material price increases will be passed on to us.
Furthermore, higher product prices could result from the recent decision by the
Chinese government to revalue their currency. Although we pay for finished goods
in U.S. dollars, it is possible that higher labor costs due primarily to the
currency revaluation could be passed on to us through higher product costs.
Should we not be able to recover these cost increases with increased pricing to
our customers, it could have a material adverse effect on our operations and
financial condition.
We also depend on third parties to receive, 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, including, as a result of increases in the cost of
fuel, there could be a material adverse effect on our operations and financial
performance.
WE ARE THE SUBJECT OF AN SEC ENFORCEMENT INVESTIGATION AND CANNOT YET DETERMINE
WHETHER ANY FINES WILL BE IMPOSED ON US BY THE SEC AND IF SO, WHETHER WE WILL
HAVE ADEQUATE FUNDS TO COVER THEM. WE MAY ALSO BE SUBJECT TO ADDITIONAL
LITIGATION OR REGULATORY ACTION.
Prior to our November 13, 2002 announcement that management had discovered
discrepancies in the reporting of our accounts payable balances, we notified the
staff of the SEC concerning the discovery of the accounting discrepancies.
Following that notification, the SEC began an enforcement proceeding, including
an investigation into the facts and circumstances giving rise to the
restatement. We have been and intend to continue cooperating fully with the SEC.
We cannot predict the outcome of this proceeding.
The investigation, the restatement overseen by the Audit Committee of the Board
of Directors, and our operation under protection of the bankruptcy laws, led to
a delay in the filing of this and other SEC reports. See "Introductory Note".
Because of these delays, we were not in compliance with the listing standards of
the NYSE and the NYSE delisted our common stock.
The Company and certain of its directors and officers were defendants in several
purported class action lawsuits (consolidated into a single action) alleging
violations of federal securities laws and breaches of fiduciary duties.
Footstar and the named plaintiffs mutually resolved the claims made in the
several purported class action lawsuits, without any admission of liability, for
the amount of $14.3 million, all of which was
16
funded with insurance proceeds. See Item 3 - Legal Proceedings. On June 14,
2005, the court approved the settlement and dismissed the action with prejudice.
Litigation or other regulatory actions against us by the SEC could have a
material adverse effect on our financial condition, results of operations or
liquidity, and would also have adverse secondary effects, such as negative
reactions from our stockholders, creditors or vendors.
For a further description of our restatement related litigation, see
"Restatement Related Litigation" under Item 3 - Legal Proceedings.
WE HAVE HAD AND CONTINUE TO HAVE MATERIAL WEAKNESSES IN INTERNAL CONTROL OVER
FINANCIAL REPORTING AND CANNOT ASSURE YOU THAT ADDITIONAL 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.
We and our independent registered public accounting firm have determined that we
have deficiencies in our internal control over financial reporting during fiscal
2004 that constitute "material weaknesses" as defined by the Public Company
Accounting Oversight Board's Audit Standard No. 2. The material weaknesses in
our internal control over financial reporting relate to the timeliness of our
accounting close process and our filing of reports with the SEC, an operational
deficiency in our controls with respect to our analysis of landed cost accounts
and a design deficiency in our controls over in-transit inventory. See Item 9A -
Controls and Procedures.
We cannot assure you that additional 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 additional 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 Sarbanes-Oxley
and the rules promulgated under Section 404. The existence of a material
weakness could result in errors in our financial statements that could result in
a restatement of financial statements, cause us to fail to meet our reporting
obligations and cause investors to lose confidence in our reported financial
information, leading to a decline in our stock price.
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 the costs
associated with operating as a public company, the expense of being in
bankruptcy, and a substantial portion of our labor expenses. If our sales
continue to decline, we will be unable to reduce our operating expenses
proportionately. In accordance with the Kmart Settlement, if Shoemart sales fall
below a certain threshold the Amended Master Agreement may be terminated early.
17
WE OPERATE IN THE HIGHLY COMPETITIVE FOOTWEAR RETAILING INDUSTRY.
The family footwear industry, where our business is now concentrated, is highly
competitive. Competition is concentrated among a limited number of retailers and
discount department stores, including Payless ShoeSource, Kmart, Wal-Mart,
Kohl's, Sears and Target, with a number of traditional mid-tier retailers such
as Shoe Carnival, Famous Footwear and Rack Room also selling lower-priced
footwear. The events that caused us to seek bankruptcy protection and the terms
of the Kmart Settlement put us at a distinct 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 this disadvantage and respond effectively to our competitors, we may be
forced to liquidate our operations.
THERE ARE RISKS ASSOCIATED WITH OUR IMPORTATION OF PRODUCTS.
Approximately 96% of Meldisco's products are 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,
issues regarding China's compliance with its agreements related to its entry
into the World Trade Organization, 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.
18
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, including sustained increases in gasoline prices, could
have a material adverse effect on our operations and financial condition.
WE MAY BE UNABLE TO ADJUST TO CONSTANTLY CHANGING FASHION TRENDS.
Our success depends, in large part, upon our ability to gauge the evolving
fashion tastes of our 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.
19
TRADEMARKS AND SERVICE MARKS
Footstar or its subsidiaries own all rights in the United States to the marks
Thom McAn, Cobbie Cuddlers and Cara Mia for use in connection with footwear
and/or related products and services. The Company or its subsidiaries have
registered or have common law rights in the United States to over 100 trademarks
and/or service marks under which we market merchandise or services. The Company
either has registered or is in the process of registering its trademarks and
service marks in foreign countries in which it operates or may operate in the
future. We vigorously protect our trademarks and service marks both domestically
and internationally.
EMPLOYEES
As of July 30, 2005, we had 4,460 employees, of which 1,398 were full-time and
3,062 were part-time employees.
AVAILABLE INFORMATION
We make available free of charge through our web site, www.footstar.com, all
materials that we file electronically with the SEC, including our Annual Report
on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and
amendments to those reports, filed or furnished pursuant to Section 13(a) or
15(d) of the Securities Exchange Act of 1934. During the period covered by this
Form 10-K, we made all such materials available through our web site as soon as
reasonably practicable after filing such materials with the SEC. As discussed in
the Introductory Note, 2004 quarterly reports will not be filed and 2005 SEC
reports have not yet been filed.
You may also read and copy any materials filed by us with the SEC at the SEC's
Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549, and you may
obtain information on the operation of the Public Reference Room by calling the
SEC at 1-800-SEC-0330. In addition, the SEC maintains an Internet web site,
www.sec.gov, that contains reports, proxy and information statements and other
information which we file electronically with the SEC.
20
ITEM 2. PROPERTIES
As of January 1, 2005, we operated licensed footwear departments in 2,340
stores. As of July 30, 2005, we operated licensed footwear departments in 2,313
stores. The licensed footwear departments are located in all 50 states, Guam,
Puerto Rico and the U.S. Virgin Islands. Of the licensed departments operated as
of January 1, 2005 and July 30, 2005, 1,482 and 1,454, respectively, were
located in Kmart discount stores and 856 and 859, respectively, were in West
Coast Rite Aid drugstores.
Kmart and other retail host stores provide us with store space to sell footwear
in exchange for certain payments. The footwear departments we operate in Kmart
stores range from 1,200 to 4,400 square feet.
Our corporate headquarters is located in 129,000 square feet of owned office
space in Mahwah, New Jersey. We also lease approximately 20,000 square feet of
space in Mahwah, New Jersey for use by our footwear testing lab and for storage.
Our corporate tax department is located in 3,500 square feet of leased office
space in Worcester, Massachusetts.
We no longer operated any Footaction or Just For Feet stores as of January 1,
2005.
Until the fourth quarter of 2004, our headquarters was located in 43,000 square
feet of leased office space in West Nyack, New York. Until its relocation to our
Mahwah office building during the third and fourth quarters of 2004, our Shared
Services Center was located in 57,000 square feet of leased office space in
Dallas, Texas. The Athletic Segment's corporate offices were located in
approximately 63,000 square feet of leased office space in Mahwah, New Jersey;
the lease expired as of September 30, 2004. We also maintained approximately
8,300 square feet of leased office space in Wausau, Wisconsin in which our
direct marketing operations were primarily located; that lease ended as of June
2004. We previously operated out of two owned distribution facilities located in
Mira Loma, California, and Gaffney, South Carolina, with a total of 1.2 million
square feet. In addition, we leased a 200,000 square foot distribution facility
in Morrow, Georgia; that lease ended as of January 31, 2005.
See "Introductory Note" for a discussion of our disposition of our facilities.
21
ITEM 3. LEGAL PROCEEDINGS
As stated in the "Introductory Note" above, we commenced the Chapter 11 Cases by
filing petitions for relief under Chapter 11 of the Bankruptcy Code. We have
continued to manage our business as debtors-in-possession, subject to the
supervision of the Court and in accordance with the provisions of the Bankruptcy
Code. An immediate effect of the filing of the Chapter 11 cases is the
imposition of the automatic stay, which, with limited exceptions, enjoins the
commencement or continuation of all collection efforts by creditors, enforcement
of liens against any assets of the Company and litigation against us arising
prior to the Petition Date. However, the automatic stay is applicable only to
litigation against us, and not against any of our officers and directors.
In addition to the matters described below, we are involved in other legal
proceedings, lawsuits and other claims incidental to the conduct of our business
and estimates of the probable costs for resolution of these claims are accrued
to the extent that they can be reasonably estimated. These estimates are based
on an analysis of potential outcomes, assuming a combination of litigation and
settlement strategies. These estimates also take into account that bar dates
have been established in connection with our bankruptcy proceedings. These bar
dates, all of which have passed, require that any claim relating to events that
occurred prior to our bankruptcy filing be reported in a proof of claim filed
with the Court in our bankruptcy case. However, legal proceedings are subject to
significant uncertainties, the outcomes are difficult to predict, and
assumptions and strategies may change. Consequently, except as specified below,
we are unable to ascertain the ultimate financial impact of any legal
proceedings.
RESTATEMENT RELATED LITIGATION
Prior to our November 13, 2002 announcement that management had discovered
discrepancies in the reporting of our accounts payable balances, we notified the
Staff of the SEC concerning the discovery of the accounting discrepancies.
Following that notification, the SEC began an enforcement proceeding captioned,
In the Matter of Footstar, Inc., MNY-7122, including an investigation into the
facts and circumstances giving rise to the discrepancies. On November 25, 2003
the SEC issued a Formal Order empowering certain members of the SEC staff to
take certain actions in the course of the investigation, including requiring
testimony and the production of documents. We cannot predict the outcome of this
proceeding.
The enforcement investigation includes determining whether the Company and
certain of its present or former directors, officers and employees may have
engaged in violations of the federal securities laws in connection with: the
purchase or sale of the securities of the Company; required filings with the
SEC; maintenance of our books, records and accounts; implementation and
maintenance of internal accounting controls; making of false or misleading
statements or omissions in connection with required audits or examinations of
our consolidated financial statements or the preparation and filing of documents
or reports we are required to file with the SEC. We have been and intend to
continue cooperating fully with the SEC.
The Company and certain of its directors and officers were defendants in two
derivative suits (consolidated into a single action as described below) and
several purported class action lawsuits (also consolidated into a single action
as described below) alleging violations of federal securities
22
laws and breaches of fiduciary duties. Messrs. Stearns, Day, Davies and Olshan,
members of the Company's Board of Directors, and J.M. Robinson, its former
Chairman, President and Chief Executive Officer, Stephen Wilson, an officer of
the Company, were named as defendants in two derivative complaints filed by
individual shareowners on behalf of the Company, one in the United States
District Court for the Southern District of New York and one in the Supreme
Court of the State of New York, Rockland County. In New York, the Supreme Court
is a trial level court. The complaints alleged that these directors and officers
breached their fiduciary duties to us by failing to implement and maintain an
adequate internal accounting control system, sought unspecified damages against
the defendants and in favor of the Company, as well as costs and expenses
associated with litigation. These complaints were consolidated in a single
action in the United States District Court for the Southern District of New York
captioned Barry Lee Bragger v J.M. Robinson, et al., Civil Action No. 02 Civ.
9163 (SCR). With Court approval, Footstar and the relevant parties mutually
agreed to resolve the claims made in the derivative complaints without any
admission of liability, for $9.2 million, all of which has been funded with
insurance proceeds paid to us. An order has been issued by the court before
which this litigation was pending dismissing the matter with prejudice.
The Company and certain of its directors and officers were defendants in several
purported shareholder class action lawsuits for alleged violations of securities
laws. These actions sought unspecified monetary damages and costs and expenses
associated with the litigation. These initial complaints alleged that beginning
mid-May 2000, the Company and its officers named above misrepresented our
financial performance. The cases were consolidated into a single action in the
United States District Court for the Southern District of New York, captioned,
Stephen Rush v. Footstar, Inc., et al., 02 Civ. 9130 (SRC) (Consolidated).
Footstar and the named plaintiffs mutually agreed to resolve the claims made in
the several purported class action lawsuits, without any admission of liability,
for the amount of $14.3 million, all of which was funded with insurance
proceeds. On June 14, 2005, the court approved the settlement and dismissed the
action with prejudice.
PROCEEDINGS INVOLVING KMART
In connection with the Kmart Settlement, all outstanding litigation between
Kmart and us has been settled. For a further discussion of the Kmart Settlement,
see "Introductory Note", "Risk Factors" under Item 1 - Business and "Kmart
Settlement" under Item 7 - Management's Discussion and Analysis of Financial
Condition and Results of Operations.
ADIDAS LITIGATION
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 seeks injunctive relief and unspecified monetary damages for 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 alleges infringes on its registered three
stripe trademark. While it is too early in litigation to predict the outcome of
the claims against us, we believe that we have meritorious defenses to the
claims asserted by Adidas and have filed an answer denying the allegations.
23
OTHER LITIGATION MATTERS
Mr. Robinson's employment as our Chairman, President and Chief Executive Officer
was terminated on September 12, 2003. Mr. Robinson had an employment agreement
with us and initiated arbitration proceedings against us for benefits under such
agreement. In July 2004, the parties agreed to settle such matter for $5.1
million.
We are involved in other various 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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during fiscal year
2004 as no annual meeting was held.
24
PART II
ITEM 5. MARKET PRICES FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Our common stock was listed on the NYSE under the trading symbol "FTS". On
December 29, 2003, the NYSE suspended trading in our common stock and, at a
later date, our common stock was delisted. See "Introductory Note". Since
December 30, 2003, our common stock has been traded on the over-the-counter
bulletin board ("OTCBB") under the symbol "FTSTQ:PK". Prices shown reflect the
intraday high and low sales prices for the common stock for each such quarter as
reported in the consolidated transaction reporting system. Prices shown for
periods during 2004 and 2005 reflect the intraday high and low bid prices for
the common stock as reported on the OTCBB System. The over-the-counter market
quotations reflect inter-dealer prices, without retail mark-up, mark-down or
commission, and may not necessarily reflect actual transactions. As of July 30,
2005, the closing price of our common stock was $6.35 and there were 2,387
shareholders of record. Information concerning the market prices of our common
stock is set forth below:
HIGH LOW
------ -----
2003
First Quarter $10.55 $5.76
Second Quarter $13.90 $7.35
Third Quarter $13.61 $6.50
Fourth Quarter $ 7.54 $2.80
2004
First Quarter $ 6.02 $0.95
Second Quarter $ 6.95 $2.15
Third Quarter $ 5.75 $2.00
Fourth Quarter $ 5.05 $2.05
2005
First Quarter $ 6.35 $3.50
Second Quarter $ 5.70 $3.75
We have not paid dividends at any time since we became a public company. We are
subject to certain conditions contained in our Amended DIP and Exit Facility
with respect to paying dividends.
25
ITEM 6. SELECTED FINANCIAL DATA
FIVE-YEAR HISTORICAL FINANCIAL SUMMARY
(dollars in millions)
2004 2003 2002 2001 2000
------ -------- -------- -------- --------
(Note 3) (Note 3) (Note 3)
STATEMENT OF OPERATIONS DATA
Net sales $800.2 $962.4 $1,321.3 $1,443.2 $1,310.1
Cost of sales 535.8 650.3 899.8 986.2 883.1
------ ------ -------- -------- --------
GROSS PROFIT 264.4 312.1 421.5 457.0 427.0
Store operating, selling, general and
administrative expenses 236.1 250.7 308.8 322.2 272.3
Depreciation and amortization 21.7 19.0 19.9 18.9 15.1
Restructuring, asset impairment and other
charges, net -- 2.5 14.0 3.3 --
Loss on Kmart Settlement (1) 6.3 -- -- -- --
Bad debt expense - Ames Department Stores -- -- 9.2 -- --
Other income (9.2) (5.4) -- -- --
Interest expense 11.0 23.4 9.5 3.8 1.4
Interest income -- (1.1) (1.1) (1.6) (1.4)
Loss on investment -- -- -- -- 3.0
------ ------ -------- -------- --------
(LOSS) INCOME BEFORE REORGANIZATION ITEMS,
INCOME TAXES, MINORITY INTERESTS,
DISCONTINUED OPERATIONS AND CUMULATIVE
EFFECT OF A CHANGE IN ACCOUNTING PRINCIPLE (1.5) 23.0 61.2 110.4 136.6
Reorganization items (37.1) -- -- -- --
------ ------ -------- -------- --------
(LOSS) INCOME BEFORE INCOME TAXES, MINORITY
INTERESTS, DISCONTINUED OPERATIONS AND
CUMULATIVE EFFECT OF A CHANGE IN ACCOUNTING
PRINCIPLE (38.6) 23.0 61.2 110.4 136.6
Benefit (provision) for income taxes (2) 2.9 (10.0) (70.9) (28.8) (38.6)
------ ------ -------- -------- --------
(LOSS) INCOME BEFORE MINORITY INTERESTS AND
DISCONTINUED OPERATIONS (35.7) 13.0 (9.7) 81.6 98.0
Minority interests in net loss (income) 11.0 (17.3) (37.1) (44.8) (51.4)
------ ------ -------- -------- --------
(LOSS) INCOME FROM CONTINUING OPERATIONS (24.7) (4.3) (46.8) 36.8 46.6
Loss from discontinued operations,
net of tax (3) (66.7) (50.1) (32.4) (67.4) (2.2)
Gain from disposal of Athletic Segment, net of
tax 21.4 -- -- -- --
------ ------ -------- -------- --------
(LOSS) INCOME FROM OPERATIONS BEFORE
CUMULATIVE EFFECT OF A CHANGE IN ACCOUNTING
PRINCIPLE (70.0) (54.4) (79.2) (30.6) 44.4
Cumulative effect of a change in accounting
principle (4) -- -- (24.3) -- --
------ ------ -------- -------- --------
NET (LOSS) INCOME $(70.0) $(54.4) $ (103.5) $ (30.6) $ 44.4
====== ====== ======== ======== ========
BASIC (LOSS) INCOME PER SHARE FROM CONTINUING
OPERATIONS $(1.20) $(0.21) $ (2.29) $ 1.82 $ 2.34
====== ====== ======== ======== ========
DILUTED (LOSS) INCOME PER SHARE FROM
CONTINUING OPERATIONS $(1.20) $(0.21) $ (2.29) $ 1.78 $ 2.29
====== ====== ======== ======== ========
26
ITEM 6. SELECTED FINANCIAL DATA, CONT.
FIVE-YEAR HISTORICAL FINANCIAL SUMMARY
(dollars in millions)
2004 2003 2002 2001 2000
------ ------ ------ ------ ------
BALANCE SHEET DATA
Current assets:
Cash and cash equivalents $189.6 $ 1.1 $ 13.4 $ 12.5 $ 14.3
Inventories 98.9 179.7 360.9 389.5 392.1
Other 50.5 39.7 87.5 123.7 90.5
Assets related to discontinued operations 6.2 284.5 -- -- --
------ ------ ------ ------ ------
Total current assets 345.2 505.0 461.8 525.7 496.9
Property and equipment, net 35.4 147.2 266.7 256.2 258.5
Other assets 13.5 12.5 46.8 116.9 58.4
------ ------ ------ ------ ------
Total assets 394.1 664.7 775.3 898.8 813.8
====== ====== ====== ====== ======
Notes payable -- 198.0 146.8 146.9 74.0
Amount due under Kmart Settlement (1) 45.0 -- -- -- --
Other current liabilities 98.0 133.2 319.0 322.4 287.7
Liabilities related to discontinued operations 3.5 110.5 -- -- --
Liabilities subject to compromise 152.3 -- -- -- --
------ ------ ------ ------ ------
Total current liabilities 298.8 441.7 465.8 469.3 361.7
Other long term liabilities 38.5 58.9 72.8 81.5 71.5
Amount due under Kmart Settlement (1) 5.5 -- -- -- --
Minority interests in subsidiaries (1) -- 42.2 61.9 70.1 78.9
------ ------ ------ ------ ------
Total liabilities 342.8 542.8 600.5 620.9 512.1
------ ------ ------ ------ ------
Shareholders' equity 51.3 121.9 174.8 277.9 301.7
------ ------ ------ ------ ------
Total liabilities and shareholders equity $394.1 $664.7 $775.3 $898.8 $813.8
====== ====== ====== ====== ======
(1) Represents additional charge incurred on Kmart Settlement and the
elimination of the minority interests as part of the cure payment.
(2) In connection with the preparation of our fiscal 2004, 2003 and 2002
consolidated financial statements, we reviewed the valuation of our
deferred tax assets based on projections of our future taxable earnings.
Primarily due to our historical losses and projected results, for
accounting purposes we cannot rely on anticipated long-term future profits
to utilize certain of our deferred tax assets. As a result, we could not
conclude that it is more likely than not that the deferred tax assets will
be realized and have recorded in fiscal 2004 an additional non-cash
valuation allowance of $21.4 million, and recorded in fiscal year 2003 an
additional non-cash valuation allowance of $24.7 million and in fiscal 2002
recorded $70.2 million.
(3) Loss from discontinued operations includes the losses from the disposition
of our Athletic Segment which was recorded in fiscal 2003 and the losses
from the disposition of our Shoe Zone stores and the footwear departments
of Gordmans and Federated, all part of our Meldisco business, in fiscal
2004. Shoe Zone commenced operations in fiscal 2001 and Gordmans and
Federated commenced operations in fiscal 2002. Accordingly, Statement of
Operations Data has been restated for fiscal years 2003, 2002 and 2001. The
assets and liabilities of the discontinued Meldisco businesses were
substantially disposed of by January 1, 2005. The loss from discontinued
operations includes the following (in millions):
2004 2003 2002 2001 2000
------ ------ ------ ------ -----
Athletic Segment $(38.9) $(39.9) $(30.8) $(66.7) $(2.2)
Meldisco Businesses (27.8) (10.2) (1.6) (0.7) --
------ ------ ------ ------ -----
Total $(66.7) $(50.1) $(32.4) $(67.4) $(2.2)
====== ====== ====== ====== =====
(4) Represents write-off of goodwill recorded in connection with the
acquisition of J. Baker assets upon the adoption of Statement of Financial
Accounting Standards No. 142, "Goodwill and Other Intangible Assets".
Amortization of goodwill in fiscal years 2001 and 2000 was $2.3 million and
$0.7 million, respectively.
27
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements made in reliance upon the safe
harbor provisions of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. 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:
- the pace at which Kmart terminates our business relationship and our
ability to develop viable business alternatives to offset the
termination of that relationship;
- our ability to emerge from bankruptcy protection and operate as a
going concern without those protections;
- our ability to operate pursuant to the terms of the Amended DIP and
Exit Facility and to otherwise obtain financing necessary to operate
our business on satisfactory terms both during and after our emergence
from bankruptcy protection;
- our ability to obtain Court approval and any other required approvals
with respect to motions in the Chapter 11 proceeding prosecuted by us
from time to time;
- our ability to develop, prosecute, confirm and consummate one or more
plans of reorganization with respect to the Chapter 11 Cases;
- risks associated with third parties seeking and obtaining court
approval to terminate or shorten the exclusivity period that we have
to propose and confirm one or more plans of reorganization, to appoint
a Chapter 11 trustee or to convert the cases to Chapter 7 cases;
- our ability to obtain and maintain normal terms with vendors and
service providers and to maintain contracts that are critical to our
operations;
- our compliance with the requirements of Sarbanes-Oxley;
- negative reactions from our stockholders, creditors or vendors to our
delay in providing financial information and the delisting of our
common stock by the NYSE;
- the impact and result of any litigation (including private
litigation), or any action by the SEC relating to us or the financial
statement restatement process;
- the impact of Hurricane Katrina on our Southern Region
- additional delays in the filing of other reports with the SEC;
- our ability to successfully implement internal controls and procedures
that ensure timely, effective and accurate financial reporting;
- our ability to reduce overhead costs commensurate with any decline in
sales;
- higher than anticipated employee levels, capital expenditures and
operating expenses, including our ability to reduce overhead and
rationalize assets, both generally and with respect to the changes
made to address the results of the investigation and the restatement;
- adverse results on our business relating to increased review and
scrutiny by regulatory authorities, media and others of financial
reporting issues and practices or otherwise;
28
- any adverse developments in existing commercial disputes or legal
proceedings; and
- intense competition in the markets in which we compete.
Additionally, it is not possible to predict the length of time we will operate
under Chapter 11 protection, the outcome of the proceeding in general, whether
we will continue to operate under our current organizational structure, or the
effect of the proceeding on our businesses and the interests of various
creditors and security holders.
Because the information in this Annual Report on Form 10-K 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 or prospects.
Additionally, we assume no obligation 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 Annual Report on Form 10-K.
OVERVIEW
Management confronts major challenges in reorganizing the Company through the
Chapter 11 process and managing the business after the Kmart Settlement.
Meldisco is our only continuing business and substantially all of our continuing
net sales and profits result from Meldisco's business in Kmart stores. If we
fail to develop viable business alternatives to offset the termination of the
Kmart relationship, we will be forced to liquidate our business when the Kmart
relationship ends.
We decided to seek bankruptcy protection after management determined it was
unable to obtain necessary liquidity from our lending syndicate or additional
debt or equity financing. We suffered a decline in our liquidity primarily
resulting from unprofitable results in the Athletic Segment, a reduction in
trade credit by certain Athletic vendors, unprofitable results of operations
from recent acquisitions and the effect of the Kmart bankruptcy. Other factors
included intense competition in the discount retailing industry, unsuccessful
sales and marketing initiatives and capital market volatility. As a
debtor-in-possession, we are authorized to continue to operate as an ongoing
business but may not engage in transactions outside the ordinary course of
business without the approval of the Court.
Since the Petition Date, actions to collect pre-petition indebtedness are stayed
and other contractual obligations against us may not be enforced. In addition,
under the Bankruptcy Code, we may assume or reject executory contracts and
unexpired leases, including leases of non-residential real property. Parties
affected by these rejections may file claims with the Court in accordance with
the Bankruptcy Code and orders issued by the Court.
For the period from the Petition Date to July 30, 2005, we incurred $40.1
million of professional fees, including trustee fees, associated with the
Chapter 11 Cases. We expect to continue to incur significant additional costs
through the remaining Chapter 11 process.
29
We have not filed our Quarterly Reports on Form 10-Q for the fiscal quarters
ended April 3, 2004, July 3, 2004 and October 2, 2004. In lieu of filing such
Quarterly Reports, this Form 10-K includes summarized quarterly financial data
and other material information that would have been available in our 2004
Quarterly Reports on Form 10-Q.
These reports were delayed as a result of our internal investigation, the
restatement of our consolidated financial statements and our operation under
protection of the bankruptcy laws. We intend to file our Quarterly Reports on
Form 10-Q for the fiscal quarters ended April 2, 2005 and July 2, 2005 as soon
as practicable following the filing of this fiscal 2004 Annual Report on Form
10-K.
Although the process for the disposition of our Athletic Segment commenced in
2003, as part of our initial reorganization plans after filing for Chapter 11 we
closed 166 underperforming stores within the Athletic Segment, comprised of all
88 Just For Feet stores, 75 Footaction stores and three Uprise stores.
After filing for bankruptcy protection, we received indications of significant
interest from potential acquirers of the remaining Footaction retail stores
comprising the Athletic Segment. We determined that a sale of these stores was
the best way to maximize the value of that business. This decision was driven in
part by the absence of a commitment from Nike USA, Inc., the largest supplier of
the Athletic Segment, to supply the Athletic Segment for more than a limited
period of time in accordance with past business practices. Accordingly, we
decided to establish an orderly sale process for the remaining Footaction retail
stores.
On April 21, 2004, we received Court approval to sell to Foot Locker 349 of the
remaining Footaction stores (including all lease rights and inventory at these
stores), along with the remaining inventory from the four remaining Footaction
stores. Effective May 2, 2004, these assets were sold to Foot Locker for $225.0
million in cash, subject to adjustment. Approximately $13.0 million of the sales
proceeds were placed in escrow with respect to 14 store locations that were
leased on a month-to-month basis. If Foot Locker entered into a new lease for
any of these store locations, the escrow amount related to that location was
paid to us. The escrow amount related to any location for which Foot Locker did
not enter into a new lease was paid to Foot Locker, thereby reducing the
purchase price by such amount. As of July 30, 2005, we have been paid
approximately $9.2 million from the escrow account, Foot Locker has been paid
approximately $2.2 million and approximately $1.6 million remained in escrow.
The parties had previously agreed to extend the above-mentioned one-year period
until July 7, 2005 for the one remaining month-to-month lease, but have been
unable to agree to a further extension as Foot Locker continues to occupy the
premises and negotiate a new lease. Accordingly, the $1.6 million remains in
escrow pending the parties resolution of the dispute relating to the release of
such funds from escrow.
The sale to Foot Locker together with the closure of the Just For Feet and
Footaction stores has been accounted for as discontinued operations in
accordance with FASB Statement No. 144, "Accounting for the Impairment or
Disposal of Long Lived Assets".
30
Our financial statements reflect the Athletic Segment as a discontinued
operation for all periods presented. As of July 30, 2005, the estimated gain on
the sale of the Athletic Segment, including the effect of closing the
underperforming stores, distribution centers and warehouse facilities was
approximately $21.4 million, including the escrow payments through July 30,
2005, which will increase by the amount of the remaining escrowed cash, if it is
released to us.
In the initial stages of the Chapter 11 cases, we sought to streamline our
Meldisco business by selling or exiting selected stores. As a result of our
continued analysis of our businesses, we sold or liquidated all of our Shoe Zone
stores. We also exited the footwear departments in 44 Gordmans stores and 87
Federated stores. Our financial statements reflect these Meldisco businesses as
discontinued operations for all periods presented.
We have sold other assets, including our distribution centers in Mira Loma in
July 2004 and Gaffney in September 2004. The purchaser of Mira Loma, Thrifty,
has leased Mira Loma to FMI which has agreed to provide us with warehousing and
distribution services through June 30, 2012 under the FMI Agreement. Pursuant to
the FMI Agreement we are obligated to pay to FMI a minimum of $15.1 million in
both 2005 and 2006.
We previously operated a Shared Services Center in Dallas, Texas. The Shared
Services Center administered accounts payable, loss prevention, payroll,
benefits, store accounting and inventory control for the entire Company and also
contained our information system's data center. In connection with our decision
to sell the Athletic Segment and streamline our Meldisco business, we determined
that, from both an internal control and cost perspective, the Shared Services
Center was no longer a viable concept given our significantly reduced operating
structure. Accordingly, during 2004 we transitioned all Shared Services Center
functions to our headquarters in Mahwah, New Jersey.
In connection with the Kmart Settlement, we anticipate filing the Amended Plan
with the Court. The Amended Plan is expected to provide for an orderly
reorganization of the Company and cash distributions to impaired parties and be
subject to a vote by eligible ballot holders. The Amended Plan is also expected
to provide for some flexibility in the timing of its confirmation and our
emergence from bankruptcy. The Amended Plan is also expected to provide that we
will not emerge from bankruptcy until we file with the SEC those periodic
reports required by the SEC. Although we expect that creditors in the bankruptcy
will be paid in full, the timing of such payments is currently subject to
negotiation and is expected to be specified in the Amended Plan.
Effective July 1, 2005, the DIP and Exit Facility was amended (the "Amended DIP
and Exit Facility"). See "Liquidity and Capital Resources".
Hurricane Katrina may have an impact on our Southern Region. In addition to the
possibility of destroyed stores, there will be a number of stores closed for a
period of time. Furthermore, our logistics systems for the distribution of
merchandise has been disrupted in this region. The impact of this hurricane on
our results of operations for the remainder of fiscal 2005 has not yet been
determined.
31
KMART SETTLEMENT
On July 2, 2005, the Company and Kmart entered into the Kmart Settlement which
dictates the structure of our relationship with Kmart. Under the Master
Agreement, the Company and Kmart had formed in excess of 1,500 Shoemart
Corporations in which we had a 51% ownership interest and Kmart had a 49%
ownership interest, other than 23 of the Shoemart Corporations which were
wholly-owned by us.
The Kmart Settlement provides that Kmart's equity interests in the Shoemart
Corporations will be extinguished effective January 2, 2005, and accordingly,
Kmart will not share in the profits or losses of those entities for fiscal 2005
or subsequent years. The Kmart Settlement fixed the cure amount with respect to
our assumption of the Amended Master Agreement at $45.0 million, which was paid
on August 26, 2005. Beginning on January 2, 2005, we are required to pay Kmart
14.625% of the gross sales of the footwear departments. Effective August 25,
2005, we are required to pay Kmart a miscellaneous expense fee of $23,500 per
open store per year. Under the Kmart Settlement, the Amended Master Agreement
will expire at the end of 2008 and Kmart will purchase our Shoemart inventory
(but not our brands) at book value, as defined, to allow for an orderly wind
down of the Shoemart business. The Kmart Settlement resulted in a charge of
approximately $6.3 million which has been reflected in our fiscal 2004
consolidated statement of operations. This charge represents the amount in
excess of previously recorded amounts due Kmart, including minority interests.
We and Kmart each will 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 such gross sales minimum will be reduced by
$0.4 million for each store that is closed or converted after the Approval Date.
The Company will 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. In the event of any such termination, Kmart will
purchase all of the inventory (including inventory that is on order but
excluding inventory that is damaged, unsaleable and seasonal inventory, as
defined) that is in our remaining stores or on order, for an amount equal to the
book value of the inventory, as defined.
Kmart will be permitted to terminate our rights to operate shoe departments in
up to 550 existing Kmart stores during the remaining term of the Amended Master
Agreement by disposing of, closing or converting those stores. The number of
such terminations 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. For
each store that is 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, for all closings
and conversions above the annual cap or the 550 aggregate limit, Kmart must pay
us a non-refundable stipulated loss value per store equal to $100,000 for
closings and conversions occurring in 2005, $60,000 for closings and conversions
occurring in 2006, $40,000 for closings and conversions occurring in 2007 and
$20,000 for closings and conversions occurring in 2008. A termination of the
entire Amended Master Agreement in accordance with its terms does not trigger a
stipulated loss value payment.
32
The Kmart Settlement 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. Kmart is required to allocate at least 52 square tab weekend newspaper
advertising insert pages per year to our products.
Kmart will have a capital claim against us in the amount of $11,000 for each
store that is an existing store, as defined, on August 25, 2005, which is
generally payable by us to Kmart at the time a store closes or converts to
another retail format in accordance with the 550 store limitation described
below. 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
capital claims not yet due and payable will be waived for any remaining stores.
If the Amended Master Agreement is terminated as a result of our breach, capital
claims for remaining stores will not be waived and will become immediately due
and payable.
BUSINESS RELATIONSHIP WITH WAL-MART STORES
In October 2002, we began supplying Thom McAn family footwear on a wholesale
basis to 300 Wal-Mart stores. In February 2003, we expanded our arrangement with
Wal-Mart to supply Thom McAn family footwear on a wholesale basis to up to 1,500
Wal-Mart stores in the United States. As of July 30, 2005, we were supplying
Thom McAn family footwear to 1,500 Wal-Mart stores in the United States and 13
stores in Puerto Rico. In 2004, we sold approximately $28.6 million of Thom McAn
products to Wal-Mart stores. Wal-Mart has advised us that, beginning in January
2006, it will no longer be purchasing Thom McAn product for any of its stores in
the United States. Wal-Mart has advised us that it will continue to buy Thom
McAn footwear for Wal-Mart stores in Puerto Rico and will continue to source
footwear from us for Wal-Mart stores under Wal-Mart's proprietary brands.
RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with and is
qualified in its entirety by our Consolidated Financial Statements and the Notes
thereto that appear elsewhere in this report.
FISCAL 2004 VERSUS FISCAL 2003
Meldisco represents substantially all of our operations. Corporate expenses
(excluding other income, interest income and interest expense), net of royalties
and commissions, were approximately $22.1 million in fiscal 2004 and $19.1
million in fiscal 2003.
33
2004 VERSUS 2003 - CORPORATE
Royalties and commissions, which were approximately $14.4 million in fiscal 2004
and $19.5 million in fiscal 2003, consisted of the following:
- The royalties Footstar charges Meldisco on the corporate trademarks
which we own and Meldisco utilizes on its products.
- Commissions on goods sourced to third parties.
- Fees associated with third party services, such as the testing lab.
Corporate expenses (excluding other income, interest income and interest
expense), which were approximately $36.5 million in fiscal 2004 and $38.6
million in fiscal 2003 and consisted of the following:
- General expenses not allocated.
- Depreciation on assets located at our former headquarters in West
Nyack, New York.
- Amortization of Company-owned trademarks.
MELDISCO FINANCIAL PERFORMANCE - 2004 VERSUS 2003
1st Quarter 2nd Quarter 3rd Quarter FULL YEAR
--------------- --------------- --------------- ---------------
(dollars in millions) 2004 2003 2004 2003 2004 2003 2004 2003
------ ------ ------ ------ ------ ------ ------ -------
Net Sales $176.9 $232.8 $216.5 $250.0 $186.0 $225.1 $800.2 $962.4
------ ------ ------ ------ ------ ------ ------ ------
Gross Profit 52.3 63.0 68.8 81.7 45.1 63.6 250.1 292.7
SG&A Expenses 49.3 59.2 51.3 54.5 51.5 55.5 204.8 217.4
Depreciation/Amortization 3.6 3.3 5.5 3.6 4.2 3.5 16.6 14.0
Loss on Kmart Settlement -- -- -- -- -- -- 6.3 --
Restructuring, Asset
Impairment and Other
Charge -- 2.5 -- -- -- -- -- 2.3
------ ------ ------ ------ ------ ------ ------ ------
Operating (Loss) Profit $ (0.6) $ (2.0) $ 12.0 $ 23.6 $(10.6) $ 4.6 $ 22.4 $ 59.0
====== ====== ====== ====== ====== ====== ====== ======
Meldisco operates through our Shoemart subsidiaries primarily in the discount
footwear market through its operation of 1,482 Kmart licensed footwear
departments as of January 1, 2005, as well as other licensed footwear and retail
businesses. Meldisco competes primarily with other discount department stores,
discount footwear retailers, as well as off-price and value retailers. As a
result, Meldisco is heavily dependent on the ability of its host retailers to
attract traffic into their stores through their promotional and advertising
programs. Our Shoemart Subsidiaries accounted for 94%, 94% and 87% of Meldisco's
sales in 2004, 2003 and 2002, respectively.
MELDISCO - FULL YEAR RESULTS
NET SALES
Net sales decreased $162.2 million, or 16.9%, in 2004, to $800.2 million
compared with $962.4 million in 2003. This sales decrease was primarily due to
Shoemart comparable store sales declines ($80 million), a reduction in open
Kmart stores ($58 million), one fewer week of sales results in the fiscal
calendar year ($12 million) and lower sales to Wal-Mart ($9 million) as 2003
sales to Wal-Mart were higher due to initial shipment quantities.
34
Shoemart sales are largely dependent on the number of open Kmart stores and
Kmart comparable store sales.
Open Kmart Kmart Shoemart Store
Stores Store Comps (A) Comps
---------- --------------- --------------
Full Year 2004 1,482 (11.0)% (9.8)%
Full Year 2003 1,511 (8.1)% (7.8)%
(A) for periods ended January 28, 2004 and January 26, 2003, respectively.
Traditionally, Shoemart sales have moved in tandem with Kmart's performance
which, typically, modestly exceeds Kmart's overall performance.
GROSS PROFIT
Gross profit decreased $42.6 million, or 14.6%, to $250.1 million in 2004
compared with $292.7 million in 2003. This decrease is primarily due to the
16.9% decrease in sales. The increase in the overall gross margin rates to 31.3%
in 2004 from 30.4% in 2003 was due to increasing the percentage of our
internally sourced purchases rather than using outside vendors and some price
increases.
SG&A EXPENSES
SG&A expenses decreased $12.6 million, or 5.8%, to $204.8 million in 2004
compared with $217.4 million in 2003. This decrease was primarily attributable
to a reduction in expenses to offset a portion of the sales declines in the
Shoemart operation and the reduction of open Kmart stores. The overall SG&A rate
as a percentage of sales increased to 25.6% in 2004 compared with 22.6% in 2003
as Shoemart was unable to reduce store selling, fixture and administrative costs
commensurate with the overall sales decline due to a certain portion of these
costs being fixed in nature.
DEPRECIATION/AMORTIZATION
Depreciation/amortization increased $2.6 million, or 18.6%, to $16.6 million in
2004 compared with $14.0 million in 2003. This increase is attributable to the
acceleration of depreciation of our shared services center assets to coincide
with the closing of the center in December 2004. This acceleration exceeded the
reduction in depreciation associated with the disposition of Mira Loma and
Gaffney distribution centers during 2004.
KMART SETTLEMENT CHARGE
In connection with the Kmart Settlement, we recorded a charge of $6.3 million in
the fourth quarter of fiscal 2004. This charge represents the amount in excess
of previously recorded amounts due Kmart, including minority interests.
35
RESTRUCTURING, ASSET IMPAIRMENT AND OTHER CHARGE
In 2003, we incurred approximately $18.2 million of restructuring and asset
impairments relating to the closing of 321 Kmart stores. These charges included
approximately $15.7 million for inventory write-downs which are included as a
component of cost of sales. The other charges, which amounted to $2.5 million,
included $1.9 million for severance costs and $0.6 million for asset
impairments. These other charges were offset by $0.2 million of reserve
reversals in the 2003 fourth quarter.
OPERATING PROFIT
Operating profit decreased $36.6 million, or 62.0%, to $22.4 million in 2004
compared with $59.0 million in 2003 due to the effect of the 16.9% decline in
sales and the Kmart Settlement in 2004, which was offset by restructuring
charges incurred in 2003.
MELDISCO - FIRST QUARTER RESULTS
2004 2003 % SALES - 2004 % SALES - 2003
------ ------ -------------- --------------
Net Sales $176.9 $232.8
------ ------
Gross Profit 52.3 63.0 29.6% 27.1%
SG&A Expenses 49.3 59.2 27.9% 25.4%
Depreciation/Amortization 3.6 3.3 2.0% 1.4%
Restructuring, Asset Impairment and
Other Charge -- 2.5 -- 1.1%
------ ------
Operating Loss $ (0.6) $ (2.0) (0.3)% (0.9)%
------ ------
NET SALES
Net sales decreased $55.9 million, or 24.0%, in 2004 to $176.9 million compared
with $232.8 million in 2003. The sales decrease is primarily attributable to
Kmart store closures ($40 million) and the comparable store sales decline ($16
million). This was offset by a $2.0 million increase in sales to Wal-Mart.
Shoemart sales are largely dependent on the number of open Kmart stores and
Kmart comparable store sales.
Open Kmart Kmart Shoemart Store
Stores Store Comps (A) Comps
---------- --------------- --------------
First Quarter 2004 1,506 (12.9)% (9.1)%
First Quarter 2003 1,829 (3.2)% (11.1)%
(A) for period ended April 28, 2004 and April 30, 2003, respectively.
Traditionally, Shoemart sales have moved in tandem with Kmart's performance
which, typically, modestly exceeds Kmart's overall performance. Shoemart's 2003
comparable store sales were lower than Kmart's due to significantly weaker
performance of winter seasonal products.
36
GROSS PROFIT
Gross profit decreased $10.7 million, or 17.0%, to $52.3 million in 2004
compared with $63.0 million in 2003. The gross margin decline is largely the
result of the 24.0% decrease in first quarter sales, which was partially offset
by an improvement in our gross margin rate. Our gross margin rate in 2003 was
adversely affected by the inventory write-downs discussed below.
SG&A EXPENSES
SG&A expenses decreased $9.9 million, or 16.7%, to $49.3 million in 2004
compared with $59.2 million in 2003. This decrease was primarily due to fewer
Kmart stores in operation and reductions in store selling and advertising costs.
The overall SG&A rate as a percentage of sales increased to 27.9% in 2004
compared with 25.4% in 2003 as Shoemart was unable to reduce store selling,
fixture rental and administrative costs commensurate with the overall sales
decline due to a certain portion of these costs being fixed in nature.
DEPRECIATION/AMORTIZATION
Depreciation/amortization increased $0.3 million, or 9.1%, in 2004 to $3.6
million compared with $3.3 million in 2003. This increase is a result of our
Mira Loma facility expansion project, which was placed in service in May 2003,
and accordingly the related depreciation commenced in the 2003 second quarter.
The 2004 first quarter reflects the depreciation of this expansion.
RESTRUCTURING, ASSET IMPAIRMENT AND OTHER CHARGE
During 2003, we recorded inventory write-downs of $15.7 million, which are
recorded in cost of sales and employee severance of $1.9 million and asset
impairments of $0.6 million in connection with the closing of 321 Kmart stores
OPERATING LOSS
The decrease in operating loss to $0.6 million in 2004 compared with an
operating loss of $2.0 million in 2003 was primarily due to restructuring
charges of $18.2 million incurred in 2003 which were offset by the effect of the
$55.9 million decline in 2004 sales.
MELDISCO - SECOND QUARTER RESULTS
2004 2003 % SALES - 2004 % SALES - 2003
------ ------ -------------- --------------
Net Sales $216.5 $250.0
------ ------
Gross Profit 68.8 81.7 31.8% 32.7%
SG&A Expenses 51.3 54.5 23.7% 21.8%
Depreciation/Amortization 5.5 3.6 2.5% 1.4%
------ ------
Operating Profit $ 12.0 $23.6 5.5% 9.4%
------ ------
NET SALES
Net sales decreased $33.5 million, or 13.4%, in 2004 to $216.5 million compared
with $250.0 million in 2003. This sales decrease was primarily due to the 11.3%
comparable store sales decline
37
at Shoemart ($26 million) due to continued traffic declines at current stores.
The balance of the decline was primarily attributable to lower sales of Thom
McAn product to Wal-Mart ($5 million) as the prior year included initial
shipment quantities.
Shoemart sales are largely dependent on the number of open Kmart stores and
Kmart comparable store sales.
Kmart Shoemart Store
Open Kmart Stores Store Comps (A) Comps
----------------- --------------- --------------
Second Quarter 2004 1,504 (14.9)% (11.3)%
Second Quarter 2003 1,512 (5.4)% (4.6)%
(A) for period ended July 28, 2004 and July 30, 2003, respectively.
Traditionally, Shoemart sales have moved in tandem with Kmart's performance
which, typically, modestly exceeds Kmart's overall performance.
GROSS PROFIT
Gross profit decreased $12.9 million, or 15.8%, to $68.8 million in 2004
compared with $81.7 million in 2003. This decrease is due to the 13.4% sales
decrease and higher markdowns taken in 2004 in the Shoemart business as part of
the product liquidation associated with excess levels of aged inventory, which
resulted in a reduction of our gross margin percentage in 2004 compared with
2003.
SG&A EXPENSES
SG&A expenses decreased $3.2 million, or 5.9%, to $51.3 million in 2004 compared
with $54.5 million in 2003. SG&A expenses decreased due to the cost reductions
that were instituted in connection with the lower sales in the Shoemart
business. The overall SG&A rate as a percentage of sales increased to 23.7% in
2004 compared with 21.8% in 2003 as Shoemart was unable to reduce store selling,
fixture rental and administrative costs commensurate with the overall sales
decline due to a certain portion of these costs being fixed in nature.
DEPRECIATION/AMORTIZATION
Depreciation/amortization increased $1.9 million, in 2004 to $5.5 million
compared with $3.6 million in 2003. During the second quarter of 2004, we
commenced the acceleration of depreciation of our shared services center assets
to ensure that they would be fully depreciated upon closing in December 2004,
which contributed to the increase in 2004 compared with 2003.
OPERATING PROFIT
Operating profit decreased $11.6 million, or 49.2%, to $12.0 million in 2004
compared with $23.6 million in 2003 primarily due to the decrease in sales and
the higher markdowns on product liquidations.
38
MELDISCO - THIRD QUARTER RESULTS
2004 2003 % SALES - 2004 % SALES - 2003
------ ------ -------------- --------------
Net Sales $186.0 $225.1
------ ------
Gross Profit 45.1 63.6 24.2% 28.3%
SG&A Expenses 51.5 55.5 27.7% 24.7%
Depreciation/Amortization 4.2 3.5 2.3% 1.6%
------ ------
Operating (Loss) Profit $(10.6) $ 4.6 (5.7)% 2.0%
------ ------
NET SALES
Net sales decreased $39.1 million, or 17.4%, in 2004 to $186.0 million compared
with $225.1 million in 2003. This sales decrease was primarily due to the
Shoemart comparable store sales declines ($29 million), Kmart stores closures
($5 million), and lower sales of Thom McAn product to Wal-Mart ($5 million) as
2003 sales to Wal-Mart included initial shipment quantities.
Shoemart sales are largely dependent on the number of open Kmart stores and
Kmart comparable store sales.
Kmart Shoemart Store
Open Kmart Stores Store Comps (A) Comps
----------------- --------------- --------------
Third Quarter 2004 1,496 (12.8)% (14.5)%
Third Quarter 2003 1,512 (8.6)% (4.5)%
(A) for period ended October 27, 2004 and October 29, 2003, respectively.
Traditionally, Meldisco sales have moved in tandem with Kmart performance, which
typically, modestly exceeds Kmart's performance. Our performance is also at
times impacted by the performance of Kmart's apparel division. During 2004,
Kmart's apparel departments store comps decreased more than its total store
comps. This adversely affected to a greater degree our overall store comps.
GROSS PROFIT
Gross profit decreased $18.5 million, or 29.1%, to $45.1 million in 2004
compared with $63.6 million in 2003. The significant reduction in gross margin
rate to 24.2% in 2004 from 28.3% was the result of higher markdowns on aged
inventory product ($4 million) and higher logistics costs ($4 million) as a
result of our outsourcing arrangement with FMI for distribution services at Mira
Loma.
SG&A EXPENSES
SG&A expenses decreased $4.0 million, or 7.2%, to $51.5 million in 2004 compared
with $55.5 million in 2003. This decrease was primarily attributable to
reductions in variable costs in the Shoemart operations due to lower sales. The
overall SG&A rate as a percentage of sales increased
39
to 27.7% in 2004 compared with 24.7% in 2003 as Shoemart was unable to reduce
store selling, fixture rental and administrative costs commensurate with the
overall sales decline due to a certain portion of these costs being fixed in
nature.
OPERATING (LOSS) PROFIT
Operating profit decreased $15.2 million to a $(10.6) million loss in 2004
compared with a $4.6 million operating profit in 2003 due to the decrease in
sales and the higher markdowns on aged inventory.
FISCAL 2003 VERSUS 2002
Meldisco represents substantially all of our operations. Corporate expenses
(excluding other income, interest income and interest expense), net of royalties
and commissions, were approximately $19.1 million in 2003 and $10.0 million in
2002.
FISCAL 2003 VERSUS FISCAL 2002 - CORPORATE
Royalties and commissions, which were approximately $19.5 million in 2003 and
$17.9 million in 2002, consisted of the following:
- The royalties Footstar charges Meldisco on the corporate trademarks
which we own and Meldisco utilizes on its products.
- Commissions on goods sourced to third parties.
- Fees associated with third party services, such as the testing lab.
Corporate expenses (excluding other income, interest income and interest
expense), were approximately $38.6 million in 2003 and $27.9 million in 2002 and
consisted of the following:
- General expenses not allocated.
- Depreciation on assets located at our former headquarters in West
Nyack, New York.
- Amortization of Company-owned trademarks.
- In fiscal 2002, we recorded a $2.8 million write-down of trademarks
acquired from J. Baker.
MELDISCO FINANCIAL PERFORMANCE - 2003 VERSUS 2002
1st Quarter 2nd Quarter 3rd Quarter FULL YEAR
--------------- --------------- --------------- -----------------
(in millions) 2003 2002 2003 2002 2003 2002 2003 2002
------------- ------ ------ ------ ------ ------ ------ ------ --------
Net Sales $232.8 $314.7 $250.0 $364.7 $225.1 $313.4 $962.4 $1,321.3
------ ------ ------ ------ ------ ------ ------ --------
Gross Profit 63.0 81.0 81.7 119.0 63.6 90.4 292.7 403.6
SG&A Expenses 59.2 77.4 54.5 70.4 55.5 66.3 217.4 286.2
Bad Debt Expense - Ames -- -- -- 9.2 -- -- -- 9.2
Depreciation/Amortization 3.3 3.9 3.6 4.0 3.5 3.7 14.0 15.0
Restructuring, Asset
Impairment & Other Charge 2.5 1.7 -- 7.0 -- 4.9 2.3 13.6
------ ------ ------ ------ ------ ------ ------ --------
Operating (Loss) Profit $ (2.0) $ (2.0) $ 23.6 $ 28.4 $ 4.6 $ 15.5 $ 59.0 $ 79.6
====== ====== ====== ====== ====== ====== ====== ========
40
MELDISCO - FULL YEAR RESULTS
NET SALES
Net sales decreased $358.9 million, or 27.2%, in 2003, to $962.4 million
compared with $1,321.3 million in 2002. The 2003 sales results include a
fifty-three week period compared with a fifty-two week period in 2002. This
sales decrease was primarily due to Kmart store closures ($193 million), a 7.8%
comparable store sales decline in Shoemart during 2003 predominantly due to
weaker seasonal product sales and promotional sales resulting from a reduction
in advertising by Kmart in the second half of 2003 ($60 million), the closing of
all Ames stores ($81 million) and the decision to exit other unprofitable
landlords acquired as part of the J. Baker acquisition ($53 million). This sales
decrease was partially offset by increased store counts at Wal-Mart for Thom
McAn product ($35 million).
GROSS PROFIT
Gross profit decreased $110.9 million, or 27.5%, to $292.7 million in 2003
compared with $403.6 million in 2002. This decrease is primarily due to the
aforementioned 27.2% decrease in sales. Overall gross margin rates deteriorated
to 30.4% in 2003 from 30.5% in 2002. This reduction in gross margin rates was
primarily due to additional markdowns in Shoemart that were taken in connection
with our efforts to liquidate inventory in the Kmart stores that were closed
during 2003.
SG&A EXPENSES
Store operating, selling, general and administrative expenses ("SG&A expenses")
decreased $68.8 million, or 24.0%, to $217.4 million in 2003 compared with
$286.2 million in 2002. SG&A expenses in Shoemart decreased by $36 million, or
15%, compared with the balance of Meldisco which declined by $22 million, or
45%. The overall SG&A rate as a percentage of sales increased to 22.6% in 2003
compared with 21.7% in 2002, as Shoemart was unable to reduce store selling and
fixture rental costs commensurate with the overall sales decline due to a
certain portion of these costs being fixed in nature.
RESTRUCTURING, ASSET IMPAIRMENT AND OTHER CHARGE
In 2003, we incurred approximately $18.2 million of restructuring and asset
impairments relating to the closing of 316 Kmart stores. These charges included
approximately $15.7 million for inventory write-downs which are included as a
component of cost of sales. The other charges, which amounted to $2.5 million,
included $1.9 million for severance costs and $0.6 million for asset
impairments. These other charges were offset by $0.2 million of reserve
reversals in the 2003 fourth quarter.
During 2002, we approved several plans in which we recorded net restructuring,
asset impairment and other charges of $43.9 million principally in connection
with our exiting various license arrangements acquired in the J. Baker
acquisition and the closing of certain Kmart stores.
41
The inventory portion, which amounted to $29.1 million, is included as a
component of cost of sales. The inventory write-downs did not materially impact
the decrease in gross margin rates in 2003 versus 2002.
The other charges, which amounted to $13.6 million, related to asset impairments
of $7.9 million, severance costs of $4.2 million and lease exit costs of $1.5
million.
OPERATING PROFIT
Operating profit decreased $20.6 million, or 25.9%, to $59.0 million in 2003
compared with $79.6 million in 2002. Operating profit margin rates increased to
6.1% in 2003 from 6.0% in 2002 primarily due to the reasons noted above.
MELDISCO - FIRST QUARTER RESULTS
2003 2002 % SALES - 2003 % SALES - 2002
------ ------ -------------- --------------
Net Sales $232.8 $314.7
------ ------
Gross Profit 63.0 81.0 27.1% 25.7%
SG&A Expenses 59.2 77.4 25.4% 24.6%
Depreciation/Amortization 3.3 3.9 1.4% 1.2%
Restructuring, Asset Impairment &
Other Charge 2.5 1.7 1.1% 0.5%
------ ------
Operating Loss $ (2.0) $ (2.0) (0.9%) (0.6%)
------ ------
NET SALES
Net sales decreased $81.9 million, or 26.0%, to $232.8 million in 2003 compared
with $314.7 million in 2002. This sales decrease was primarily due to Kmart
store closures ($29 million), an 11.1% comparable store sales decline in
Shoemart during 2003 predominantly due to weaker winter seasonal product sales
($23 million), the closing of all Ames stores ($22 million) and the decision to
exit other unprofitable landlords acquired as part of the J. Baker acquisition
($12 million).
This sales decrease was partially offset by increased store counts at Wal-Mart
for Thom McAn product ($5 million).
GROSS PROFIT
Gross profit decreased $18.0 million, or 22.2%, to $63.0 million in 2003
compared with $81.0 million in 2002. This decrease is primarily due to the 26.0%
decrease in sales. Overall gross margin rates improved to 27.1% in 2003 from
25.7% in 2002. This increase in gross margin rates was primarily due to lower
excess rent payments in Shoemart in connection with lower profitability in these
stores.
SG&A EXPENSES
SG&A expenses decreased $18.2 million, or 23.5%, to $59.2 million in 2003
compared with $77.4 million in 2002. The overall SG&A rate as a percentage of
sales increased to 25.4% in 2003
42
compared with 24.6% in 2002, as Shoemart was unable to reduce store selling and
fixture rental costs commensurate with the overall sales decline due to a
certain portion of these costs being fixed in nature.
RESTRUCTURING, ASSET IMPAIRMENT AND OTHER CHARGE
During 2003, we recorded inventory write-downs of $15.7 million, which are
recorded in cost of sales and employee severance and asset impairments of $2.5
million in connection with the closing of 318 Kmart stores and a $0.8 million
reserve reversal related to a prior period. In 2002, we recorded inventory
write-downs of $13.1 million and employee severance and asset impairments of
$1.7 million in connection with the closing of 283 Kmart stores. The inventory
write-downs did not materially impact the decrease in gross margin rates in 2003
versus 2002.
OPERATING LOSS
Operating loss remained at $2.0 million in 2003 compared with 2002 primarily due
to the reasons noted above.
MELDISCO - SECOND QUARTER RESULTS
2003 2002 % SALES - 2003 % SALES - 2002
------ ------ -------------- --------------
Net Sales $250.0 $364.7
------ ------
Gross Profit 81.7 119.0 32.7% 32.6%
SG&A Expenses 54.5 70.4 21.8% 19.3%
Bad Debt Expense - Ames -- 9.2 N/A 2.5%
Depreciation/Amortization 3.6 4.0 1.4% 1.1%
Restructuring, Asset Impairment &
Other Charge -- 7.0 N/A 1.9%
------ ------
Operating Profit $ 23.6 $ 28.4 9.4% 7.8%
------ ------
NET SALES
Net sales decreased $114.7 million, or 31.5%, in 2003, to $250.0 million
compared with $364.7 million in 2002. This sales decrease was primarily due to
Kmart store closures ($68 million), a 5.4% comparable store sales decline in
Shoemart during 2003 predominantly due to reduced Kmart traffic levels ($11
million), the closing of all Ames stores ($28 million) and the decision to exit
other unprofitable landlords acquired as part of the J. Baker acquisition ($16
million). This sales decrease was partially offset by increased store counts at
Wal-Mart for Thom McAn product ($10 million).
GROSS PROFIT
Gross profit decreased $37.3 million, or 31.3%, to $81.7 million in 2003
compared with $119.0 million in 2002. This decrease is primarily due to the
31.5% decrease in sales. Overall gross margin rates increased to 32.7% in 2003
from 32.6% in 2002. This reduction in gross margin rates was
43
primarily due to additional markdowns in Shoemart that were taken in connection
with our efforts to liquidate additional inventory in the Kmart stores due to
the comparable store sales decline.
SG&A EXPENSES
SG&A expenses decreased $15.9 million, or 22.6%, to $54.5 million in 2003
compared with $70.4 million in 2002. The overall SG&A rate as a percentage of
sales increased to 21.8% in 2003 compared with 19.3% in 2002, as Shoemart was
unable to reduce store selling and fixture rental costs commensurate with the
overall sales decline due to a certain portion of these costs being fixed in
nature.
BAD DEBT EXPENSE - AMES
As a result of the Ames bankruptcy, we recorded a charge of $9.2 million in 2002
as an allowance for bad debt expense in connection with our receivable from
Ames.
RESTRUCTURING, ASSET IMPAIRMENT AND OTHER CHARGE
During 2002, we recorded inventory write-downs of $7.6 million, which are
included in cost of sales and asset impairment charges, lease exit costs and
severance costs of $7.0 million associated with our termination of two
unprofitable licensed footwear departments. There were no restructuring charges
recorded in 2003.
OPERATING PROFIT
Operating profit decreased $4.8 million, or 16.9%, to $23.6 million in 2003
compared with $28.4 million in 2002 primarily due to the reasons noted above.
MELDISCO - THIRD QUARTER RESULTS
2003 2002 % SALES - 2003 % SALES - 2002
------ ------ -------------- --------------
Net Sales $225.1 $313.4
------ ------
Gross Profit 63.6 90.4 28.3% 28.8%
SG&A Expenses 55.5 66.3 24.7% 21.2%
Depreciation/Amortization 3.5 3.7 1.6% 1.2%
Restructuring, Asset Impairment &
Other Charge -- 4.9 N/A 1.6%
------ ------
Operating Profit $ 4.6 $ 15.5 2.0% 4.9%
------ ------
NET SALES
Net sales decreased $88.3 million, or 28.2%, in 2003, to $225.1 million compared
with $313.4 million in 2002. This sales decrease was primarily due to Kmart
store closures ($44 million), an 8.6% comparable store sales decline in Shoemart
during 2003 predominantly due to reduced Kmart traffic levels ($10 million), the
closing of all Ames stores ($33 million) and the decision to exit other
unprofitable landlords acquired as part of the J. Baker acquisition ($10
million).
44
This sales decrease was partially offset by increased store counts at Wal-Mart
for Thom McAn product ($10 million).
GROSS PROFIT
Gross profit decreased $26.8 million, or 29.6%, to $63.6 million in 2003
compared with $90.4 million in 2002. This decrease is primarily due to the 28.2%
decrease in sales. Overall gross margin rates deteriorated to 28.3% in 2003 from
28.8% in 2002. This reduction in gross margin rates was primarily due to
additional markdowns in Shoemart that were taken in connection with our efforts
to liquidate inventory in the Kmart stores due to the comparable store sales
decline.
SG&A EXPENSES
SG&A expenses decreased $10.8 million, or 16.3%, to $55.5 million in 2003
compared with $66.3 million in 2002. SG&A expenses in Shoemart decreased by $7.9
million, or 13.5%. The overall SG&A rate as a percentage of sales increased to
24.7% in 2003 compared with 21.2% in 2002, as Shoemart was unable to reduce
store selling and fixture rental costs commensurate with the overall sales
decline due to a certain portion of these costs being fixed in nature.
RESTRUCTURING, ASSET IMPAIRMENT AND OTHER CHARGE
In 2002, we recorded inventory write-downs of $8.4 million in cost of sales and
asset impairment charges and employee severance costs of $4.9 million in
connection with Ames store closings. There were no restructuring charges
recorded in 2003.
OPERATING PROFIT
Operating profit decreased $10.9 million to $4.6 million in 2003 compared with
$15.5 million in 2002 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 our Amended DIP and Exit Facility. The Amended DIP and
Exit Facility is structured to support general corporate borrowing requirements
while operating under Chapter 11 and upon emergence. We have also obtained
improved payment terms with our vendors and factories overseas applicable to
orders for merchandise placed on or after December 1, 2004.
In accordance with the Amended Master Agreement, on August 26, 2005, we made the
$45.0 million cure payment to Kmart. On August 29, 2005, we made an estimated
payment to Kmart of $14.0 million based on the revised percent of gross sales
due under the Amended Master Agreement for the period beginning January 2, 2005
through August 27, 2005. On September 6, 2005, we paid an additional $1.5
million to Kmart for the final payment of the amount due.
Although we expect that creditors in the bankruptcy will be paid in full, the
timing of such payments is currently subject to negotiation and is expected to
be specified in the Amended Plan.
45
Other factors that could affect our liquidity include, among other things, the
success and Court approval of our Amended Plan, maintaining the support of our
key vendors and lenders, retaining key personnel, the impact of subsequent
financial results, many of which are beyond our control. We also cannot
reasonably assess the impact on liquidity of the implementation of the Kmart
Settlement, as the timing of the wind-down and ultimate liquidation of the
Shoemart business is outside our control (within certain parameters described
under the "Kmart Settlement" above), and it is currently unknown whether the
board of directors of the reorganized Company will choose to commit its
financial resources to the commencement of one or more new business activities.
To the extent the Company does undertake any such new business activity, it is
expected that it will do so utilizing its available cash and/or its then
available credit facilities. If the Company does not develop viable business
alternatives to offset the termination of its Kmart business at the end of 2008,
it is expected that the Company will liquidate its business when the Kmart
relationship ends. Due to these uncertainties, we cannot reasonably assess the
impact on our short-term and long-term liquidity needs.
The Amended DIP and Exit Facility
Effective March 4, 2004, we entered into the DIP Credit Agreement and
subsequently entered into the DIP and Exit Facility, which, among other things,
reduced the amount of DIP commitments to $100.0 million, including a sub-limit
for letters of credit with availability determined by a borrowing base formula
based upon inventory and accounts receivable. Pursuant to the DIP and Exit
Facility, upon emergence from Chapter 11, we would have the option, subject to
satisfaction of certain conditions, to convert the DIP and Exit Facility to
post-emergence financing which would have provided us with up to $160.0 million
in revolving commitments, including a $75.0 million sub-limit for letters of
credit.
Effective July 1, 2005, we entered into the Amended DIP and Exit Facility to,
among other things, reflect a change in the maturity date for the
debtor-in-possession portion of the facility from the earlier of (a)(i) March 4,
2006 or (ii) 15 days following confirmation of the Amended Plan to the earlier
of (b)(i) October 31, 2006 or (ii) emergence from Chapter 11. The maturity date
of the exit portion of the Amended DIP and Exit Facility is the earlier of
(c)(i) 36 months after our emergence from Chapter 11 or (ii) March 4, 2009.
Our borrowing availability under the Amended DIP and Exit Facility continues to
be determined by a formula based upon accounts receivable and inventory.
However, pursuant to the amendment, revolving commitments upon emergence from
Chapter 11 have been reduced from $160.0 million to $100.0 million, including a
$40.0 million sub-limit for letters of credit at our option and upon
satisfaction of certain conditions. The conditions to be satisfied prior to
emergence from Chapter 11 include the absence of any default or event of
default, confirmation of the Amended Plan and occurrence of all conditions
related thereto, and our delivery of forward looking projections acceptable to
the lender illustrating required availability levels.
Borrowings under the Amended DIP and Exit Facility bear interest at either
Fleet's prime rate plus 0.0% to 0.5% or LIBOR plus 1.75% to 2.50%, at our
option, with the applicable margin based on quarterly excess availability
levels. A quarterly fee of 0.3% per annum is payable on the unutilized balance.
46
Pursuant to the Amended DIP and Exit Facility we are required to maintain
minimum excess availability equal to at least 10% of the borrowing base, as
defined, provided, however, that prior to our emergence from Chapter 11, in the
event that loans are outstanding, the minimum excess availability requirement
will be an amount equal to at least (i) 10% of the borrowing base plus (ii)
$20.0 million.
The Amended DIP and Exit 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, stock repurchases and capital
expenditures. After our emergence from Chapter 11, if minimum excess
availability falls below 20% of the borrowing base, we will be subject to a
fixed charge coverage covenant.
The Amended DIP and Exit Facility also includes representations and warranties,
that, on an ongoing basis, there are no material adverse events affecting our
business, operations, property, assets, or condition and that the Amended Master
Agreement is in full force and effect and not in default. A failure by us to
satisfy any of the covenants, representations or warranties would result in
default or other adverse impact under the Amended DIP and Exit Facility. Upon
the request of the Company, the lenders have extended the time for the delivery
of the 2004 annual consolidated financial statements and certain compliance
certifications until we exit from Chapter 11.
As of July 30, 2005, we had no loans outstanding and $16.7 million of
outstanding letters of credit under the Amended DIP and Exit Facility. Letters
of credit reduce the borrowing capacity of the Amended DIP and Exit Facility.
The Pre-Petition Credit Facility
Prior to the Petition Date, our principal sources of liquidity used in funding
our short-term operations were our operating cash flows and our senior secured
credit facility ("Credit Facility") with a syndicate of lenders led by Fleet.
The Credit Facility has since been replaced by the Amended DIP and Exit
Facility.
2004 First Quarter
Our principal sources of liquidity used in funding short-term operations were
our operating cash flows, asset sales and borrowing capacity under the Credit
Facility. The Credit Facility had a maturity date of October 17, 2005, and as
amended, was comprised of a $255.0 million revolving credit facility and a
fully-drawn $90.0 million term loan.
In connection with our decision to close 88 Just For Feet stores, 75
underperforming Footaction stores and three Uprise stores, we received
approximately $55.7 million in March, 2004 from our liquidation agent which
represented the initial guarantee amount related to such closings.
Effective March 4, 2004, we entered into the DIP Credit Agreement. The DIP
Credit Agreement provided a $300.0 million credit facility consisting of
revolving loans of up to $240.0 million (with a sub-limit of $75.0 million for
letters of credit) and a fully-drawn term loan of $60.0 million. Based
47
upon the borrowing base availability calculation contained in the DIP Credit
Agreement, as of April 3, 2004, we had approximately $73.5 million of excess
availability remaining after the application of excess availability and reserve
requirements. On that date, the interest rate on the term loan was 15.0%, the
weighted average interest rate on the outstanding revolving loans was 5.15% and
the weighted average interest rate of all outstanding loans under the DIP Credit
Agreement was 10.0%.
2004 Second Quarter
Our principal sources of liquidity used in funding short-term operations were
our operating cash flows, asset sales and borrowing capacity under our DIP
Credit Agreement. On May 7, 2004, we received $212.0 million from the sale of
349 Footaction stores (including all lease rights and inventory at the stores),
along with the remaining inventory from four remaining Footaction stores. An
additional $13.0 million was placed in escrow in connection with this sale. Of
this amount, as of July 30, 2005, we have been paid $9.2 million, $2.2 million
has been paid to Foot Locker and $1.6 million remains in escrow. In addition,
during 2004, we received an additional $5.7 million in connection with the store
closings.
On May 25, 2005, the DIP Credit Agreement was amended (the "Amended DIP Credit
Agreement") which, among other things, reduced the revolving loan from $240.0
million to $130.0 million and eliminated the $60.0 million term loan. As a
result of the aforementioned asset sales and other restructuring activities, as
of May 12, 2004, we fully repaid all loans outstanding totaling approximately
$121.0 million under the Amended DIP Credit Facility.
As of July 3, 2004, there were no loans outstanding under the Amended DIP Credit
Agreement and outstanding letters of credit thereunder totaled $19.7 million.
2004 Third Quarter
Our principal sources of liquidity used in funding short-term operations were
our operating cash flows, asset sales and borrowing capacity under the Amended
DIP Credit Agreement.
During 2004, we received approximately $52.1 million in proceeds from additional
asset sales; $28.0 million for Mira Loma; $18.7 million for Gaffney and $5.4
million in connection with 26 Shoe Zone stores.
On July 22, 2004, we entered into the DIP and Exit Facility. Under the DIP and
Exit Facility, we had access of up to $100.0 million of secured DIP financing,
including letters of credit. Availability under the DIP and Exit Facility was
determined by a borrowing base formula based upon inventory and accounts
receivable. Loans under the DIP and Exit Facility bore interest at Fleet's prime
rate plus 0.0% to 0.25% or LIBOR plus 1.75% to 2.50%, at our option with the
applicable margin based excess availability levels. A quarterly unused fee of
0.3% per annum was payable on the unutilized balance.
The DIP portion of the DIP and Exit Facility had a term of two years from the
Petition Date and expired upon Plan confirmation. The Exit Facility was to be
effective upon our emergence from bankruptcy and its term was three years.
48
As of October 2, 2004, there were no loans outstanding under the DIP and Exit
Facility and outstanding letter of credit thereunder totaled $21.8 million.
2003 First Quarter
Our principal sources of liquidity used in funding our short-term operations
were our operating cash flows and borrowing capacity under the Credit Facility.
Effective March 21, 2003, we amended the Credit Facility to, among other things,
waive certain financial covenant compliance for prior periods.
As of March 29, 2003, we had $70.0 million outstanding under the term loan
portion of the Credit Facility and $132.6 million outstanding under the
revolving commitments, including outstanding letters of credit. Based upon the
borrowing base availability calculation contained in the Credit Facility, as of
March 29, 2003, we had approximately $67.1 million of excess availability
remaining after application of excess availability and reserve requirements.
On that date, the interest rate on the term loan was 14.25%, the weighted
average interest rate on the outstanding revolving loans was 3.7% and the
weighted average interest rate of all outstanding borrowings was 7.4%.
2003 Second Quarter
Our principal sources of liquidity used in funding our short-term operations
were our operating cash flows and borrowing capacity under the Credit Facility.
As of June 28, 2003, we had $70.0 million outstanding under the term loan
portion of the Credit Facility and $180.0 million outstanding under the
revolving commitments, including outstanding letters of credit. Based upon the
borrowing base availability calculation contained in the Credit Facility, as of
June 28, 2003, we had approximately $36.6 million of excess availability
remaining after application of $20.0 million in required excess availability. On
that date, the interest rate on the term loan was 14.25%, the weighted average
interest rate on the outstanding revolving loans was 3.6% and the weighted
average interest rate of all outstanding borrowings was 6.5%.
2003 Third Quarter
Our principal sources of liquidity used in funding our short-term operations
were our operating cash flows and borrowing capacity under the Credit Facility.
Effective September 24, 2003, we further amended the Credit Facility to among
other things, increase the term loan portion of the Credit Facility from $70.0
million to $90.0 million and the overall principal amount of the Credit Facility
from $325.0 million to $345.0 million. As of September 27, 2003, we had $179.6
million outstanding under the term loan portion of the Credit Facility and
$174.1 million outstanding under the revolving commitments, including
outstanding letters of credit. Based upon the borrowing base availability
calculation contained in the Credit Facility, as of September 27, 2003, we had
approximately $26.8 million of excess availability remaining after application
of $20.0 million in required excess availability. On that date, the interest
rate on the term loan was 15.0%, the weighted average interest rate on the
outstanding revolving loans was 3.5% and the weighted average interest rate of
all outstanding borrowings was 7.6%.
49
Contractual Obligations
The following is a summary of our significant contractual obligations as of
January 1, 2005 (in millions):
Payments Due By Period
--------------------------------------------------------
Total Less than 1 Year 1-3 Years 4-5 Years After 5 Years
------ ---------------- --------- --------- -------------
Miscellaneous expense fee $124.1 $34.2 $89.9 $ -- $ --
Mortgage payable 7.1 1.8 2.1 2.5 0.7
Operating leases 8.2 2.9 4.0 1.3 --
------ ---------------- --------- --------- -------------
Total $139.4 $38.9 $96.0 $3.8 $0.7
------ ---------------- --------- --------- -------------
The above table does not include the Kmart license fees, as defined in the
Amended Master Agreement, as such fees are based on sales. The Amended Master
Agreement, however, requires the payment of a miscellaneous expense fee equal to
$23,500 per open store per year.
In addition, pursuant to the FMI Agreement, we are obligated to pay to FMI a
minimum of $15.1 million in both 2005 and 2006.
CRITICAL ACCOUNTING ESTIMATES
Management's Discussion and Analysis of Financial Condition and Results of
Operations is based in part upon the Consolidated Financial Statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States of America.
The preparation of these consolidated financial statements requires us to make
estimates and judgments that affect the reported amounts of assets, liabilities,
expenses and related disclosure of contingent liabilities. On an ongoing basis,
we evaluate these estimates, including those related to the valuation of
inventory, deferred tax assets and the impairment of long-lived assets. We base
these estimates on historical experience and on various other assumptions that
are believed to be reasonable, the results of which form the basis for making
judgments about the carrying values of assets and liabilities that are not
readily apparent from other sources. Actual results may ultimately differ from
these estimates. Our management has discussed with the Audit Committee of its
Board of Directors the development, selection and disclosure of our critical
accounting estimates and the application of these estimates. We considered the
following to be our critical accounting estimates in the preparation of the
Consolidated Financial Statements included in this report.
Valuation and Aging of Inventory and Shrink Reserve
Merchandise inventory is a significant portion of our consolidated balance
sheets, representing approximately 26% of total assets from continuing
operations as of January 1, 2005 compared with approximately 47% of total assets
as of January 3, 2004.
Inventories are valued using the lower of cost or market value, determined by
the reverse mark-up or retail inventory method ("RIM"). Under the RIM, the
valuation of inventories at cost and the resulting gross margins are calculated
by applying a calculated cost-to-retail ratio to the retail value
50
of inventories. RIM is an averaging method that is widely used in the retail
industry due to its practicality. Also, it is recognized that the use of RIM
will result in valuing inventories at the lower of cost or market if markdowns
are currently taken as a reduction of the retail value of inventories.
The methodologies we utilize in our application of RIM are consistent for all
periods presented. Such methodologies include the development of cost-to-retail
ratios, the development of shrinkage reserves and the accounting for price
changes. RIM calculations require management to make estimates, such as
merchandise mark-on, mark-ups, markdowns and shrinkage, that can significantly
impact the ending inventory valuation at cost as well as resulting gross
margins. These significant estimates, coupled with the fact that the RIM is an
averaging process, may not, in all circumstances, reflect actual historical
experience, and could result in significant differences to amounts recorded.
Future events, such as store closings and liquidations, could result in an
increase in the level of estimated markdowns which could result in lower
inventory values and increases to cost of sales in future periods. In addition,
failure to take markdowns currently can result in an overstatement of inventory
value under the lower of cost or market principle.
As a supplement to the inventory values established under the RIM, we establish
reserves for additional markdowns associated with shrink and aged product. The
shrink expense reserve represents a reserve for the unidentified loss of
inventory. Management uses historical percentages to accrue shrink expense.
Physical inventory counts are performed at each store and distribution location
throughout the year. At the completion of the inventory count, actual shrink
expense is quantified and compared to the shrink reserve. Any difference between
actual shrink expense and the reserve is recorded as a reduction or addition to
inventory on the consolidated balance sheet and as a reduction or addition to
cost of sales in the consolidated statements of operations.
The aged inventory reserve represents an estimate of the markdown required to
liquidate aged inventory, which is generally defined as inventory that is aged
12 months or more. Management calculates a reserve for aged inventory by
comparing the cost of the inventory to the estimated realizable value of the
inventory. In order to accomplish this, we analyze the quantity and quality of
all inventory in seasonal aging brackets (i.e., aged one season, two seasons,
etc.). The expected markdowns necessary to liquidate each aging bracket are thus
analyzed to determine if the related cost exceeds the net realizable value and a
reserve, if necessary, is established.
Impairment of Long-Lived Assets
We evaluate the recoverability of our long-lived assets in accordance with
Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived
Assets to be Disposed Of, which generally requires us to assess these assets for
recoverability whenever events or changes in circumstances indicate that the
carrying amounts of long-lived tangible assets and intangible assets that are
amortized may not be recoverable.
We consider historical performance and future estimated results in our
evaluation of potential impairment and then compare the carrying amount of the
asset to the estimated future undiscounted cash flows expected to result from
the use of the asset. The ability to accurately predict future cash flows may
impact the determination of fair value. Management's assessments of cash flows
represent its best estimate as of the time of the impairment review and are
based upon expected future results of operations. Management believes that its
estimates of applicable cash flows in the
51
current period are reasonable; however, if different cash flows had been
estimated in the current period, the long-lived asset balances could have been
materially impacted. Furthermore, estimates may change from period to period as
new information is generated and as trends are identified, and this could
materially impact results in future periods.
Factors that management must estimate when performing impairment tests include,
among other items, sales volume, the related cost of product, markdowns, shrink
and estimated flow through or operating profit percentages. Actual results may
ultimately differ from these estimates and, as a result, the fair values may be
adjusted in the future.
Insurance and Self-Insurance Liabilities
We are primarily self-insured for worker's compensation and medical costs, as
our deductible under third party coverage is $250,000 per claim. We establish
accruals for our insurance programs based on available claims data and
historical trends and experience, as well as loss development factors prepared
by third party actuaries. Loss development factors are estimates based on our
actual historical data and other retail industry data.
We evaluate the accrual and the underlying assumptions for workers compensation
claims and for medical costs quarterly and make adjustments as needed based on
third party actuarial assessments. The ultimate cost of these claims may be
greater than or less than the established accrual. While we believe that the
recorded amounts are adequate, there can be no assurance that changes to
management's estimates will not occur due to limitations inherent in the
estimating process. In the event we determine the accruals should be increased
or reduced, we record such adjustments in the period in which such determination
is made.
The accrued obligation for these self-insurance programs was approximately $10.1
million at the end of fiscal year 2004 and $12.4 million at the end of fiscal
year 2003. Because loss development factors are estimates at a point in time,
should unknown claim issues, such as adverse medical costs, occur, develop or
become realized over the course of the claim, actual claim payments could
materially differ from our accrued obligation.
Deferred Tax Assets
We currently have significant deferred tax assets resulting from net operating
loss carryforwards and temporary differences, which will reduce taxable income
in future periods.
As of January 1, 2005 we have recorded a net deferred tax asset of $118.9
million and a related valuation allowance of $116.2 million. In connection with
the audits of our fiscal years 2004, 2003 and 2002 consolidated financial
statements, we reviewed the valuation of our deferred tax assets based on
projections of our future taxable earnings. Primarily due to our historical
losses and projected results, for accounting purposes we cannot rely on
anticipated long-term future profits to utilize certain of our deferred tax
assets. As a result, we could not conclude that it is more likely than not that
certain deferred tax assets will be realized and have recorded in fiscal year
2004 an additional non-cash valuation allowance of $21.4 million and recorded in
fiscal 2003 an additional non-cash valuation allowance of $24.7 million and in
fiscal 2002 recorded $70.2 million.
52
Retiree Medical Benefits
The costs and obligations of our retiree medical plans (for current retirees and
a "closed" group of active associates who meet certain eligibility requirements)
are calculated by third party actuarial assessments using many assumptions to
estimate the benefit that the employee earns while working, the amount of which
cannot be completely determined until the benefit payments cease.
The most significant assumptions, as presented in Note 26 to the consolidated
financial statements, include discount rate and future trends in health care
costs. The selection of assumptions is based on historical trends and known
economic and market conditions at the time of valuation. Future health care
costs may differ substantially from these assumptions. These differences may
significantly impact future retiree medical expenses.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In November 2004, FASB Statement No. 151, Inventory Costs, an Amendment of APB
No. 43, Chapter 4 ("Statement No. 151"), was issued. Statement No. 151 requires
certain abnormal expenditures to be recognized as expenses in the current
period. It also requires that the amount of fixed production overhead allocated
to inventory be based on the normal capacity of the production facilities.
Statement No. 151 is effective for the fiscal year beginning January 1, 2006.
The adoption of Statement No. 151 is not expected to have a material impact on
our financial statements.
In December 2004, the FASB issued Statement No. 153, Exchanges of Nonmonetary
Assets, an Amendment of APB Opinion No. 29 ("Statement No. 153"). Statement No.
153 is effective for nonmonetary asset exchanges occurring in our fiscal year
beginning January 1, 2006. Statement No. 153 requires that exchanges of
productive assets be accounted for at fair value unless fair value cannot be
reasonably determined or the transaction lacks commercial substance. Statement
No. 153 is not expected to have a material impact on our financial statements.
In December 2004, the FASB issued Statement No. 123 (Revised 2004), Share-Based
Payment, which is a revision of Statement No. 123. With limited exceptions,
Statement No. 123 (Revised 2004) requires that the fair value of share-based
payments to employees be expensed over the period service is received. This
Statement is effective for us beginning with our first interim period subsequent
to December 15, 2005. We intend to adopt this Statement using the modified
prospective method. We can not yet determine the impact that any future
share-based payment transactions will have on our financial position or results
of operations.
In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error
Corrections - A Replacement of APB Opinion No. 20 and FASB Statement No. 3. This
Statement requires retrospective application to prior periods' financial
statements of changes in accounting principle, unless it is impracticable to
determine either the period-specific effects or the cumulative effect of the
change. This Statement does not change the guidance for reporting the correction
of an error in previously issued financial statements or a change in accounting
estimate. The provisions of this Statement shall be effective for accounting
changes and correction of errors made in fiscal years beginning after December
15, 2005.
53
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
DERIVATIVES
As of January 1, 2005, 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. That is, we do not hold derivative financial
investments for trading or speculative purposes. On January 8, 2004, four
interest rate swap agreements we had previously entered into to limit the
variability of a portion of our interest expense in connection with outstanding
variable rate debt under the Credit Facility expired.
INTEREST RATES
As of January 1, 2005, we had no borrowings outstanding under the DIP and Exit
Facility, other than approximately $22.1 million of outstanding letters of
credit. The Company, from time to time, undertakes borrowings to finance working
capital and other corporate requirements. Our peak borrowing periods coincide
with peak inventory purchases.
We assess interest rate cash flow risk by continually identifying and monitoring
changes in interest rate exposures that may adversely impact expected future
cash flows and by evaluating hedging opportunities.
FOREIGN EXCHANGE
A significant percentage of Meldisco'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.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The reports of independent registered public accounting firms, the consolidated
financial statements of the Company, the notes to consolidated financial
statements, and the supplementary financial information called for by this Item
8 are listed below. Specific financial statements and supplementary data can be
found beginning on the page listed in the following index:
INDEX
PAGE
----
Report of Independent Registered Public Accounting Firm F-2
Report of Independent Registered Public Accounting Firm F-3
Report of Independent Registered Public Accounting Firm 59
Consolidated Statements of Operations for the Fiscal Years Ended
January 1, 2005, January 3, 2004 and December 28, 2002 F-4
Consolidated Balance Sheets as of January 1, 2005 and January 3, 2004 F-5
Consolidated Statements of Shareholders' Equity and Comprehensive
Income for the Fiscal Years Ended January 1, 2005, January 3, 2004
and December 28, 2002 F-6
Consolidated Statements of Cash Flows for the Fiscal Years Ended
January 1, 2005, January 3, 2004 and December 28, 2002 F-7
Notes to Consolidated Financial Statements F-8
Schedule II - Valuation and Qualifying Accounts for the Fiscal Years
ended January 1, 2005, January 3, 2004 and December 28, 2002 85
55
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A. CONTROLS AND PROCEDURES
(A) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
Under the supervision and with the participation of management, including our
Chief Executive Officer and Senior Vice President of Financial Reporting and
Controls, we conducted an evaluation of the effectiveness of our disclosure
controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the
Securities and Exchange Act) as of January 1, 2005. Based on this evaluation,
and due to the material weaknesses in our internal control over financial
reporting (as described below in Management's Report on Internal Control over
Financial Reporting), our Chief Executive Officer and Senior Vice President of
Financial Reporting and Controls concluded that, as of January 1, 2005, our
disclosure controls and procedures were not effective to provide reasonable
assurance that information required to be disclosed by us in reports that we
file or submit under the Securities and Exchange Act is recorded accurately,
processed, summarized and reported within the time periods specified in SEC
rules and forms. See (c) "Remediation Plan" below.
(B) MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
We are responsible for establishing and maintaining adequate internal control
over financial reporting, as defined in the Exchange Act Rule 13a-15(f). Under
the supervision and with the participation of management, including our Chief
Executive Officer and Senior Vice President of Financial Reporting and Controls,
we conducted an evaluation of the effectiveness of internal control over
financial reporting as of January 1, 2005 based on the framework established by
the Committee of Sponsoring Organizations of the Treadway Commission ("COSO")
entitled Internal Control - Integrated Framework. Based on this evaluation and
the material weaknesses described below, our management concluded that, as of
January 1, 2005, our internal control over financial reporting was not
effective.
- Timeliness of filing of reports with the SEC and timeliness of the
accounting close process
This material weakness related to our inability to file the reports
required under the Securities and Exchange Act within the time periods
specified in the SEC rules and forms and the timeliness of the accounting
close process. This delay resulted from our internal investigation, the
restatement of previously issued financial statements over a
five-and-one-half year period from the beginning of fiscal 1997 through
2002 and our operation under protection of the bankruptcy laws. As a result
of the delay caused by the restatement, we were unable to complete account
analysis and perform the necessary procedures to close accounting periods
in a timely manner.
56
- Operational deficiency in controls over landed cost accounts
We had performed an analysis of the components of our landed cost accrual
as of January 1, 2005, which resulted in a significant adjustment. Although
adequate analysis, documentation, review and oversight were in place as of
January 1, 2005, such procedures were not in effect for all periods during
fiscal 2004.
- Design deficiency in controls over in-transit inventory
A deficiency in the design of our process for determining the point of
title transfer resulted in a significant decrease in inventory and accounts
payable. We have recorded this decrease to properly state these balances as
of January 1, 2005.
In the aggregate, these control deficiencies result in a more than remote
likelihood that a material misstatement to our annual or interim consolidated
financial statements could occur and not be prevented or detected in a timely
manner.
Management's assessment of the effectiveness of internal control over financial
reporting as of January 1, 2005 has been audited by Amper, Politziner & Mattia,
P.C. ("APM"), an independent registered public accounting firm, who also audited
our consolidated financial statements.
APM's attestation report on management's assessment of our internal control over
financial reporting is contained herein.
(C) REMEDIATION PLAN
Following the filing of this Fiscal 2004 Form 10-K, we anticipate filing as soon
as practicable our first and second quarter 2005 Form 10-Q's. We will then be
current in filings required under the Securities and Exchange Act. As a result
of the procedures that are now in place, we anticipate filing our third quarter
fiscal 2005 Form 10-Q timely. The related material weakness will then be
remediated.
Although the analysis of the components of our landed cost accrual was performed
by us at the end of fiscal 2004, this analysis was not being performed monthly
throughout fiscal 2004. Commencing January 2, 2005, the analysis of the
components of our landed cost accrual is being performed monthly. As a result,
the related material weakness has been remediated.
As of January 2, 2005 we have corrected the design deficiency in our controls
over in-transit inventory. We have revised the inventory in-transit reports that
we receive from our logistics consolidator to ensure that the title transfer
date is clearly identified. This revision will ensure that inventory and
accounts payable are properly stated for all periods presented. As a result, the
related material weakness has been remediated.
The organizational and process changes that we have made will ensure that our
disclosure controls and procedures will be effective to provide reasonable
assurance that information required to be disclosed by us in reports that we
file under the Securities and Exchange Act is recorded accurately, processed,
summarized and reported within the time periods specified in the SEC's rules and
forms.
57
We are committed to maintaining disclosure controls and procedures that are
designed to ensure that the information required to be disclosed in the reports
we file under the Securities Exchange Act of 1934 ("Exchange Act") is recorded,
processed, summarized and reported within the time frame periods specified in
the SEC's rules and forms, and that this information is accumulated and
communicated to our management, including our Chief Executive Officer and Senior
Vice President of Financial Reporting and Control, as appropriate, to allow for
timely decisions regarding required disclosure. In designing and evaluating
disclosure controls and procedures, management recognizes that any controls and
procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control objectives and management
necessarily is required to apply its judgment in evaluating the cost-benefit
relationship of possible controls and procedures.
The effectiveness of the Company's or any system of disclosure controls and
procedures and internal controls is subject to certain limitations, including
the exercise of judgment in designing, implementing and evaluating the controls
and procedures, the assumptions used in identifying the likelihood of future
events, and the inability to eliminate misconduct completely. As a result, there
can be no assurance that our disclosure controls and procedures and internal
controls will prevent all errors or fraud or ensure that all material
information will be made known to management in a timely fashion.
Rule 13a-15(b) requires that we evaluate the effectiveness of the design and
operation of our disclosure controls and procedures at the end of each fiscal
quarter. Because of the late filing of this report we conducted an evaluation
both as of January 1, 2005, the end of the period covered by this report, and as
of July 30, 2005. The evaluations were conducted by our management, under the
supervision and with the participation of our Chief Executive Officer and our
Senior Vice President of Financial Reporting and Control.
Based upon the January 1, 2005 evaluation, our Chief Executive Officer and
Senior Vice President of Financial Reporting and Control concluded, as described
above, that, as of January 1, 2005, our disclosure controls and procedures were
not effective at the reasonable assurance level to ensure that information
required to be disclosed in our Exchange Act reports was accumulated and
communicated to our management, including our Chief Executive Officer and our
Senior Vice President of Financial Reporting and Control, as appropriate to
allow timely decisions regarding required disclosure. During 2003 we implemented
an Internal Process and Controls Plan (formerly the "Remediation Plan") and
revised our Disclosure Controls Policy and Procedures (together, the "Internal
Process and Controls Plan") designed to improve our internal controls. The
Internal Process and Controls Plan is administered by an Internal Process and
Controls Committee. The Internal Process and Controls Plan provides for
continuous updates as improvements in internal controls are identified and
implemented and for new processes and systems or changes to the existing
processes and systems. During 2003, we also adopted a comprehensive
certification process to ensure that our Chief Executive Officer and Senior Vice
President of Financial Reporting and Controls are provided with timely and
accurate information and to provide them with the opportunity to address the
quality and accuracy of operating and financial results in order to enable them
to provide their certifications which accompany our Annual Reports on Form 10-K
and Quarterly Reports on Form 10-Q.
The processes described above to improve internal and disclosure controls
commenced during 2003 and have continued through the date of the filing of this
Annual Report on 10-K. We are committed
58
to continuing this process. Based on the new policies and procedures and the
remediation of the material weaknesses referred to above, our Chief Executive
Officer and our Senior Vice President of Financial Reporting and Control
concluded that, as of July 30, 2005, our disclosure controls and procedures were
effective at the reasonable assurance level to ensure that the information
required to be disclosed in this 2004 Form 10-K was accumulated and communicated
to our management, including our Chief Executive Officer and our Senior Vice
President of Financial Reporting and Control, as appropriate to allow timely
decisions regarding disclosure and the information required to be disclosed by
us was recorded accurately.
(D) CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
We have implemented significant changes in our internal control over financial
reporting during our most recently completed fiscal year that have improved our
internal controls over financial reporting.
(E) REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of Footstar, Inc.
We have audited management's assessment, included in the accompanying
Management's Report on Internal Control Over Financial Reporting appearing under
Item 9A, that Footstar, Inc. did not maintain effective internal control over
financial reporting as of January 1, 2005, because of the effect of the material
weaknesses identified in management's assessment based on criteria established
in Internal Control - Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission ("COSO"). Footstar, Inc.'s management
is responsible for maintaining effective internal control over financial
reporting. Our responsibility is to express an opinion on management's
assessment and an opinion on the effectiveness of the company's internal control
over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, evaluating management's assessment, testing and evaluating
the design and operating effectiveness of internal control and performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition,
59
use, or disposition of the company's assets that could have a material effect on
the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
A material weakness is a control deficiency, or combination of control
deficiencies, that results in more than a remote likelihood that a material
misstatement of the annual or interim financial statements will not be prevented
or detected. The following material weaknesses have been identified and included
in management's assessment as of January 1, 2005:
- Timeliness of filing of reports with the SEC and timeliness of the
accounting close process
This material weakness related to the Company's inability to file the
reports required under the Securities and Exchange Act within the time
periods specified in the SEC rules and forms and the timeliness of the
accounting close process. This delay resulted from the Company's internal
investigation, the restatement of previously issued financial statements
over a five-and-one-half year period from the beginning of fiscal 1997
through 2002 and the Company's operation under protection of the bankruptcy
laws. As a result of the delay caused by the restatement, the Company was
unable to complete account analysis and perform the necessary procedures to
close accounting periods in a timely manner.
- Operational deficiency in controls over landed cost accounts
The Company had performed an analysis of the components of its landed cost
accrual as of January 1, 2005, which resulted in a significant adjustment.
Although adequate analysis, documentation, review and oversight were in
place as of January 1, 2005, such procedures were not in effect for all
periods during fiscal 2004.
- Design deficiency in controls over in-transit inventory
A deficiency in the design of the Company process for determining the point
of title transfer resulted in a significant decrease in inventory and
accounts payable. The Company has recorded this decrease to properly state
these balances as of January 1, 2005.
These material weaknesses were considered in determining the nature, timing and
extent of audit tests applied in our audit of the 2004 consolidated financial
statements, and this report does not affect our report dated September 27, 2005
on those consolidated financial statements.
In our opinion, management's assessment that Footstar, Inc. did not maintain
effective internal control over financial reporting as of January 1, 2005, is
fairly stated, in all material respects, based on the criteria established in
Internal Control-Integrated Framework issued by COSO. Also, in our
60
opinion, because of the effect of the material weaknesses described above on the
achievement of the objectives of the control criteria, Footstar, Inc. has not
maintained effective internal control over financial reporting as of January 1,
2005, based on criteria established in Internal Control-Integrated Framework
issued by COSO.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated financial
statements of Footstar, Inc. and our report dated September 27, 2005 expressed
an unqualified opinion.
/s/ Amper, Politziner & Mattia, P.C.
Edison, New Jersey
September 27, 2005
ITEM 9B. OTHER INFORMATION
Not applicable.
61
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
EXECUTIVE OFFICERS OF THE REGISTRANT
The following information sets forth the name, age and business experience
during the past five years of the executive officers of the Company as of July
30, 2005:
Dale W. Hilpert, age 62, was appointed Chairman of the Board, Chief Executive
Officer and President on January 19, 2004. From 2001 to 2003, Mr. Hilpert was
President and Chief Executive Officer of Williams-Sonoma, Inc. From 1998 to
2001, he was Chairman and Chief Executive Officer of Foot Locker. Prior to that,
he spent 17 years at May Department Stores serving in senior management
positions, including Chairman and Chief Executive Officer of its Payless Shoe
Source division.
Neele E. Stearns, Jr., age 69, has been Interim Vice Chairman of the Board of
Directors since January 2004. Since July 2004, Mr. Stearns has been Interim
Chief Executive Officer of Boulevard Healthcare. From September 2003 to January
2004, he was Interim Chairman and Chief Executive Officer of the Company. Since
February 2001 he has been Chairman of Financial Investments Corporation, a
private equity investment firm. Mr. Stearns was Chairman of the Board of Wallace
Computer Services, Inc. from January 2000 through November 2000. Prior to 1995,
he was President and Chief Executive Officer of CC Industries, Inc.
Stephen R. Wilson, age 58, is Executive Vice President and Chief Administrative
Officer. He was Executive Vice President and Chief Financial Officer of the
Company from May 2001 to December 2003. From 2000 to 2001, Mr. Wilson was
Executive Vice President, Finance and Administration, of Bridge Information
Systems. Bridge Information Systems filed a voluntary petition for
reorganization under the U.S. bankruptcy laws in February 2001. In May 2001, the
bankruptcy court approved the sale of substantially all of the assets of Bridge
Information Systems to Reuters, which sale closed in September 2001. From 1999
to 2000, he was Finance Director in the United Kingdom of Reckitt & Colman, plc;
and from 1995 to September 1997, Executive Vice President, Chief Financial
Officer, for The Reader's Digest Association.
Jeffrey A. Shepard, age 55, was appointed to the Board of Directors in January
2005. He has been an Executive Vice President of the Company since March 2002
and has been Chief Executive Officer and President of Meldisco since 1996.
Maureen Richards, age 48, has been the Senior Vice President, General Counsel
and Corporate Secretary of the Company since March 2001. From October 1996 to
March 2001, Ms. Richards was Vice President, General Counsel and Corporate
Secretary of the Company.
Richard L. Robbins, age 65, was appointed as Senior Vice President, Financial
Reporting and Control on January 5, 2004 and, as our Principal Financial
Officer, is the functional equivalent of our Chief Financial Officer. From
October 2003 to January 2004, he was Senior Vice President, Financial Reporting
of the Company. From August 2002 to October 2003, Mr. Robbins was a Partner in
Robbins Consulting LLP (financial, strategic and management consulting firm).
From 1978 to July 2002, Mr. Robbins was a Partner in Arthur Andersen LLP.
62
BOARD OF DIRECTORS
General. The Board currently consists of eight members divided into three
classes. Directors have been generally elected for three-year terms on a
staggered term basis, so that each year the term of office of one class would
expire and the terms of office of the other classes will extend for additional
periods of one and two years, respectively. Footstar's last annual meeting was
held in May 2002. All of the directors, other than Dale W. Hilpert and Jeffrey
A. Shepard, have served since that time. The term of Class I directors would
have expired at the 2003 Annual Meeting of Shareholders. The term of Class II
directors would have expired at the 2004 Annual Meeting of Shareholders. The
term of Class III directors would have expired at the 2005 Annual Meeting of
Shareholders. Directors whose terms would have expired continue to serve until
their successors are elected. The names of the directors and certain information
about each of them are set forth below.
Director
Name and Age Principal Occupation and Background Since Term
------------ ----------------------------------- -------- --------
Dale W. Hilpert, 62 Chairman of the Board, Chief Executive Officer and 2004 Class II
President. From 2001 to 2003, Mr. Hilpert was President
and Chief Executive Officer of Williams-Sonoma, Inc.
From 1998 to 2001, he was Chairman and Chief Executive
Officer of Foot Locker. Prior to that, he spent 17
years at May Department Stores serving in senior
management positions, including Chairman and Chief
Executive Officer of its Payless Shoe Source division.
He is a member of the Board of Directors and the Audit
Committee of the Signet Group plc. and he is a member of
the Board of Directors and the Audit Committee of Ann
Taylor Stores Corporation.
63
Director
Name and Age Principal Occupation and Background Since Term
------------ ----------------------------------- -------- --------
Neele E. Stearns, Jr., 69 Presently Interim Vice Chairman of the Board of 2000 Class I
Directors. Also presently Interim Chief Executive
Officer of Boulevard Healthcare since July 2004. From
September 2003 to January 2004, Interim Chairman and
Chief Executive Officer of the Company. Mr. Stearns has
been Chairman of Financial Investments Corporation, a
private equity investment firm since February 2001. He
was Chairman of the Board of Wallace Computer Services,
Inc. from January 2000 through November 2000. Prior to
1995, he was President and Chief Executive Officer of CC
Industries, Inc. Mr. Stearns is a Director of Maytag
Corporation and a member of its Executive Committee and
Chairman of the Audit Committee. He is also a Director
of Click Commerce, Inc. and Chairman of the Audit
Committee. He is a Trustee of Evanston Northwestern
Healthcare and Presbyterian Homes.
Stanley P. Goldstein, 71 Former Chairman and Chief Executive Officer of CVS 1996 Class I
Corporation and former Chief Executive Officer of
Melville Corporation (CVS's predecessor). Mr. Goldstein
serves as a Director and Chairman of the Audit Committee
of Linens'n Things, Inc. He is also a Director of CVS
Corporation.
Robert A. Davies, III, 69 Chairman of Church & Dwight Co., Inc. since July 2004, 998 Class II
Chairman and Chief Executive Officer of Church & Dwight
Co., Inc. from February 2001 to July 2004. President,
Chief Executive Officer and Director of Church & Dwight
Co., Inc. from October 1995 to January 2001.
64
Director
Name and Age Principal Occupation and Background Since Term
------------ ----------------------------------- -------- --------
George S. Day, 68 Geoffrey T. Boisi Professor of Marketing and 1996 Class III
Co-Director, Mack Center for Technological Innovation
and former Director of Huntsman Center for Global
Competition and Innovation at The Wharton School,
University of Pennsylvania; consultant to companies
including AT&T, Eastman Kodak, General Electric, Nortel
Networks and IBM Corporation.
Bettye Martin Musham, 72 Chairwoman and Chief Executive Officer of Gear Holdings, 1996 Class III
Inc., which she co-founded in 1977.
Kenneth S. Olshan, 73 Former Chairman and Chief Executive Officer of Wells 1996 Class III
Rich Greene/BDDP. Mr. Olshan also serves as a director
of WellGen, Inc. and as a Trustee of the Central Park
Conservancy.
Jeffrey A. Shepard, 55 Appointed Director of the Company in January 2005. 2005 Class II
Mr. Shepard has been an Executive Vice President of
Footstar, Inc. since March 2002 and has been Chief
Executive Officer and President of Meldisco since 1996.
Section 16(a) Beneficial Ownership Reporting Compliance. Section 16(a) of the
Securities Exchange Act of 1934 requires our officers and directors to file with
the SEC reports regarding ownership of our common stock, and to furnish us with
copies of all such filings. Based on a review of these filings, we believe that
all filings were timely made during fiscal 2004 except a form 4, reporting a
single transaction, which was filed late by Mr. Davies.
We have adopted a Code of Business Conduct and Ethics (the "Code of Ethics")
that applies to our chief executive officer, principal financial officer,
principal accounting officer, and to all other directors, officers and
employees. The Code of Ethics is available on our website www.footstar.com. A
waiver from any provision of the Code of Ethics in favor of a director or
executive officer may only be granted by the Board of Directors and any such
waiver will be publicly disclosed. We will disclose substantive amendments to,
and any waivers from, the Code of Ethics provided to our chief executive
officer, principal financial officer or principal accounting officer, as well as
any other executive officer or director, on our Internet website:
www.footstar.com/financial/pdf/Code_of_Conduct_andCompliance_Program.pdf, our
Code of Conduct.
The Board of Directors has determined that Robert A. Davies, III is an audit
committee financial
65
expert within the meaning of the SEC regulations. This designation is an SEC
disclosure requirement related to Mr. Davies' experience and understanding of
accounting and auditing matters and is not intended to impose any additional
duty, obligation or liability on Mr. Davies.
ITEM 11. EXECUTIVE COMPENSATION
Summary Compensation Table. The following table summarizes compensation awarded
to, earned by or paid to the following executive officers of the Company (the
"Named Officers") for services rendered to us.
SUMMARY COMPENSATION TABLE
LONG TERM COMPENSATION
----------------------------------------
ANNUAL COMPENSATION AWARDS PAYOUTS
------------------------------------------- ----------------------------------------
Restricted/
Other Deferred Securities All Other
Name and Principal Fiscal Annual Stock Underlying Compensation
Position Year Salary($) Bonus($) Compensation($) (Award(s)($) Options(#) ($)(2)
------------------ ------ --------- -------- --------------- ------------ ---------- ------------
Dale W. Hilpert 2004 2,108,654 (1) 0 261,734 (3) 0 0 3,075
Chairman of the Board,
Chief Executive Officer
and President
Neele E. Stearns,* 2004 305,769 0 0 0 0 0
Former Chairman of the 2003 263,076 0 0 0 0 91,750 (8)
Board, Chief Executive
Officer
Jeffrey A. Shepard, 2004 588,808 0 26,288 (3) 2,898 (5) 0 9,025
Executive Vice President 2003 561,500 368,550 0 25,708 (6) 0 8,000
2002 540,000 294,300 0 110,358 (7) 40,000 7,000
Stephen R. Wilson, 2004 463,154 0 0 0 0 7,175
Executive Vice 2003 439,538 223,000 0 0 0 2,500
President, Chief 2002 421,250 212,500 0 0 12,000 2,500
Administrative Officer
Maureen Richards, Senior 2004 333,077 0 0 1,258 (5) 0 7,525
Vice President, General 2003 300,076 137,250 0 11,942 (6) 0 7,000
Counsel and Corporate 2002 285,500 130,050 0 7,520 (7) 14,000 6,500
Secretary
James DeVeau 2004 295,577 116,000 (4) 0 889 (5) 0 297,025 (9)
Senior Vice President,
Logistics
* Served as Chairman of the Board and CEO from September, 2003 - January,
2004. Became Interim Vice Chairman of the Board effective January 19, 2004.
(1) For the fiscal year ended January 1, 2005, Mr. Hilpert received a base
salary of $833,654 and a supplemental salary of $1,275,000.
(2) The amounts represent our contributions under our 401(k) and profit sharing
plan.
(3) Amount represents perquisites for Mr. Hilpert including $157,500 for
payment of housing expenses, a one-time payment of $38,255 (inclusive of a
$13,255 tax gross-up) paid pursuant to his original employment agreement,
$45,745 (inclusive of a $18,245 tax gross-up) paid in consideration for
opting out of certain benefit plans and $20,234 for reimbursement of travel
expenses. Mr.
66
Hilpert will also be entitled to an additional tax gross-up on the above
housing and travel expense reimbursement in the amount of $130,962 and
$16,825, respectively, which has not yet been paid. The tax gross-ups were
paid in accordance with Mr. Hilpert's employment agreement. For Mr. Shepard
this amount represents perquisites for payment on a long-term disability
plan in 2004.
(4) Mr. DeVeau ceased employment in 2004. Mr. DeVeau was a participant in the
Key Employee Retention Plan ("KERP") providing bonuses and severance for
key employees approved by Court order in May 2004. This amount represents
payment of the KERP bonus in accordance with such plan.
(5) Amounts include the following match by the Company in deferred shares as a
result of the voluntary deferral of a portion of the annual incentive
bonus: Mr. Shepard, 1,343 shares, Ms. Richards, 555 shares and Mr. DeVeau,
402 shares. The amounts shown also include the following deferred shares
awarded as part of the Career Equity Program, 50% of which shares vest in
five years and the remaining 50% of which shares vest at retirement: Mr.
Shepard, 644 shares, Ms. Richards, 307 shares and Mr. DeVeau, 207 shares.
Dividends were not paid on deferred shares.
(6) Amounts include the following match by the Company in deferred shares as a
result of the voluntary deferral of a portion of the annual incentive
bonus: Mr. Shepard, 1,094 shares, Ms. Richards, 489 shares. The amounts
shown also include the following deferred shares awarded as part of the
Career Equity Program, 50% of which shares vest in 5 years and the
remaining 50% of which shares vest at retirement: Mr. Shepard, 1,737
shares, Ms. Richards, 826 shares. The amounts for 2003 were not included in
our previously filed 2003 10-K. Dividends were not paid on deferred shares.
(7) The number and value of all restricted stock units and of all Company
grants of deferred shares including the restricted and deferred shares
granted in prior years, which were held by each of the Named Officers as of
January 1, 2005 was: Mr. Hilpert, 0; Mr. Shepard, 30,315 shares valued at
$138,845; Mr. Wilson, 8,637 shares valued at $39,558; Ms. Richards, 7,313
shares valued at $33,492; and Mr. Stearns, 3,000 shares valued at $13,740.
Dividends were not paid on restricted stock units or deferred shares.
(8) Mr. Stearns was paid $91,750 for services as Director in 2003.
(9) This amount represents severance paid to Mr. DeVeau in accordance with the
KERP of $290,000 and Company contributions under the 401(k) profit sharing
plan in the amount of $7,025.
Option Grants in Last Fiscal Year. There were no grants of stock options made to
the Named Officers during fiscal year 2004.
Option Exercises and Fiscal Year-End Option Holdings. The following table shows
information regarding option exercises during fiscal year 2004 as well as fiscal
year 2004 year-end option holdings for each of the Named Officers.
67
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR-END OPTION VALUES
NUMBER OF SECURITIES VALUE OF UNEXERCISED
SHARES UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS
ACQUIRED ON VALUE OPTIONS AT FY-END (#) AT FY-END ($)
NAME EXERCISE (#) REALIZED ($) EXERCISABLE/UNEXERCISABLE EXERCISABLE/UNEXERCISABLE
---- ------------ ------------ ------------------------- -------------------------
Dale W. Hilpert 0 0 0 0/0
Neele E. Stearns 0 0 1,600/400 0/0
Jeffrey A. Shepard 0 0 110,033/47,200 0/0
Stephen R. Wilson 0 0 16,798/15,202 0/0
Maureen Richards 0 0 61,353/17,522 0/0
James DeVeau (1) 0 0 23,360/0 0/0
(1) As a result of his separation from employment, Mr. DeVeau no longer has any
remaining stock options.
68
Supplemental Retirement Plan. The following table indicates the approximate
amount of annual retirement income that would be payable under the Supplemental
Retirement Plan for Select Senior Management of Footstar (the "Supplemental
Retirement Plan"), including to each of the Named Officers, based on various
assumptions as to compensation and years of service, assuming benefits are
computed under a straight life annuity formula and retirement at age 60.
The annual benefit will be reduced by the annualized value of any retirement or
deferred profit sharing benefit paid or payable under our 401(k) profit sharing
plan or any other plan maintained by us (excluding benefits attributable to
contributions made by participants), and without offset for Social Security or
other benefits.
PENSION PLAN TABLE
ESTIMATED ANNUAL RETIREMENT BENEFITS BASED ON YEARS OF SERVICE AND COMPENSATION
YEARS OF SERVICE
-----------------------------------------
COMPENSATION 10 15 20 25
------------ -------- -------- -------- --------
$ 200,000 $ 40,000 $ 60,000 $ 80,000 $100,000
400,000 80,000 120,000 160,000 200,000
800,000 160,000 240,000 320,000 400,000
1,000,000 200,000 300,000 400,000 500,000
1,200,000 240,000 360,000 480,000 600,000
1,400,000 280,000 420,000 560,000 700,000
1,600,000 320,000 480,000 640,000 800,000
1,800,000 360,000 540,000 720,000 900,000
The Supplemental Retirement Plan is designed to provide competitive retirement
benefits to select executives with at least ten years of credited service. The
normal retirement benefit commencing at age 60 is equal to the lesser of (x) or
(y) where (x) is 2% of the average of the executive's base salary for the
highest three years out of the ten years preceding the date of termination or
change in control plus the participant's full target annual incentive
compensation in effect for the year termination or change in control occurs,
multiplied by the number of years of credited service with the Company and
reduced by an actuarial calculation of any other vested retirement benefits or
retirement benefits already paid to the executive by us, and (y) is 50% of the
average of the executive's base salary for the highest three years out of the
ten years preceding the date of termination or change in control plus annual
target incentive compensation in effect for the year termination or change in
control occurs. In the case of retirement on or after age 55 but before age 60,
a reduced benefit is provided. Except in the event of a change in control (as
defined in the Supplemental Retirement Plan) or as provided in the Employment
Agreements referred to below, no benefits are payable to an eligible executive
who terminates employment prior to age 55 and prior to completing ten years of
credited service. Benefits are generally payable in annual installments for the
life of the executive, but other forms of payment of equivalent actuarial value
may be elected by the participant.
69
By order of the Court dated December 15, 2004, we are authorized to continue to
honor our obligations under the Supplemental Retirement Plan with certain
modifications in the event the Company is sold pursuant to a plan of
reorganization as follows: future benefit calculations are modified to reflect
current salary levels of participating employees, however, bonus payments used
to make such calculations will be approved at the 2004 bonus level; the
Supplemental Retirement Plan will not vest but will continue under its terms if
a reorganization of Meldisco is effected as expected to be contemplated by the
Amended Plan and no additional participants will be added to the Supplemental
Retirement Plan. (See also the discussion of fixed Supplemental Plan Retirement
payments on page 76 below).
Covered compensation (base pay plus annual incentive target bonus) under the
Supplemental Retirement Plan as of January 1, 2005 for Mr. Shepard, Mr. Wilson
and Ms. Richards was $1,072,500, $669,000, and $510,000, respectively. (Neither
Mr. Hilpert or Mr. Stearns were eligible for the Supplemental Retirement Plan
under the terms of their employment agreements). As of January 1, 2005, the
credited years of service under the Supplemental Retirement Plan for Mr.
Shepard, Mr. Wilson and Ms. Richards, were 8, 3 and 8 years, respectively. If a
covered executive is terminated without "cause" or voluntarily terminates
employment for "good reason" (as each such term is defined in the Supplemental
Retirement Plan) contemporaneously with or within two years following a change
in control, and after reaching age 60, the executive would receive a lump sum
payment equal to the actuarial equivalent of the executive's normal retirement
benefit. Where such termination following a change in control occurs after 10
years of service but prior to the executive reaching age 60, the executive would
receive a lump sum payment equal to the actuarial equivalent of the executive's
normal retirement benefit in the form of a single life annuity commencing upon
such executive reaching age 60. Where such termination following a change in
control occurs prior to 10 years of service, the executive would receive,
payable upon such executive reaching age 60, a lump sum payment equal to the
actuarial equivalent of the benefit determined by a fraction where the numerator
is the executive's actual years of credited service (but not more than 10)
multiplied by the executive's normal retirement benefit and the denominator is
10 (thus reducing the benefit proportionately to the extent the executive's
actual years of credited service are less than 10).
For purposes of the Supplemental Retirement Plan, "change in control" is defined
generally as (a) an acquisition by any person of beneficial ownership of 25% of
the Company's then outstanding common stock or 25% or more of the total voting
power of the Company's then outstanding securities; or (b) the approval by the
stockholders of the Company of a reorganization, merger, consolidation, complete
liquidation or dissolution of the Company, the sale or disposition of all or
substantially all of the assets of the Company or similar corporate transaction;
or (c) a change in the composition of the board of directors such that the
individuals who, as of the effective date of the Supplemental Retirement Plan,
constitute the board (the "Incumbent Board") cease for any reason to constitute
at least a majority of the board (provided that any individual who becomes a
member of the board subsequent to the effective date of the Supplemental
Retirement Plan whose election, or nomination for election by the Company's
stockholders, was approved by a vote of at least a majority of those individuals
who are members of the Incumbent Board are deemed members of the Incumbent
Board; and provided, further, that any individual whose initial assumption of
office
70
occurs as a result of either an actual or threatened election contest or other
actual or threatened solicitation of proxies or consents other than by the board
may not be considered a member of the Incumbent Board).
Employment Agreements
As of January 1, 2005, we had employment agreements with Messrs. Hilpert, Wilson
and Stearns. Mr. Shepard and Ms. Richards each waived their rights under their
employment agreements when they entered into the Meldisco Compensation Plan (the
"Meldisco Plan") subject to retention of rights to assert claims should we
breach any portion of the Meldisco Plan or non-compete agreements. The following
briefly summarizes the principal terms of the employment agreements, the
Meldisco Plan and the settlement agreements, subject in each case to the actual
terms of the applicable agreement.
Mr. Hilpert
Mr. Hilpert entered into an agreement with us on January 15, 2004 which was
amended and restated on March 1, 2004, May 27, 2004 and January 25, 2005. The
agreement is for a term commencing March 1, 2004 and ending the later of January
19, 2006 or the effective date of a plan of reorganization.
The agreement provides for an annual base salary of $850,000, to be reviewed
annually (subject to Court approval or creditor/equity committee approval of any
increase), a one-time payment of $25,000 paid on or before January 31, 2004, and
an annual incentive award opportunity of no less than 150% of base salary
effective January 2, 2005 (for the fiscal year ended January 1, 2005 the
agreement provided for payment of a supplemental salary, as defined). The
agreement also provides for an additional incentive award of $1.7 million to be
paid upon the effective date of a plan of reorganization.
The agreement generally provides for (i) participation in benefit plans and
programs including retirement benefits, life insurance and medical benefits, and
(ii) restrictive covenants including non-disclosure, non-solicitation of
employees and availability for litigation support. Under the terms of the
agreement, Mr. Hilpert, at his option, opted out of our Supplemental Retirement
Plan, financial and tax planning and excess disability plans and in
consideration for exercising such option to opt out of such plans we pay him the
sum of $25,000 annually.
In the event Mr. Hilpert terminates his employment with good reason, as defined
(including a change in control termination) he is entitled to receive (i) base
salary through the date of termination; (ii) base salary through January 19,
2006 and his 2005 annual incentive award; and (iii) the additional incentive
award payable on the effective date of a plan of reorganization; to the extent
that any of such amounts have not already been paid to him.
If he is terminated by us without cause he is entitled to (i) base salary
through the date of termination, (ii) his base salary through January 19, 2006
and his 2005 annual incentive award to the extent such amounts have not been
paid to him, and (iii)(a) one-half the additional incentive award if the
termination occurs prior to the filing of a plan of reorganization with the
Creditor and Equity Committees' consents or (b) the entire additional incentive
award if the termination occurs after the filing of a plan of reorganization
with the Creditors and Equity Committee's consent.
71
If Mr. Hilpert terminates his employment without good reason he is not entitled
to severance. Mr. Hilpert would not be precluded from receiving the additional
incentive award or the annual incentive award provided they were earned pursuant
to the terms of his agreement prior to such termination. If his employment is
terminated for cause, as defined, he is not entitled to the annual incentive
award or the additional incentive award to the extent not already paid.
We also acknowledged that Mr. Hilpert's principal residence was located in the
western United States and, as a result, agreed during the term of Mr. Hilpert's
employment to lease an apartment selected by the him and to pay all rental and
other amounts (including brokerage fees and security deposits) relating to such
apartment, up to $15,000 per month; reimburse him for reasonable travel expenses
from his principal residences to our headquarters until such time as we had
leased such apartment; provide him with an automobile and pay the expenses
relating to the use, upkeep and insurance thereof for use in connection with
Company-related activities, the type and cost of such automobile to be mutually
and reasonably agreed upon by Mr. Hilpert and the Compensation Committee of the
Board; reimburse him for reasonable expenses in shipping his personal items from
his current residence to the apartment leased for his use; in the event that the
Company and Mr. Hilpert agree that the he should permanently relocate his
principal residence near our headquarters, provide him with relocation benefits
consistent with our policy to secure permanent residence within 25 miles of our
headquarters; to pay the reasonable costs of two (2) trips for travel to the New
York area for Mr. Hilpert and his immediate family in locating such temporary or
permanent housing; and annually pay him an amount equal to $2,500 as an
additional allowance under our medical plan. In the event that the above
benefits, as well as the $2,500 annual payment referenced above, result in the
liability to the executive for any federal, state and local tax, the Company
agrees to pay an amount equal to such tax and a tax gross-up thereon. In January
2005, the Board of Directors approved a new arrangement with respect to housing
and related expenses.
Under the new arrangement the lease for Mr. Hilpert's housing was terminated and
he is entitled to reimbursement for travel and housing expenses incurred in
connection with travel from his principal residence to our headquarters, such
reimbursement includes a tax gross-up theron, (Mr. Hilpert acknowledged this
amount would not exceed the prior monthly housing allowance). Mr. Hilpert will
be reimbursed for reasonable expenses incurred in return shipping charges for
his personal items. Mr. Hilpert will no longer be entitled to receive any
relocation benefits.
If payments under the employment agreement are subject to the golden parachute
excise tax, we also agreed to make an additional gross-up payment sufficient to
ensure that the net after-tax amount retained by Mr. Hilpert (taking into
account all taxes, including those on the gross-up payment) is the same as it
would have been had such excise tax not applied.
Under Mr. Hilpert's employment agreement, "change in control" is defined
generally as (i) any person, other than the Company, becoming the beneficial
owner of more than 20% of the total voting power of the Company's then
outstanding securities, with such person having the right to approve one or more
directors or otherwise having a designee on the Board; (ii) any person, other
than the Company, becoming the beneficial owner of 30% or more of the total
voting power of the Company's then outstanding securities; (iii) if during any
period of 2 consecutive years individuals who, at the beginning of the period,
constituted the Board cease to constitute at least a majority thereof, unless
the election or nomination for election for each new director was approved by
vote of at least 2/3 of the directors then still in office and were directors at
the beginning of the 2 year
72
period; (iv) merger or consolidation of the Company with any other entity, other
than a merger or consolidation that would result in voting securities of the
Company outstanding immediately prior thereto continuing to represent at least
80% of the total voting power represented by voting securities of the Company or
such surviving entity outstanding immediately after such merger or
consolidation; or (v) approval by stockholders of a plan of complete liquidation
of the Company or agreement for the sale or disposition by the Company of all or
substantially all the Company's assets; provided that a change in control does
not include the sale of the athletic segment or the acquisition of equity by any
creditor, or any Board change, under a Plan of Reorganization.
"Good Reason" includes an assignment of duties inconsistent with his CEO
position without his consent, being requested to engage in illegal or criminal
conduct, unapproved relocation or a material breach of the employment agreement
by the Company. "Cause" is generally defined as a material breach by the
Executive or conduct that constitutes gross neglect or gross misconduct
resulting in material harm to the Company. "Change in Control Termination" means
a termination of employment by the Executive for any or no reason within 180
days following a change in control.
Mr. Wilson
Mr. Wilson is a participant in KERP approved by order of the Court in May 2004.
The retention plan provides for bonuses and severance designed to encourage key
employees to remain employed by us throughout the reorganization process. In
consideration for a release from any and all claims, inclusive of any claims
related to his employment agreement, Mr. Wilson would be eligible to receive the
following amounts in a lump sum, less applicable deductions within fourteen days
of separation under the KERP plan, provided that we are in receipt of an
executed copy of a release agreement (inclusive of a release of all rights under
his employment agreement) and the revocation period has expired: (i) $669,000
($111,500 of which was paid to Mr. Wilson in July 2005 pursuant to Court order
with the balance to be paid upon termination of employment or emergence from
Chapter 11, whichever comes first) and (ii) seventy-eight (78) weeks of
guaranteed severance.
Under the release agreement Mr. Wilson would be eligible to participate in our
medical and dental plans for a period of up to eighteen (18) months following
separation, unless such coverage becomes available to Mr. Wilson through other
employment. We would provide outplacement services for Mr. Wilson for a period
of eighteen (18) months following separation.
Mr. Wilson's outstanding stock options as of his separation would be exercisable
for a period of ninety (90) days. Mr. Wilson would also receive 100% of his
deferred vested shares under our Switch to Equity Plan. In consideration of the
payments to Mr. Wilson pursuant to the release agreement, he would agree to
fully release us and all related persons and entities from any and all claims.
Mr. Wilson becomes eligible for benefits under the KERP only if he enters into a
release waiving all rights under his employment agreement. He cannot receive the
benefit of both.
73
Mr. Wilson's employment agreement (before taking into account any limitations
imposed by the Court) provides for: (i) automatic one-year extensions unless
either party provides 180 days notice of non-renewal; (ii) salary review
annually but no decreases; (iii) participation in annual incentive compensation
programs with a target at 50% of base salary; (iv) participation in long term
incentive compensation programs with a target award opportunity at 30% of base
salary; (v) participation in benefit plans and programs including retirement
benefits, life insurance, medical benefits, and the Supplemental Retirement
Plan; (vi) deferred compensation arrangements; and (vii) restrictive covenants
including an 18-month non-competition, non-disclosure, non-solicitation of
employees and availability for litigation support.
Mr. Wilson's employment agreement also provides that if he is terminated without
cause prior to a change in control (before taking into account any limitations
imposed by the Court) for the receipt of (i) base salary earned through
termination; (ii) continued payment of base salary for 18 months; (iii) a lump
sum amount equal to his pro rata annual incentive award for the year in which
termination occurs at an annual incentive target level of base salary; (iv) an
amount equal to 1.5 times an annual incentive target level of base salary
payable in monthly installments over 18 months; (v) a grant of common stock
equal to any outstanding award of contingent shares including any matching grant
under our "STEP" program and under our "Founder's Stock" or similar program
(multiplied by a fraction the numerator of which is the number of completed
years of service and the denominator is the vesting period); (vi) the right to
exercise all vested stock options for the shorter of 18 months or the remainder
of the exercise period; (vii) immediate vesting and lump sum payment of all
outstanding awards under our Career Equity Program (which was our long term
incentive plan, with awards payable 50% in cash and 50% in deferred shares based
on achievement of financial targets measured over three-year cycles) relating to
completed performance cycles; (viii) payment of the balance of any unpaid
incentive awards earned as of December 31 of the prior year; (ix) settlement of
all deferred compensation arrangements and (x) continued participation in all
medical, health and life insurance plans until the earlier of 18 months or the
receipt from a subsequent employer of equivalent coverage. Mr. Wilson's
employment agreement further provides that if employment is terminated without
cause following a change in control (as defined) (before taking into account any
limitations imposed by the Court) for the receipt of the above benefits except
that options would be exercisable for 24 months, participation in medical and
insurance programs could continue for 24 months; receipt of a lump sum severance
payment of 2 times base salary and a lump sum severance payment of 2 times base
salary multiplied by an annual incentive target level; and grants of common
stock under our "STEP" program and the "Founder's Stock" or similar program
would be made without regard to designated vesting periods.
If any such payments are subject to the golden parachute excise tax, we are
required to make an additional gross-up payment sufficient to ensure that the
net after-tax amount retained by Mr. Wilson (taking into account all taxes,
including those on the gross-up payment) would be the same as would have been
the case had such excise tax not applied.
In the event of a termination for cause, Mr. Wilson's employment agreement
provides for: (i) payment of base salary earned through the cessation of
employment; (ii) payment of the balance of any unpaid incentive award earned as
of December 31 of the prior year; (iii) settlement of all deferred compensation
arrangements; and (iv) other or additional benefits then due or earned in
accordance with our applicable plans or programs including but not limited to
the Supplemental
74
Retirement Plan.
The employment agreement also provides for indemnification to the fullest extent
permitted by law including the advancement of expenses and reimbursement of
expenses incurred in seeking enforcement of his agreement unless his assertion
of rights was in bad faith or frivolous.
Mr. Shepard and Ms. Richards
Mr. Shepard and Ms. Richards are participants under the Meldisco Plan. The
Meldisco Plan is designed to retain the services of key executives critical to
our business. The Meldisco Plan was approved by the Court on December 15, 2004.
Under the Meldisco Plan, after entering into a confidentiality and
non-competition agreement providing that the executives would not compete with
us during their employment and for a period ending at the earlier of (a) 12
months after the executives are terminated or (b) 12 months after the Master
Agreement is terminated, these executives are eligible for:
- A performance bonus for fiscal year 2005 upon achievement of certain
free cash flow goals. For Mr. Shepard, the performance bonus at target
is 100% of base salary in effect on January 1, 2005. For Ms. Richards,
the performance bonus at target is 50% of base salary. Performance
bonuses will be pro-rated in the event of an involuntary termination
during fiscal year 2005.
- A retention bonus equal to 75% of the employee's normal 2004
performance target award level for fiscal year 2005. For Mr. Shepard,
the retention bonus is calculated to be $316,875. For Ms. Richards,
the retention bonus is calculated to be $123,750.
- Retention bonuses will be pro-rated in the event of an involuntary
termination during fiscal year 2005. If there is a sale of the
Company, we will also pay the retention bonus on a pro rated basis.
- If there is a sale of the Company as part of its plan of
reorganization, and the executive is not offered comparable employment
by the acquiring entity, Mr. Shepard would be entitled to receive a
guaranteed severance payment in an amount equal to 24 months of base
pay and an annual target incentive, a KERP payment of $936,000 and a
fixed Supplemental Retirement Plan payment of $1,010,300. Under the
same circumstances, Ms. Richards would be entitled to receive a
guaranteed severance payment in an amount equal to 18 months of base
pay and an annual bonus at target, a KERP payment of $495,000 and a
fixed Supplemental Retirement Plan payment of $462,700.
- In the event of involuntary termination other than in connection with
such sale of the Company, Mr. Shepard would receive a guaranteed
severance payment in an amount equal to 18 months of base pay and an
annual target incentive, a KERP payment of $936,000 and a pro-rata
payment of fiscal year 2005 performance and retention bonuses. Ms.
Richards
75
- would receive a guaranteed severance payment in an amount equal to 18
months of base pay and an annual bonus at target, a KERP payment of
$495,000 and a pro rata payment of fiscal year 2005 performance and
retention bonuses.
- If we effect our Amended Plan, and the executive is employed by us on
the emergence date, the executive will receive the balance of any KERP
payment due, performance (provided free cash flow goals are achieved)
and retention bonuses not yet paid for fiscal 2005, the right to
receive a guaranteed severance payment in an amount equal to 18 months
of base pay and an annual bonus at target in the event of involuntary
termination and the right to continued participation in the
Supplemental Retirement Plan subject to all terms of such plan as in
effect before the Company filed for bankruptcy protection.
Mr. Stearns
The initial period of employment under Mr. Stearns employment agreement was from
September 12, 2003 through December 31, 2003 and related to his employment as
Chairman and Chief Executive Officer on an interim basis and his agreement to
continue to serve as a director.
Mr. Stearns' original employment agreement provided for (i) an annual base
salary; (ii) a one-time payment of $100,000 in consideration for entering into
the agreement; (iii) an opportunity for a bonus upon expiration of the term of
employment (or any renewal); (iv) eligibility to participate in benefit plans
and programs including long and short term incentive plans and programs,
employee welfare and pension plans programs and arrangements, executive
perquisites and insurance; (v) restrictive covenants including non-disclosure
and availability for litigation support; and (vi) severance benefits upon
termination of employment.
Mr. Stearns' employment agreement was amended on January 16, 2004 to reflect
that effective March 1, 2004 his employment changed to a per diem basis, as
needed. He would continue to serve as Interim Vice Chairman of the Board of
Directors and as a director of the Company. He is no longer eligible to
participate in any employee benefits programs but is compensated at the rate of
$5,000 per diem, as needed. In lieu of paying Mr. Stearns' for partial days
worked, we pay him a $1,000 fee for his participation in meetings with our
senior management. He is also no longer eligible to participate in severance
benefits upon termination of employment.
Director Compensation
Directors, as of January 1, 2005, who are not receiving compensation as officers
or employees of the Company or any affiliate ("non-employee directors") are paid
an annual retainer of $25,500 and a $1,000 fee for attendance at each meeting of
the Board or any committee of the Board. Non-employee directors are entitled to
a $2,500 annual fee for serving as a committee chair, other than for the Audit
Committee Chair, who is paid an annual retainer of $7,500. Non-employee
directors are also eligible to participate in the 1996 Non-Employee Director
Stock Plan (the "1996 Director Plan"). Under the 1996 Director Plan, each
non-employee director receives a one-time non-qualified option to purchase 2,000
shares of common stock at an exercise price equal to the fair market value of
common stock on the grant date. Each option becomes exercisable in 20%
increments beginning one year from the date of grant, and thereafter remains
exercisable until the option expires. As of January 1, 2005, the 1996 Director
Plan also provides for an automatic grant of 4,000 stock units ("Stock Units")
to each non-employee director on the date of each annual meeting of the
Company's stockholders. We have not held an annual meeting since 2002, so no
76
grants have been made since such time. Each Stock Unit represents the right to
receive one share of common stock at the end of a specified period. Fifty
percent of such Stock Units vest six months and a day after the grant date,
provided the non-employee director has not ceased to serve as a director for any
reason other than death, disability, or retirement at or after attaining age 65,
except that payment of such Stock Units will be accelerated in the event of a
change in control.
The remaining fifty percent of such Stock Units become payable upon the later of
ceasing to be a director or attaining age 65, provided that delivery of such
Stock Units is accelerated in the event of death, disability, or a change in
control.
The 1996 Director Plan permits a non-employee director to elect to defer receipt
of all or a portion of the shares otherwise deliverable in connection with Stock
Units.
The 1996 Director Plan also permits a non-employee director to elect to defer
receipt of fees otherwise payable in cash, with such deferred amounts deemed
invested in Stock Units. In 2000, the Board approved voluntary stock ownership
guidelines for all independent directors providing for ownership of common stock
of the Company in an amount equal to at least five times their annual retainer
and fees, to be achieved over a five-year period.
Compensation Committee Interlocks and Insider Participation
The Compensation Committee of the Board is comprised of three outside
independent directors, George S. Day, Stanley P. Goldstein and Bettye Martin
Musham.
77
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information as to beneficial ownership of
the outstanding common stock of the Company as of July 30, 2005, by each person
known to us to own beneficially more than 5% of the outstanding common stock, by
each director of the Company, by each of the Named Officers and by all directors
and executive officers of the Company as a group. To our knowledge, except as
otherwise indicated, all persons listed below have sole voting and investment
power with respect to such shares.
NUMBER OF COMMON SHARES
NAME OF BENEFICIAL OWNER BENEFICIALLY OWNED (1) PERCENT OF CLASS
------------------------ ----------------------- ----------------
Directors and Named Officers:
Robert A. Davies, III 15,993 (2) *
George S. Day 26,705 (2) *
Stanley P. Goldstein 73,292 (2)(3) *
Dale W. Hilpert 0 *
Bettye Martin Musham 16,347 (2) *
Kenneth S. Olshan 20,677 (2) *
Neele E. Stearns, Jr. 9,000 (2) *
Jeffrey A. Shepard 232,611 (2) *
Stephen R. Wilson 35,569 (2) *
Maureen Richards 101,454 (2) *
All current executive officers and
directors as a group 531,648 (2)(3)
James DeVeau (4) 29,676 (4) *
5% Stockholders:
FMR Corp.
Edward C. Johnson, 3d and
Abigail P. Johnson
82 Devonshire Street
Boston, MA 02109 2,047,200 (5) 10.0%
ESL Partners, L.P.
ESL Institutional Partners, L.P.
ESL Investors, L.L.C.
ESL Investment Management, L.L.C.
200 Greenwich Avenue
Greenwich, CT 06830 1,999,800 (6) 9.8%
78
NUMBER OF COMMON SHARES
NAME OF BENEFICIAL OWNER BENEFICIALLY OWNED (1) PERCENT OF CLASS
------------------------ ----------------------- ----------------
North Run Capital, L.P.
North Run GP, L.P.
North Run Advisors, L.L.C.
Todd B. Hammer
Thomas B. Ellis
One International Place, Ste 2401
Boston, MA 02110 2,000,000 (7) 9.8%
Triage Management, L.L.C.
Leonid Frenkel
401 City Avenue, Suite 526
Bala Cynwyd, PA 19004
Triage Offshore Fund, Ltd.
c/o International Fund
Administration, Ltd.
48 Par-la-Ville Road, Suite 464
Hamilton, HM11 Bermuda 1,849,859 (8) 9.1%
Dimensional Fund Advisors Inc.
1299 Ocean Avenue, 11th Floor
Santa Monica, CA 90401 1,194,000 (9) 5.9%
Schultze Asset Management, LLC
George J. Schultze
3000 Westchester Avenue
Purchase, NY 10577 1,117,713 (10) 5.6%
Couchman Partners, L.P.
c/o Hedge Fund Services (BVI)
Limited
Skelton Building, 2nd Floor
Road Town, Tortola
British Virgin Islands
Couchman Capital, L.L.C.
Jonathan Couchman
800 Third Avenue, 31st Floor
New York, NY 10022 1,121,900 (11) 5.5%
1. Beneficially owned shares include shares over which the named person
exercises either sole or shared voting power or sole or shared investment
power and includes restricted or deferred shares.
2. The amounts shown also include the following shares issuable pursuant to
stock options
79
which, as of July 30, 2005, were currently exercisable or would become
exercisable within 60 days: Mr. Shepard, 133,234; Mr. Wilson, 23,198; Ms.
Richards, 70,474; Mr. Davies, 2,000; Dr. Day, 2,000; Mr. Hilpert, 0; Mr.
Goldstein, 2,000; Ms. Musham, 2,000; Mr. Olshan, 2,000; and Mr. Stearns,
2,000.
3. Of the shares shown, 5,758 shares are owned by Mr. Goldstein's wife. Mr.
Goldstein disclaims beneficial ownership of such shares.
4. Ceased employment in December 2004 and calculations based on information
available to us as of July 30, 2005.
5. Pursuant to a Schedule 13G filed on February 14, 2005, FMR Corp., Edward C.
Johnson, 3d and Abigail P. Johnson (collectively "FMR"); FMR has sole
voting power with respect to no shares and sole dispositive power with
respect to 2,047,200 shares.
6. Pursuant to a Schedule 13G filed on July 2, 2004, ESL Partners, L.P. has
sole voting and sole dispositive power with respect to 1,483,798 shares;
ESL Investment Management L.L.C has sole voting and sole dispositive power
with respect to 2,313 shares; ESL Institutional Partners, L.P. has sole
voting and sole dispositive power with respect to 9,847 shares; and ESL
Investors, L.L.C. has sole voting and sole dispositive power with respect
to 503,842 shares.
7. Pursuant to a Schedule 13G filed on March 17, 2004, North Run Capital, L.P.
North Run GP, L.P., North Run Advisors, L.L.C., Todd B. Hammer and Thomas
B. Ellis (collectively "North Run"), North Run has sole voting and sole
dispositive power with respect to 2,000,000 shares.
8. Pursuant to a Schedule 13G filed on July 1, 2004, Triage Management L.L.C.,
Leonid Frenkel and Triage Offshore Fund, Ltd., Triage Management L.L.C. and
Leonid Frenkel have shared voting power with respect to 1,849,859 shares
and shared dispositive power with respect to 1,695,567 shares and Triage
Offshore Fund, Ltd. has shared voting and shared dispositive power with
respect to 1,245,276 shares.
9. Pursuant to a Schedule 13G filed on February 9, 2005, Dimensional Fund
Advisors Inc. has sole voting and sole dispositive power with respect to
1,194,000 shares.
10. Pursuant to a Schedule 13D/A filed on June 28, 2005, Schultze Asset
Management, LLC and George J. Schultze have shared voting and shared
dispositive power with respect to 1,143,413 shares.
11. Pursuant to a Schedule 13G filed on March 12, 2004, Couchman Partners,
L.P., Couchman Capital, L.L.C. and Jonathan Couchman (collectively
"Couchman"), Couchman has sole voting and sole dispositive power with
respect to 1,121,900 shares.
80
EQUITY COMPENSATION PLAN INFORMATION
(c)
Number of securities
(a) (b) remaining available for
Number of securities to be Weighted-average exercise future issuance under
issued upon exercise of price of outstanding equity compensation plans
outstanding options, options, (excluding securities
Plan category warrants and rights warrants and rights reflected in column (a))
------------- -------------------------- ------------------------- -------------------------
Equity compensation plans
approved by security
holders (1) 716,026 $28.00 1,675,996
Equity compensation plans not
approved by security
holders (2) 474,099 $30.00 1,455,308
--------- ------ ---------
Total 1,190,125 $29.00 3,131,304
(1) 1996 Non-Employee Director Stock Plan and 1996 Incentive Compensation Plan
(2) 2000 Equity Incentive Plan
Our 2000 Equity Incentive Plan was adopted by the Board and became effective on
March 10, 2000. The plan is administered as a "broadly-based plan" within the
meaning of Section 312 of the New York Stock Exchange Listing Rules. The plan
provides for grants of stock options and other stock based awards to our
full-time employees other than to any individual who would be a named executive
officer in the proxy statement to be filed with the SEC in connection with the
annual meeting for the applicable year. Participants in the plan may be granted
stock options, stock appreciation rights, restricted stock, deferred stock,
bonus stock, dividend equivalents, or other stock based awards, performance
awards or annual incentive awards. All stock option grants have an exercise
price per share no less than the fair market value per share of common stock on
the grant date and may have a term of no longer than ten years from grant date.
For further information concerning the plan, see Note 23 to the Consolidated
Financial Statements.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
We made a $75,000 loan to Mr. Neville in 1999 and a $75,000 loan in 2002. The
1999 loan bore interest at 8.0% and was due upon separation of employment. The
2002 loan bore no interest and would be forgiven after Mr. Neville completed
five years of employment from the loan date with the Company. Both loans were
forgiven upon Mr. Neville's separation of employment in March, 2004.
81
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The following table presents fees for (1) professional audit services rendered
by KPMG LLP for the audit of our annual financial statements for fiscal 2002,
and fees billed for other services rendered by KPMG LLP and (2) professional
audit services rendered by APM for fiscal 2003 and 2004.
2002 2003 2004
---------- -------- --------
Audit fees (1) $6,377,000 $900,000 $900,000
Audit-related fees (2) 38,000 16,800 19,000
---------- -------- --------
Audit and audit related fees 6,415,000 916,800 919,000
Tax fees 40,000 -- --
---------- -------- --------
Total fees $6,455,000 $916,800 $919,000
========== ======== ========
(1) Audit fees for fiscal 2002 include fees relating to our restatement of our
consolidated financial statements. Audit fees for fiscal 2004 include fees
relating to management's assessment of internal controls over financial
reporting. The audit fees above exclude KPMG fees of $200,000 incurred in
2005 in connection with the reissuance of its opinions and the discontinued
operations restatement as it relates to the 2003 Form 10-K and 2004 Form
10-K.
(2) Audit related fees consist of fees for audits of the financial statements
of our employee benefit plans.
POLICY FOR APPROVAL OF AUDIT SERVICES
The services performed by our independent registered public accounting firm in
2004 were pre-approved in accordance with the pre-approval policy and procedures
adopted by the Audit Committee in 2003. This policy describes the permitted
audit, audit-related, tax and other services that the independent registered
public accounting firm may perform. The policy also requires that requests or
applications to provide services that require specific approval, in each of the
specified categories, be presented to the Audit Committee for pre-approval
together with a statement as to whether such request or application is
consistent with application rules on auditor independence. Any pre-approval is
detailed as to the particular service or category of services and generally is
subject to a budget.
Any services for audit, audit-related, tax and other services not contemplated
by those pre-approved services must be submitted to the Audit Committee for
specific pre-approval. Normally, pre-approval is considered at regularly
scheduled meetings. However, the authority to grant specific pre-approval
between meetings, as necessary, has been delegated to the Chairman of the Audit
Committee where fees do not exceed $50,000. The Chairman must update the Audit
Committee at the next regularly scheduled meeting of any services that were
granted specific pre-approval. Any proposed services exceeding the pre-approval
fee levels will require specific pre-approval by the Audit Committee.
82
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(A)(1) FINANCIAL STATEMENTS
Page
----
The following financial statements are included within this report:
Report of Independent Registered Public Accounting Firm F-2
Report of Independent Registered Public Accounting Firm F-3
Report of Independent Registered Public Accounting Firm 59
Consolidated Statements of Operations for the Fiscal Years
ended January 1, 2005, January 3, 2004 and December 28, 2002 F-4
Consolidated Balance Sheets as of January 1, 2005 and F-5
January 3, 2004
Consolidated Statements of Shareholders' Equity and Comprehensive
Income for the Fiscal Years ended January 1, 2005, January 3, 2004
and December 28, 2002 F-6
Consolidated Statements of Cash Flows for the Fiscal Years ended
January 1, 2005, January 3, 2004 and December 28, 2002 F-7
Notes to Consolidated Financial Statements F-8
(A)(2) SCHEDULE
Page
----
The following schedule is included in Part IV of this report:
Schedule II - Valuation and Qualifying Accounts for the Fiscal 85
Years ended January 1, 2005, January 3, 2004 and December 28, 2002
Schedules not included above have been omitted because they are not applicable
or the required information is shown in the consolidated financial statements or
related notes.
(A)(3) EXHIBITS
The exhibits to this report are listed in the Exhibit Index included elsewhere
herein.
SIGNATURES
83
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
INDEX
PAGE
----
Report of Independent Registered Public Accounting Firm F-2
Report of Independent Registered Public Accounting Firm F-3
Consolidated Statements of Operations for the Fiscal Years Ended January 1,
2005, January 3, 2004 and December 28, 2002 F-4
Consolidated Balance Sheets as of January 1, 2005 and January 3, 2004 F-5
Consolidated Statements of Shareholders' Equity and Comprehensive Income for
the Fiscal Years Ended January 1, 2005, January 3, 2004 and December 28, 2002 F-6
Consolidated Statements of Cash Flows for the Fiscal Years Ended January 1,
2005, January 3, 2004 and December 28, 2002 F-7
Notes to Consolidated Financial Statements F-8
Schedule II - Valuation and Qualifying Accounts for the Fiscal Years ended
January 1, 2005, January 3, 2004 and December 28, 2002 (Part IV, Item 15(a)2)
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of Footstar, Inc.:
We have audited the consolidated balance sheets of Footstar, Inc. and
subsidiaries (the "Company") as of January 1, 2005 and January 3, 2004, and the
related consolidated statements of operations, stockholders' equity and
comprehensive income and cash flows for the years then ended. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Footstar, Inc. and
subsidiaries as of January 1, 2005 and January 3, 2004 and the results of its
operations and its cash flows for the years ended January 1, 2005 and January 3,
2004 in conformity with accounting principles generally accepted in the United
States of America.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 1 to the
consolidated financial statements, on March 2, 2004 the Company filed voluntary
petitions for reorganization under Chapter 11 of the U.S. Bankruptcy Code. This
filing for reorganization raises substantial doubt about the Company's ability
to continue as a going concern. Management's plans in regard to these matters
are also described in Note 1. The financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board of the United States of America, the effectiveness of
the internal control over financial reporting of Footstar, Inc. and Subsidiaries
as of January 1, 2005, based on criteria established in Internal Control -
Integrated Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO) and our report dated August 26, 2005 expressed an
unqualified opinion on management's assessment of the effectiveness of internal
control over financial reporting and an adverse opinion on the effectiveness of
internal control over financial reporting.
We have also audited the consolidated financial statement schedule listed in the
index at item 15(a), Schedule II for the years ended January 1, 2005 and January
3, 2004. In our opinion, such consolidated financial statement schedule, when
considered in relation to the basic consolidated financial statements taken as a
whole, presents fairly in all material respects information set forth therein.
/s/ Amper, Politziner & Mattia, P.C.
Edison, New Jersey
September 27, 2005
F-2
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of Footstar, Inc.:
We have audited the accompanying consolidated statements of operations,
stockholders' equity and comprehensive income and cash flows of Footstar, Inc.
and Subsidiary Companies for the year ended December 28, 2002. In connection
with our audit of the consolidated financial statements, we also have audited
the financial statement schedule for the year ended December 28, 2002. These
consolidated financial statements and the financial statement schedule is the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements and the financial statement
schedule based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes consideration of
internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Company's internal control
over financial reporting. Accordingly, we express no such opinion. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion.
In our opinion, the 2002 consolidated financial statements referred to above
present fairly, in all material respects, the results of operations and cash
flows of Footstar, Inc. and Subsidiary Companies for the year ended December 28,
2002 in conformity with United States generally accepted accounting principles.
Also in our opinion, the related financial statement schedule referred to above
when considered in relation to the consolidated financial statements taken as a
whole, presents fairly, in all material respects, the information set forth
therein.
As discussed in Note 3 to the consolidated financial statements, the
accompanying statements of operations and cash flows for the fiscal year ended
December 28, 2002 have been restated to give effect to the Company's Shoe Zone,
Gordmans and Federated store discontinued operations.
The accompanying consolidated financial statements and the financial statement
schedule have been prepared assuming that the Company will continue as a going
concern. As discussed in Note 1 to the consolidated financial statements, on
March 2, 2004 the Company filed voluntary petitions for reorganization under
Chapter 11 of the U.S. Bankruptcy Code. This filing for reorganization raises
substantial doubt about the Company's ability to continue as a going concern.
Management's plans in regard to these matters are also described in Note 1. The
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
/s/ KPMG LLP
New York, New York
August 27, 2004, except as to Note 3 as it relates to Fiscal 2002 which is as of
September 27, 2005.
F-3
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF OPERATIONS
(in millions, except per share amounts)
For the Fiscal Years Ended
-----------------------------------------------------
JANUARY 1, 2005 January 3, 2004 December 28, 2002
--------------- --------------- -----------------
(Note 3) (Note 3)
Net sales $800.2 $962.4 $1,321.3
Cost of sales 535.8 650.3 899.8
------ ------ --------
GROSS PROFIT 264.4 312.1 421.5
Store operating, selling, general and administrative expenses 236.1 250.7 308.8
Depreciation and amortization 21.7 19.0 19.9
Loss on Kmart Settlement 6.3 -- --
Restructuring, asset impairment and other charges, net -- 2.5 14.0
Bad debt expense - Ames Department Stores -- -- 9.2
Other income (9.2) (5.4) --
Interest expense 11.0 23.4 9.5
Interest income -- (1.1) (1.1)
------ ------ --------
(LOSS) INCOME BEFORE REORGANIZATION ITEMS, INCOME TAXES,
MINORITY INTERESTS, DISCONTINUED OPERATIONS AND CUMULATIVE
EFFECT OF A CHANGE IN ACCOUNTING PRINCIPLE (1.5) 23.0 61.2
Reorganization items (37.1) -- --
------ ------ --------
(LOSS) INCOME BEFORE INCOME TAXES, MINORITY INTERESTS,
DISCONTINUED OPERATIONS AND CUMULATIVE EFFECT OF A CHANGE
IN ACCOUNTING PRINCIPLE (38.6) 23.0 61.2
Benefit (provision) for income taxes 2.9 (10.0) (70.9)
------ ------ --------
(LOSS) INCOME BEFORE MINORITY INTERESTS, DISCONTINUED
OPERATIONS AND CUMULATIVE EFFECT OF A CHANGE IN
ACCOUNTING PRINCIPLE (35.7) 13.0 (9.7)
Minority interests in net loss (income) 11.0 (17.3) (37.1)
------ ------ --------
LOSS FROM CONTINUING OPERATIONS (24.7) (4.3) (46.8)
Loss from discontinued operations, net of tax (66.7) (50.1) (32.4)
Gain from disposal of Athletic Segment, net of tax 21.4 -- --
------ ------ --------
LOSS FROM OPERATIONS BEFORE CUMULATIVE EFFECT OF A CHANGE IN (70.0) (54.4) (79.2)
ACCOUNTING PRINCIPLE
Cumulative effect of a change in accounting principle -- -- (24.3)
------ ------ --------
NET LOSS $(70.0) $(54.4) $ (103.5)
====== ====== ========
AVERAGE COMMON SHARES OUTSTANDING
Basic and diluted 20.5 20.5 20.4
====== ====== ========
LOSS PER SHARE:
Basic and diluted:
Loss from continuing operations $(1.20) $(0.21) $ (2.29)
Loss from discontinued operations (2.21) (2.44) (1.58)
Cumulative effect of a change in accounting principle -- -- (1.19)
------ ------ --------
Net loss $(3.41) $(2.65) $ (5.06)
====== ====== ========
See accompanying notes to consolidated financial statements.
F-4
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
(IN MILLIONS, EXCEPT SHARE AMOUNTS)
JANUARY 1, 2005 January 3, 2004
--------------- ---------------
ASSETS
Current assets:
Cash and cash equivalents $ 189.6 $ 1.1
Accounts receivable, net 22.1 16.6
Inventories 98.9 179.7
Prepaid expenses and other current assets 28.4 23.1
Assets related to discontinued operations 6.2 284.5
------- -------
Total current assets 345.2 505.0
Property and equipment, net 35.4 147.2
Intangible assets, net 10.3 11.0
Deferred charges and other noncurrent assets 3.2 1.5
------- -------
Total assets $ 394.1 $ 664.7
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Liabilities not subject to compromise
Notes payable $ -- $ 198.0
Accounts payable 48.0 79.8
Accrued expenses 48.0 51.4
Amount due under Kmart Settlement 45.0 --
Income taxes payable 2.0 2.0
Liabilities related to discontinued operations 3.5 110.5
Liabilities subject to compromise 152.3 --
------- -------
Total current liabilities 298.8 441.7
------- -------
Other long-term liabilities 38.5 58.9
Amount due under Kmart Settlement 5.5 --
Minority interests in subsidiaries -- 42.2
------- -------
Total liabilities 342.8 542.8
------- -------
Shareholders' equity:
Common stock $.01 par value: 100,000,000 shares
authorized; 31,018,065 and 30,949,958 shares
issued 0.3 0.3
Additional paid-in capital 343.1 345.2
Accumulated other comprehensive loss -- (0.4)
Treasury stock: 10,711,569 shares, at cost (310.6) (310.6)
Unearned compensation (0.4) (1.5)
Retained earnings 18.9 88.9
------- -------
Total shareholders' equity 51.3 121.9
------- -------
Total liabilities and shareholders' equity $ 394.1 $ 664.7
======= =======
See accompanying notes to consolidated financial statements.
F-5
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME
(IN MILLIONS, EXCEPT SHARE AMOUNTS)
Accum.
Other
Compre-
Common Stock Treasury Stock Add'l Unearned hensive
------------------ ------------------- Paid-in Compen- Retained Income
Shares Amount Shares Amount Capital sation Earnings (Loss) Total
---------- ------ ---------- ------- ------- -------- -------- ------- -------
BALANCE AS OF DECEMBER 29,
2001 30,770,372 $0.3 10,711,569 $(310.6) $347.3 $(5.8) $246.8 $(0.1) $ 277.9
Comprehensive loss:
Net loss -- -- -- -- -- -- (103.5) -- (103.5)
Unrealized loss on
interest rate swap
agreement -- -- -- -- -- -- -- (1.5) (1.5)
-------
Total comprehensive loss (105.0)
Common stock incentive
plans 125,820 -- -- -- (1.0) 2.9 -- -- 1.9
---------- ---- ---------- ------- ------ ----- ------ ----- -------
BALANCE AS OF DECEMBER 28,
2002 30,896,192 $0.3 10,711,569 $(310.6) $346.3 $(2.9) $143.3 $(1.6) $ 174.8
Comprehensive loss:
Net loss -- -- -- -- -- -- (54.4) -- (54.4)
Unrealized gain on
interest rate swap
agreement -- -- -- -- -- -- -- 1.2 1.2
-------
Total comprehensive loss (53.2)
Common stock incentive
plans 53,766 -- -- -- (1.1) 1.4 -- -- 0.3
---------- ---- ---------- ------- ------ ----- ------ ----- -------
BALANCE AS OF JANUARY 3,
2004 30,949,958 $0.3 10,711,569 $(310.6) $345.2 $(1.5) $88.9 $(0.4) $ 121.9
Comprehensive loss:
Net loss -- -- -- -- -- -- (70.0) -- (70.0)
Unrealized gain on
interest rate swap
agreement -- -- -- -- -- -- -- 0.4 0.4
-------
Total comprehensive loss (69.6)
Common stock incentive
plans 68,107 -- -- -- (2.1) 1.1 -- -- (1.0)
---------- ---- ---------- ------- ------ ----- ------ ----- -------
BALANCE AS OF JANUARY 1,
2005 31,018,065 $0.3 10,711,569 $(310.6) $343.1 $(0.4) $18.9 $ -- $ 51.3
---------- ---- ---------- ------- ------ ----- ------ ----- -------
See accompanying notes to consolidated financial statements.
F-6
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in millions)
For the Fiscal Years Ended
--------------------------------------
JANUARY 1, January 3, December 28,
2005 2004 2002
---------- ---------- ------------
(Note 3) (Note 3)
Cash flows from operating activities:
Net loss $ (70.0) $(54.4) $(103.5)
Loss from discontinued operations (45.3) (50.1) (32.4)
------- ------ -------
Loss from continuing operations (24.7) (4.3) (71.1)
Adjustments to reconcile loss from continuing operations to net cash
provided by operating activities:
Restructuring, asset impairment and other charges
(reversals), net -- 18.2 43.1
Loss on sale of assets included in reorganization items 24.1 -- --
Bad debt expense -- -- 9.4
Minority interests in net (loss) income (11.0) 17.3 37.1
Depreciation and amortization 21.7 19.0 19.9
Cumulative effect of change in accounting principle -- -- 24.3
Loss on disposal of fixed assets 2.1 17.5 2.2
Deferred income taxes (1.6) (0.9) 50.8
Stock incentive plans (1.0) 0.7 0.4
Changes in operating assets and liabilities:
(Increase) decrease in accounts receivable, net (6.6) 19.9 12.0
Decrease (increase) in inventories 72.0 (6.6) 22.3
(Increase) in prepaid expenses and other assets (5.7) (0.6) (21.1)
Increase (decrease) in accounts payable, accrued expenses and amount
due under Kmart Settlement 7.4 (23.9) (10.6)
(Decrease) increase in income taxes payable and other long-term
liabilities (2.1) (27.9) 7.0
------- ------ -------
Net cash provided by operating activities 74.6 28.4 125.7
------- ------ -------
Cash flows provided by (used in) investing activities:
Additions to property and equipment (3.8) (17.5) (39.8)
Proceeds from the sale of assets included in reorganization items 47.4 -- --
Proceeds from sale of furniture and equipment and building -- -- 3.7
Proceeds from sale of the Athletic Segment 222.1 -- --
------- ------ -------
Net cash provided by (used in) investing activities 265.7 (17.5) (36.1)
------- ------ -------
Cash flows (used in) provided by financing activities:
Net (payments) proceeds from note payable (198.0) 51.2 (0.1)
Dividends paid to minority interests -- (36.2) (44.8)
Payments for return of capital to minority shareholders -- -- (0.5)
Proceeds from exercise of stock options -- -- 1.0
Payments on capital leases -- (0.8) (0.8)
Payments on mortgage note -- (0.8) (0.7)
Other 0.3 (1.4) (1.4)
------- ------ -------
Net cash (used in) provided by financing activities (197.7) 12.0 (47.3)
------- ------ -------
Discontinued operations 45.9 (35.2) (41.4)
------- ------ -------
Net increase (decrease) in cash and cash equivalents 188.5 (12.3) 0.9
------- ------ -------
Cash and cash equivalents, beginning of year 1.1 13.4 12.5
Cash and cash equivalents, end of year $ 189.6 $ 1.1 $ 13.4
------- ------ -------
See accompanying notes to consolidated financial statements.
F-7
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THE COMPANY
Footstar, Inc. ("Footstar", the "Company", "we", "us" or "our") is a holding
company in which its businesses are operated through its subsidiaries. We are
principally a retailer conducting business through our Meldisco and, formerly,
Athletic segments. (see Note 1 "Business Risks - Bankruptcy Filing"). The
Meldisco segment (the "Meldisco Segment" or "Meldisco") sells family footwear
through licensed footwear departments and wholesale arrangements. Prior to its
disposition the Athletic Segment sold athletic footwear and apparel through
various retail chains (for example, Footaction and Just For Feet) and via
catalogs and the Internet.
1. BUSINESS RISKS - BANKRUPTCY FILING
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 are being jointly administered under the caption "In re: Footstar, Inc.,
et al. Case No. 04-22350 (ASH)" (the "Chapter 11 Cases"). The Debtors are
currently operating their business and managing their properties as
debtors-in-possession pursuant to Sections 1107(a) and 1108 of the Bankruptcy
Code. As debtors-in-possession, we are authorized to continue to operate as an
ongoing business but may not engage in transactions outside the ordinary course
of business without the approval of the Court.
Although the process for the disposition of our Athletic Segment commenced in
2003, as part of our initial reorganization plans after filing Chapter 11, we
closed 166 underperforming stores within the Athletic Segment: all 88 Just For
Feet stores; 75 Footaction stores and three Uprise stores. On April 21, 2004, we
received Court approval to sell to certain affiliates of Foot Locker, Inc.
(collectively "Foot Locker") 349 of the remaining Footaction stores (including
all lease rights and inventory at these stores), along with the remaining
inventory from the other three remaining Footaction stores (see Note 3
"Discontinued Operations" and Note 11 "Assets and Liabilities Related to
Discontinued Operations").
Within the Meldisco Segment, we exited the footwear departments in 87 stores
operated by subsidiaries of Federated Department Stores, Inc.("Federated"), and
44 Gordmans, Inc. ("Gordmans") stores; closed 13 Shoe Zone stores and sold 26
Shoe Zone stores located in Puerto Rico. In fiscal 2004, 2003 and 2002 the net
sales of these Meldisco businesses were $24.1 million, $53.2 million and $24.7
million, respectively. These stores are reflected as discontinued operations
(see Note 3 "Discontinued Operations" and Note 11 "Assets and Liabilities
Related to Discontinued Operations").
In March 2004, we entered into a debtor-in-possession credit agreement, which
was substantially amended in May 2004, July 2004 and July 2005 (see Note 16 "The
Amended DIP and Exit Credit Facility").
During 2004, we sold certain other assets, including our distribution centers in
Mira Loma, California ("Mira Loma") and Gaffney, South Carolina ("Gaffney"). 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 has agreed to provide us with warehousing and distribution
services through June 30, 2012 under a receiving, warehousing and physical
distribution services agreement (the "FMI Agreement"). See Note 28 "Commitments
and Contingencies". We sold Gaffney to Automated Distribution Systems, L.P., a
logistics provider, for approximately $20.2 million.
F-8
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Under the Bankruptcy Code, we have the ability to reject executory contracts and
unexpired leases, subject to the approval of the Court and certain other
conditions. Parties affected by the rejection of a contract or lease may file
claims against us in the Court in accordance with the Bankruptcy Code. Due to
the uncertain nature of many of the potential claims, which have been or may be
asserted against us, we are unable to project the magnitude of such claims with
certainty. We have incurred, and will continue to incur, significant costs
associated with our reorganization.
In order to exit Chapter 11 successfully, we will need to obtain Court
confirmation of a Chapter 11 plan that satisfies the requirements of the
Bankruptcy Code. At this time, it is not possible to accurately predict the
effect of the Chapter 11 Cases on our business, creditors or stockholders or
when we may emerge from Chapter 11, if at all.
On November 12, 2004, we filed a proposed joint plan of reorganization with the
Court. Following the Kmart Settlement, we anticipate filing an amended plan with
the Court (the "Amended Plan"). The Amended Plan is expected to provide for an
orderly reorganization of the Company and certain cash distributions and be
subject to a vote by eligible ballot holders. The Amended Plan is also expected
to provide for some flexibility in the timing of its confirmation and our
emergence from bankruptcy. The Amended Plan is also expected to provide that we
will not emerge from bankruptcy until we file with the SEC these periodic
reports required by the SEC. Although we expect that creditors in the bankruptcy
will be paid in full, the timing of such payments is currently subject to
negotiation and is expected to be specified in the Amended Plan.
On July 2, 2005, the Company and Kmart entered into an agreement (the "Kmart
Settlement") with respect to the assumption, interpretation and amendment of the
Master Agreement with Kmart, effective July 1, 1995, as amended (the "Master
Agreement"). On August 25, 2005, the Court approved the Kmart Settlement. The
Kmart Settlement, which is effective as of January 2, 2005, allows us to
continue operating the footwear departments in Kmart stores pursuant to the
Master Agreement as amended by the Kmart Settlement (the "Amended Master
Agreement"). See Note 5 "Meldisco's Relationship with Kmart".
The Company is currently reorganizing under Chapter 11. If the Company is not
successful in its reorganization it will face liquidation and cease to be a
going concern. It is not currently known whether management will be able to
successfully complete its reorganization plan or whether the Court will approve
the Company's emergence from Chapter 11, which raises substantial doubt about
the Company's ability to continue as a going concern. Management's plans with
respect to this uncertainty include continuing to operate the business to
maximize cash flow for payment to creditors. The financial statements do not
include any adjustments that might result from the outcome of this uncertainty.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
Our consolidated financial statements include the accounts of all subsidiary
companies. Intercompany balances and transactions between the entities have been
eliminated. The minority interests represent the 49% participation of Kmart in
the ownership of substantially all subsidiaries of Meldisco formed or to be
formed for the purpose of operating licensed footwear departments in Kmart
stores (see Note 5 "Meldisco's Relationship with Kmart" for the elimination of
Kmart's interests as of January 2, 2005).
F-9
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For simplicity of presentation, these consolidated financial statements are
referred to as financial statements herein.
BASIS OF PRESENTATION
Our fiscal 2004 financial statements have been prepared in accordance with the
provisions of Statement of Position 90-7 "Financial Reporting by Entities in
Reorganization Under the Bankruptcy Code" ("SOP 90-7"). Pursuant to SOP 90-7,
our pre-petition liabilities that are 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
reporting of certain expenses, realized gains and losses and provisions for
losses related to the bankruptcy filing as reorganization items. See Note 15
"Liabilities Subject to Compromise" and Note 22 "Reorganization Items".
FISCAL YEARS
The accompanying financial statements include our consolidated results of
operations, assets and liabilities for the 53-week fiscal year ended January 3,
2004 and for the 52-week fiscal years ended January 1, 2005 and December 28,
2002.
USE OF ESTIMATES IN PREPARATION OF FINANCIAL STATEMENTS
The preparation of the financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent liabilities at the date of
the financial statements and the reported amount of expenses during the
reporting period. Actual results could differ from those estimates. Our critical
accounting estimates, which may be impacted by management's estimates and
assumptions, are discussed in these notes and include the valuation and aging of
inventory and shrink reserve, the impairment of long-lived assets, insurance
liabilities, the valuation of deferred taxes, other intangible assets, the
valuation of retiree medical benefits and the reserve for excess rent and
minority interest.
CASH AND CASH EQUIVALENTS
Cash equivalents consist of highly liquid instruments with maturities of three
months or less from the date acquired and are stated at cost that approximates
their fair market value. Our cash management program utilizes zero balance
accounts. Accordingly, all book overdraft balances have been reclassified to
current liabilities.
MERCHANDISE INVENTORIES AND COST OF SALES
Inventories are finished goods, consisting of merchandise purchased from
domestic and foreign vendors, and are carried at the lower of cost or market
value, determined by the retail inventory method on a first-in, first-out
("FIFO") basis. The retail inventory method is commonly used by retail companies
to value inventories at cost by applying a cost-to-retail percentage to the
retail value of inventories. The retail inventory method is a system of averages
that requires management's estimates and assumptions regarding mark-ons,
mark-ups, markdowns and shrink, among others and, as such, could result in
distortions of inventory amounts. The cost of inventories includes the cost of
F-10
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
merchandise, freight-in, duties, royalties and related fees and the cost of our
merchandise sourcing operations. Cost of sales is comprised of the cost of
merchandise, warehousing and delivery costs, inventory shrinkage, rent and
buying/merchandising costs.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation and amortization of
property and equipment are computed on a straight-line basis, generally over the
estimated useful lives of the assets or, when applicable, the life of the lease,
whichever is shorter. Capitalized software costs are amortized on a
straight-line basis over their estimated useful lives not exceeding five years.
Maintenance and repairs are charged directly to expense as incurred. Major
renewals or replacements are capitalized after making the necessary adjustment
to the asset and accumulated depreciation accounts of the items renewed or
replaced.
IMPAIRMENT OF LONG-LIVED ASSETS
An impairment loss is recognized whenever events or changes in circumstances
indicate that the carrying amounts of long-lived tangible and intangible assets
with finite lives may not be recoverable. Assets are grouped and evaluated at
the lowest level for which there are identifiable cash flows that are largely
independent of the cash flows of other groups of assets. We have generally
identified this lowest level to be principally individual stores or leased
departments. We consider historical performance and future estimated results in
our evaluation of potential impairment and then compare the carrying amount of
the asset to the estimated future cash flows expected to result from the use of
the asset. If the carrying amount of the asset exceeds estimated expected future
cash flows, we measure the amount of the impairment by comparing the carrying
amount of the asset to its fair value. The estimation of fair value is generally
measured by discounting expected future cash flows at our weighted average cost
of capital. We estimate fair value based on the best information available using
estimates, judgments and projections as considered necessary.
DEFERRED CHARGES
Deferred charges, which primarily include deferred financing costs, are
amortized on a straight-line basis over the remaining term of the debt.
GOODWILL AND OTHER INTANGIBLES
Goodwill represents the excess of costs over fair value of assets of businesses
acquired. We adopted the provisions of Statement No. 142, Goodwill and Other
Intangible Assets, ("Statement No. 142") as of the first day of fiscal year
2002. Statement No. 142 requires that goodwill and intangible assets with
indefinite useful lives no longer be amortized, but instead be tested for
impairment annually in accordance with the provisions of Statement No. 142. (see
Note 13 "Goodwill and Other Intangible Assets.") Statement No. 142 also requires
that intangible assets with definite useful lives be amortized over their
respective estimated useful lives to their estimated residual values. Intangible
assets with definite useful lives are reviewed for impairment in accordance with
Statement No. 144. Intangible assets that do not have indefinite useful lives
consist of trade names and trademarks and are classified within other noncurrent
assets in the accompanying consolidated balance sheets. The costs of these
intangibles are amortized on a straight-line basis over the estimated useful
lives of the respective assets and liabilities, which range from 5 to 20 years.
F-11
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
REVENUE RECOGNITION
Revenues from retail stores are recorded at the point of sale when the product
is delivered to customers and revenues from wholesale operations are recorded
when the product is shipped to customers in accordance with the terms of the
applicable contractual agreement. Retail sales exclude all taxes. Provisions for
merchandise returns are provided in the period that the related sales are
recorded and are reflected as a reduction of revenues. We determine the amount
of provisions based on historical information. Sales discounts and other similar
incentives are recorded as a reduction of revenues in the period in which the
related sales are recorded.
ADVERTISING COSTS
Advertising and sales promotion costs are expensed at the time the advertising
or promotion takes place. Advertising costs are recorded as a component of store
operating, selling, general and administrative expenses in the accompanying
consolidated statements of operations and were $21.5 million, $24.2 million and
$32.8 million in 2004, 2003 and 2002, respectively.
INCOME TAXES
We determine our deferred tax provision under the liability method, whereby
deferred tax assets and liabilities are recognized for future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases and operating
loss and tax credit carryforwards. Deferred tax assets and liabilities are
measured using currently enacted tax rates. A valuation allowance is established
for amounts which we cannot conclude that it is more likely than not that such
amounts will be realized (see Note 21 "Income Taxes.")
POSTRETIREMENT BENEFITS
We provide a defined benefit health care plan for substantially all retirees who
meet certain eligibility requirements, including current active full-time
associates who had a minimum of 10 years of service as of December 31, 1992 and
work up to age 60. As of January 1, 2005 and January 3, 2004, we had an accrual
of $27.9 million and $29.3 million, respectively, relating to postretirement
benefits in other long-term liabilities on our consolidated balance sheets. The
annual cost of postretirement benefits is funded as it arises and the cost is
recognized over an employee's term of service to us (see Note 26 "Postretirement
Benefits".)
INSURANCE LIABILITIES
We are primarily self-insured for health care costs. We maintain workers'
compensation insurance that has a deductible of $250,000, property insurance
with deductibles ranging between $25,000 to $100,000 and general liability
insurance with no deductible. For self-insured claims, including medical,
postretirement benefits, workers' compensation, general, automobile and property
claims, provisions are made for our actuarially determined estimates of
discounted future claim costs for such risks.
F-12
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
STOCK-BASED COMPENSATION PLANS
As permitted under Statement No. 123, Accounting for Stock-Based Compensation
("Statement No. 123"), we have elected not to adopt the fair value method of
accounting for our stock-based compensation plans, but continue to apply the
provisions of Accounting Principles Board Opinion ("APB 25"), Accounting for
Stock Issued to Employees. In accordance with APB 25, compensation expense is
not recorded for options granted if the option price is not less than the quoted
market price at the date of grant. Compensation expense is also not recorded for
employee purchases of stock under the 1997 Associate Stock Purchase Plan since
the plan is non-compensatory as defined in APB 25. We plan to adopt FASB
Statement No. 123 (Revised 2004), which requires that the fair value of
share-based payments to employees be expensed, in 2006 (see Note 4 "Impact of
Recently Issued Accounting Standards".)
As of January 1, 2005, we had three stock-based employee compensation plans (see
Note 23 "Stock Incentive Plans.") We have adopted the disclosure standards of
Statement No. 123 and Statement No. 148, Accounting for Stock-Based Compensation
- Transition and Disclosure (an amendment of FASB Statement No. 123) which
requires us to provide pro forma net loss and pro forma loss per share
disclosures for employee stock option grants made in 1995 and subsequent years
as if the fair value method of accounting for stock options as defined in
Statement No. 123 had been applied.
The following table illustrates the effect on net loss and loss per share
amounts if we had applied the fair value recognition provisions of Statement No.
123 to stock-based employee compensation (in millions, except per share
amounts):
2004 2003 2002
------ ------ -------
NET LOSS:
Reported $(70.0) $(54.4) $(103.5)
Stock-based employee compensation
expense determined under fair
value method for all awards -- (0.8) (7.0)
------ ------ -------
Pro forma net loss $(70.0) $(55.2) $(110.5)
------ ------ -------
LOSS PER SHARE:
Basic and Diluted:
Reported $(3.41) $(2.65) $ (5.06)
Pro forma $(3.41) $(2.69) $ (5.41)
The weighted average fair value of options granted during fiscal year 2002 was
$13.75. There were no options granted during fiscal 2004 or 2003. During 2002,
the fair value of each option granted was estimated on the date of grant using
the Black-Scholes option-pricing model with the following assumptions:
Expected volatility 49.6%
Expected life in years 6.0
Risk-free interest rate 4.4%
Assumed forfeiture rate --
F-13
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 loss
per share (in millions):
2004 2003 2002
---- ---- ----
Average shares outstanding 20.3 20.2 20.1
Contingently issuable shares (1) 0.2 0.3 0.3
---- ---- ----
Average shares outstanding - basic 20.5 20.5 20.4
---- ---- ----
Average shares outstanding - diluted (2) 20.5 20.5 20.4
---- ---- ----
(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. During
the years ended January 1, 2005, January 3, 2004 and December 28, 2002, we
had a net loss; as a result, any assumed conversions would result in
reducing the loss per share and, therefore, are not included in the
calculation. Shares having an anti-dilutive effect on EPS and, therefore,
excluded from the calculation of diluted earnings per share, totaled 0
shares, 841 shares and 20,158 shares for the years ended January 1, 2005,
January 3, 2004 and December 28, 2002, respectively.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Statement No. 107, Disclosures About Fair Value of Financial Instruments,
requires disclosure of the fair value of certain financial instruments. Cash and
cash equivalents, accounts receivable, notes payable, accounts payable and
accrued expenses are reflected in the consolidated balance sheets at carrying
value, which approximates fair value due to the short-term nature of these
instruments and the variability of the respective interest rates where
applicable. The carrying value of mortgages as of January 1, 2005 and January 3,
2004 was $7.1 million, which approximated fair value. The fair value of our four
interest rate swap agreements is reflected in accrued expenses in the
accompanying consolidated balance sheet as of January 3, 2004 and totaled
approximately $0.4 million. As of January 1, 2005, we had no derivative or
hedging activities outstanding.
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
We account for our derivative instruments and hedging activities in accordance
with Statement No. 133, Accounting for Derivative Instruments and Certain
Hedging Activities ("Statement No. 133") and Statement No. 138, Accounting for
Certain Derivative Instruments and Certain Hedging Activities, an Amendment of
FASB 133 ("Statement No. 138"). Statements No. 133 and 138 require that all
derivative instruments be recorded on the balance sheet at their respective fair
values.
F-14
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
On the date a derivative contract is entered into, we designate the derivative
as a hedge of the variability of cash flows to be received or paid related to a
recognized asset or liability (cash flow hedge) or a hedge of variability of
fair value released to a recognized asset or liability (fair value hedge). For
all hedging relationships, we formally document the hedging relationship, its
risk-management objective, the strategy for undertaking the hedge, the hedging
instrument, the item, the nature of the risk being hedged, how the hedging
instrument's effectiveness in offsetting the hedged risk will be assessed, and a
description of the method of measuring ineffectiveness. This process includes
linking all derivatives that are designated as cash-flow hedges to specific firm
commitments. We also formally assess, both at the hedge's inception and on an
ongoing basis, whether the derivatives that are used in hedging transactions are
highly effective in offsetting changes in fair values or cash flows of hedged
items. When it is determined that a derivative is not highly effective as a
hedge or that it has ceased to be a highly effective hedge, the Company
discontinues hedge accounting prospectively.
Changes in the fair value of a derivative instrument that is not considered to
be highly effective, along with the loss or gain on the hedged asset or
liability or unrecognized firm commitment of the hedged item that is
attributable to the hedged risk are recorded in earnings. Changes in the fair
value of a derivative that is highly effective and that is designated and
qualifies as a cash-flow hedge are recorded in other comprehensive income to the
extent that the derivative is effective as a hedge. Cash settlements under the
hedge are recorded in the period in which earnings are affected by the
variability in cash flows of the designated hedged item.
We discontinue hedge accounting prospectively when we determine that the
derivative is no longer effective in offsetting changes in the fair value or
cash flows of the hedged item, the derivative expires or is sold, terminated, or
exercised, a hedged firm commitment no longer meets the definition of a firm
commitment or designation of the derivative as a hedging instrument is no longer
appropriate.
As of January 1, 2005, we had no derivative instruments or hedging activities
outstanding.
3. DISCONTINUED OPERATIONS
The sale in 2004 of certain Footaction stores to Foot Locker together with the
closure of the underperforming Just For Feet and Footaction stores, which
comprised the Athletic Segment has been accounted for as discontinued
operations. Our financial statements reflect the Athletic Segment as
discontinued operations for all periods presented. The gain on disposition in
2004 was approximately $21.4 million.
During 2003 we initiated a plan for the disposition of our Athletic Segment. In
2004 we closed 166 underperforming stores and, effective May 2, 2004, the assets
of 349 Footaction stores were sold to Foot Locker for $225.0 million in cash,
subject to adjustment. Approximately $13.0 million of the sales proceeds were
placed in escrow with respect to 14 store locations that were leased on a
month-to-month basis. In the event that Foot Locker entered into a new lease for
any of these store locations, the escrow amount related to that location was
paid to us.
In 2004, the escrow deposit was released on seven stores and approximately $6.2
million was received by us and included as part of the gain from disposal of the
Athletic Segment. During 2005, an additional $3.0 million was received from
escrow as a result of five leases that were entered into during 2005, $2.2
million was released to Foot Locker and $1.6 million remained in escrow. The
parties had previously agreed to extend until July 7, 2005 the one remaining
month-to-month lease, but have been unable to agree to a further extension as
Foot Locker continues to occupy the premises and
F-15
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
negotiate a new lease. Accordingly, the $1.6 million remains in escrow pending
the parties resolution of the dispute relating to the release of such funds from
escrow.
Net sales and loss from discontinued operations of our Athletic Segment before
interest and taxes for 2004, 2003 and 2002 were as follows (in millions):
2004 2003 2002
------ ------- -------
Net sales $218.8 $973.2 $953.9
Loss from discontinued operations
before interest and taxes $(30.1) $(32.6) $(28.9)
In the initial stages of the Chapter 11 cases in 2004, we decided to streamline
our Meldisco business by selling or exiting selected stores. As a result, we
sold or liquidated all of our Shoe Zone stores. We also exited the footwear
departments in 44 Gordmans stores and the footwear departments in 87 stores
operated by Federated. As we determined that the disposition of these stores met
the requirements of SFAS No. 144 "Accounting for the Impairment or Disposal of
Long-Lived Assets" ("SFAS No. 144"), the results of operations for these stores
have been accounted for as discontinued operations. Accordingly, our financial
statements for fiscal years 2003 and 2002 have been restated to reflect these
stores as a discontinued operation in our consolidated statements of operations
and cash flows. The assets and liabilities of the discontinued operations were
disposed of by January 1, 2005. Statement of operations information presented in
the notes to consolidated financial statements has been restated to reflect
continuing operations for all periods presented.
Net sales and loss from discontinued operations of Shoe Zone, Gordmans and
Federated before interest and taxes for 2004 were as follows (in millions):
Net sales $ 24.1
Loss from discontinued operations before interest and taxes
(including exit costs of approximately $16.1 million) $(26.8)
F-16
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following is a summary of financial information of our discontinued and
continuing operations before minority interests and cumulative effect of change
in accounting principle of Shoe Zone, Gordmans and Federated for 2003 and 2002
(in millions):
CONSOLIDATED CONTINUING
2003 (AS REPORTED) DISCONTINUED (AS RESTATED)
---- ------------- ------------ -------------
Net sales $1,015.6 $ 53.2 $962.4
Cost of sales 691.8 41.5 650.3
-------- ------ ------
Gross profit 323.8 11.7 312.1
Operating expenses 290.6 20.9 269.7
Restructuring, asset impairment
and other charges 2.5 -- 2.5
Other (income) expense (5.4) -- (5.4)
Interest expense, net 23.3 1.0 22.3
-------- ------ ------
Income (loss) before provision for income taxes 12.8 (10.2) 23.0
Provision for income taxes 10.0 -- 10.0
-------- ------ ------
Income (loss) before minority interests $ 2.8 $(10.2) $ 13.0
======== ====== ======
CONSOLIDATED CONTINUING
2002 (AS REPORTED) DISCONTINUED (AS RESTATED)
---- ------------- ------------ -------------
Net sales $1,346.0 $24.7 $1,321.3
Cost of sales 917.4 17.6 899.8
-------- ----- --------
Gross profit 428.6 7.1 421.5
Selling, general and depreciation expenses 337.1 8.4 328.7
Restructuring, asset impairment
and other charges 14.0 -- 14.0
Bad debt expense 9.2 -- 9.2
Interest expense, net 8.7 0.3 8.4
-------- ----- --------
Income (loss) before provision for income taxes 59.6 (1.6) 61.2
Provision for income taxes 70.9 -- 70.9
-------- ----- --------
Loss before minority interests $ (11.3) (1.6) (9.7)
======== ===== ========
In addition, we applied the provisions of SFAS No. 144 to the stores closed by
Kmart during 2004 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.
F-17
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
The Medicare Prescription Drug, Improvement and Modernization Act, enacted in
December 2003, introduces a prescription drug benefit under Medicare ("Medicare
Part D") as well as a federal subsidy to sponsors of retiree health care benefit
plans that provide a benefit that is at least actuarially equivalent to Medicare
Part D. FASB Statement No. 106, Employers ' Accounting for Postretirement
Benefits Other Than Pensions, addresses employers' accounting for postretirement
health care benefits. FASB Staff Position 106-2 requires that employers that
qualify for a prescription drug subsidy must recognize the reduction in costs as
employees provide services in future years, commencing with reporting periods
ending after June 15, 2004. We estimate that the medical drug subsidy that we
will receive from 2006 through 2014 will approximate $2.4 million.
In November 2004, FASB Statement No. 151, Inventory Costs, an Amendment of APB
No. 43, Chapter 4 ("Statement No. 151"), was issued. Statement No. 151 requires
certain abnormal expenditures to be recognized as expenses in the current
period. It also requires that the amount of fixed production overhead allocated
to inventory be based on the normal capacity of the production facilities.
Statement No. 151 is effective for the fiscal year beginning January 1, 2006.
The adoption of Statement No. 151 is not expected to have a material impact on
our financial statements.
In December 2004, the FASB issued Statement No. 153, Exchanges of Nonmonetary
Assets, an Amendment of APB Opinion No. 29 ("Statement No. 153"). Statement No.
153 is effective for nonmonetary asset exchanges occurring in our fiscal year
beginning January 1, 2006. Statement No. 153 requires that exchanges of
productive assets be accounted for at fair value unless fair value cannot be
reasonably determined or the transaction lacks commercial substance. Statement
No. 153 is not expected to have a material impact on our financial statements.
In December 2004, the FASB issued Statement No. 123 (Revised 2004), Share-Based
Payment, which is a revision of Statement No. 123. With limited exceptions,
Statement No. 123 (Revised 2004) requires that the fair value of share-based
payments to employees be expensed over the period service is received.
This Statement is effective for us beginning with our first interim period
subsequent to December 15, 2005. We intend to adopt this Statement using the
modified prospective method. We do not yet know the impact that any future
share-based payment transactions will have on our financial position or results
of operations.
In May 2005, the FASB issued SFAS No. 154 Accounting Changes and Error
Corrections - A Replacement of APB Opinion No. 20 and FASB Statement No. 3. This
Statement requires retrospective application to prior periods' financial
statements of changes in accounting principle, unless it is impracticable to
determine either the period-specific effects or the cumulative effect of the
change. This Statement does not change the guidance for reporting the correction
of an error in previously issued financial statements or a change in accounting
estimate. The provisions of this Statement shall be effective for accounting
changes and correction of errors made in fiscal years beginning after December
15, 2005. We are not able to assess at this time the future impact of this
Statement on our consolidated financial position or results of operations.
F-18
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5. MELDISCO'S RELATIONSHIP WITH KMART
We operated the footwear departments in 1,482 Kmart stores (the "Shoemart
Corporations") as of January 1, 2005. Prior to January 2, 2005, Kmart owned a
49% equity interest in substantially all of the subsidiaries that operated these
footwear departments. The business relationship between Meldisco and Kmart is
extremely important to us, particularly now that we have exited all of our
Athletic Segment businesses and have exited certain Meldisco footwear
departments. The loss of Meldisco's Kmart 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.
The Shoemart Corporations own the inventory and are responsible for staffing the
footwear departments. The Kmart licensed footwear departments account for
substantially all of our sales and operating profit from continuing operations,
as shown in the following tables (in millions):
2004 2003 2002
------ ------ --------
(Note 3) (Note 3)
Sales from continuing operations
Footstar $800.2 $962.4 $1,321.3
Kmart footwear departments $753.0 $901.4 $1,154.3
Kmart footwear sales from continuing operations as
percentage of Footstar 94% 94% 87%
2004 2003 2002
----- ----- ------
Operating profit from continuing operations
Footstar $ 9.5 $45.3 $ 69.6
Meldisco $22.4 $59.0 $ 79.6
Kmart footwear departments $14.6 $55.6 $109.4
Kmart's interest in footwear departments'
operating profit $ 7.2 $24.8 $ 50.9
----- ----- ------
Operating profit adjusted to exclude Kmart's 49%
interest in applicable footwear departments'
operating income
Footstar $ 2.3 $20.5 $ 18.7
Meldisco $15.2 $34.2 $ 28.7
Kmart footwear departments $ 7.4 $30.8 $ 58.5
Our arrangement with Kmart was governed by the Master Agreement. The Master
Agreement provided us with the non-transferable, exclusive right and license to
operate a footwear department in every Kmart store. The initial term of the
Master Agreement would have expired on July 1, 2012, and was renewable for a 15
year term upon mutual agreement, unless either party gave notice of termination
at least four years prior to the end of the applicable term.
On July 2, 2005, the Company and Kmart entered into the Kmart Settlement. On
August 25, 2005, the Court approved the Kmart Settlement. The Kmart Settlement,
which is effective as of January 2, 2005, allows us to continue operating the
footwear departments in Kmart stores pursuant to the Amended Master Agreement.
Under the Master Agreement, the Company and Kmart had formed in excess of 1,500
Shoemart Corporations in which we had a 51% ownership interest and Kmart had a
49%
F-19
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
interest, other than 23 of the Shoemart Corporations which were wholly-owned by
us. The Kmart Settlement resulted in a charge of approximately $6.3 million
which has been reflected in our fiscal 2004 consolidated statement of
operations. This charge represents the amount in excess of previously recorded
amounts due Kmart, including minority interests. The significant provisions of
the Kmart Settlement are as follows:
- Elimination of all outstanding litigation between Kmart and us.
- Expiration of the Amended Master Agreement at the end of 2008 and the
requirement that Kmart will purchase our Shoemart inventory (but not
our brands) at book value, which will allow for an orderly wind down
of the business without the need for a complex liquidation and the
attendant costs.
Kmart has agreed to purchase all of the inventory (excluding inventory
that is damaged, unsaleable and seasonal inventory, as defined) that
is in our remaining stores on December 31, 2008, or that is on order
on that date pursuant to Kmart's written request, for an amount equal
to the book value of the inventory, as defined. We will vacate those
stores and the Amended Master Agreement will expire.
- Our cure obligation to Kmart is fixed at $45.0 million.
The cure amount is inclusive of all claims of Kmart, including,
without limitation, retained earnings, and retained deficit of all
stores that were no longer in operation as of January 1, 2005 and any
dividend/excess fees. This entire amount was paid to Kmart on August
26, 2005.
- Elimination of all annual fees/payments previously paid Kmart in favor
of annual payments to Kmart equal to 14.625% of gross sales plus a
miscellaneous expense fee of $23,500 per store per year; elimination
of Kmart's equity interests in the Shoemart Corporations.
Kmart's equity interests in the Shoemart Corporations have been
extinguished effective as of January 2, 2005 and accordingly Kmart
will no longer share in the profits or losses of these entities for
fiscal 2005 or subsequent years. Beginning on January 2, 2005, we were
required to begin paying Kmart 14.625% of the gross sales of the
footwear departments. Effective August 25, 2005, we are also required
to pay Kmart a miscellaneous expense fee of $23,500 per store per
year. These are the only material fees which we will be required to
pay Kmart pursuant to the Kmart Settlement.
Kmart will have a capital claim against us in the amount of $11,000
for each store that is an existing store, as defined on August 25,
2005, which is generally payable by us to Kmart at the time a store
closes or converts to another retail format in accordance with the 550
store limitation described below. However, upon the expiration of the
Amended Master Agreement or upon early termination as a result of
our breach, all capital claims not yet due and payable will be waived
for any remaining stores. If the Amended Master Agreement is
terminated as a result of our breach, capital claims for remaining
stores will not be waived.
F-20
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- Kmart will be prohibited from reducing the number of stores in which
we operate below specified levels, unless it pays us the stipulated
loss value for the loss of each incremental store.
Kmart will be permitted to terminate our rights to operate footwear
departments in up to 550 existing Kmart stores during the remaining
term of the Amended Master Agreement by disposing of, closing or
converting these stores. The number of such terminations 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. For each store
that is 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, for all closings and conversions above the annual cap or the
550 aggregate limit, Kmart must pay us a nonrefundable stipulated loss
value per store equal to $100,000 for closings and conversions
occurring in 2005, $60,000 for closings and conversions occurring in
2006, $40,000 for closings and conversions occurring in 2007 and
$20,000 for closings and conversions occurring in 2008. A termination
of the entire Amended Master Agreement in accordance with its terms
does not trigger a stipulated loss value payment.
- Reduction of staffing obligations as sales decline.
We must spend at least 10% of gross sales in the footwear departments
on staffing for the stores; and we must schedule staffing in each
store at a minimum of 40 hours per week.
- Elimination of the performance standards in favor of a minimum sales
test.
The Company and Kmart will each have the right to terminate the
Amended Master Agreement if the gross sales of the footwear
departments are less than $550.0 million in any year, less $0.4
million for each store that is closed or converted after August 25,
2005. We will also have a separate, 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 fiscal quarters is less than $450.0 million. Upon
termination under either circumstance, Kmart must purchase all of the
inventory at the stores, (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.
- Kmart is required to allocate 52 weekend newspaper advertising insert
pages per year to our products.
As set forth in the Master Agreement, Kmart collected proceeds from the sale of
our inventory and remitted those sales proceeds to us on a weekly basis less any
applicable fees outlined in the Master Agreement. Such fees were $118.7 million,
$136.0 million and $171.0 million for fiscal 2004, 2003 and 2002, respectively.
As of January 1, 2005 and January 3, 2004, we had outstanding accounts
receivable due from Kmart of $17.5 million and $12.1 million respectively, which
were subsequently collected in January 2005 and January 2004, respectively.
Under the Master Agreement, Meldisco distributed annually at the end of the
first quarter of each fiscal year, a payment to Kmart for a portion of profits
representing Kmart's 49% minority interest in Meldisco subsidiaries for the
preceding fiscal year and an excess rent payment (excess fee) for the preceding
fiscal year which were contingent upon store-by-store or store level profits
above certain levels. As of January 3, 2004 and December 28, 2002, Kmart's
undistributed equity percentage share
F-21
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
of the retained earnings (minority interests) amounted to $13.2 million and
$32.9 million, respectively. As our fiscal 2002 audited financial statements
were not finalized by March 31, 2003, the payment due date, we made an estimated
payment of $36.2 million for the fiscal 2002 dividend on March 31, 2003.
In addition to the minority interest dividends, as of January 3, 2003 and
December 28, 2002, we had a liability for undistributed excess fees of $4.7
million and $15.8 million, respectively. We made an estimated excess fee payment
of $15.2 million for fiscal 2002 on March 31, 2003.
The Kmart Settlement included a $45.0 million cure obligation, which we recorded
in December, 2004. Included therein were all amounts owed to Kmart as of January
1, 2005 for minority interests and excess fees.
6. 2003 RESTRUCTURING PLAN
In fiscal 2003, we incurred approximately $18.2 million of restructuring and
asset impairments relating to the closing of 316 Kmart stores. These charges
included approximately $15.7 million for inventory write-downs which have been
reflected in the consolidated statements of operations as a component of cost of
sales. The non-inventory amounts, which amounted to $2.5 million, included $1.9
million for severance costs and $0.6 million for asset impairments. Such costs
have been reflected in restructuring, asset impairment and other charges in the
accompanying consolidated statements of operations. All charges under the 2003
restructuring plan were paid during fiscal 2003.
7. 2002 RESTRUCTURING PLAN AND OTHER CHARGES
During fiscal 2002, we approved several plans in which we recorded net
restructuring, asset impairment and other charges (the "Charge") of $43.9
million principally in connection with our exiting various license arrangements
acquired in the J. Baker acquisition and the closing of certain Kmart stores.
The inventory portion of the Charge, which amounted to $29.1 million, has been
reflected in the consolidated statements of operations as a component of cost of
sales.
F-22
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The non-inventory amounts, which amounted to $14.8 million, net, have been
reflected as restructuring, asset impairment and other charges in the
accompanying consolidated statements of operations. In addition to the Charge,
net reversals of $(0.8) million were recorded during 2002 related to
restructuring and other charges recorded in fiscal 2001.
2002 2003
------------------------- ---------------
Initial
Charge Usage Balance Usage Balance
------- ----- ------- ----- -------
Non-cash components
Inventory write-downs $29.1 $29.1 $ -- $ -- $--
Lease exit costs 1.2 1.2 -- -- --
Asset impairment 7.9 7.9 -- -- --
----- ----- ---- ---- ---
Subtotal 38.2 38.2 -- -- --
Cash Components
Severance 4.6 3.5 1.1 1.1 $--
Store, building and lease exit
costs 1.1 1.1 -- -- --
----- ----- ---- ---- ---
Subtotal 5.7 4.6 1.1 1.1 --
----- ----- ---- ---- ---
Total $43.9 $42.8 1.1 1.1 $--
===== ===== ==== ==== ===
8. J. BAKER ACQUISITION
In February 2001, we completed the acquisition of the footwear assets of J.
Baker. The business operated 1,163 licensed footwear departments under 13
agreements with retail chains including Ames, Variety, Stein Mart, Today's Man
and Spiegel, Inc. The purchase price was allocated to the acquired assets and
liabilities assumed, both tangible and intangible, based upon valuations from
outside experts and certain management estimates.
The excess of the purchase price over the fair market value of the net assets
acquired amounted to $26.0 million, was recorded as goodwill and was being
amortized over 15 years. As discussed in Note 13, "Goodwill and Other Intangible
Assets," the remaining unamortized goodwill related to this acquisition, which
totaled $24.3 million, was written off in fiscal 2002. We have exited all of the
J. Baker businesses.
9. ACCOUNTS RECEIVABLE
Accounts receivable consisted of the following (in millions):
2004 2003
----- -----
Due from Kmart $17.5 $12.1
Other - primarily trade 5.0 4.8
22.5 16.9
Less: Allowance for doubtful accounts 0.4 0.3
----- -----
Total $22.1 $16.6
===== =====
F-23
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
On August 14, 2002, Ames announced that, as a result of continued weak sales, it
would cease operations and close all of its 327 store locations. We continued to
operate licensed footwear departments within Ames stores until all the stores
were closed in October 2002. As a result of Ames' decision to cease operations
and close all its stores, we recorded a charge in fiscal 2002 of $9.2 million as
a write off to bad debt expense in connection with the receivables from Ames
In fiscal 1998, we sold our right, title and interest in the trademark Land
Rover for a minimum payment of $5.0 million payable in 2004. Subsequent to the
sale, the acquiror filed for bankruptcy and the principal ownership of the
company changed. In July 2003, we began negotiating with the new owners of the
Land Rover trademark and revised the initial agreement to include certain
additional future rights to the use of the name in exchange for an additional
$0.4 million and the acceleration of the required $5.0 million payment. The
amended sale price of $5.4 million was paid in two installments of $2.7 million.
The first installment was paid in August 2003, and the second was paid in
January 2004. Based upon these revisions and due to our collection of all
amounts owed to us, we recorded the $5.4 million as other income in the
accompanying consolidated statements of operations during fiscal 2003 and
established a receivable for the final installment of $2.7 million.
10. PREPAID EXPENSES AND OTHER CURRENT ASSETS
Prepaid expenses and other current assets consisted of the following (in
millions):
2004 2003
----- -----
Deferred income taxes $ 2.7 $ 4.3
Income tax refund receivable and
other prepaid taxes 20.1 14.5
Other 5.6 4.3
----- -----
Total $28.4 $23.1
===== =====
See Note 21, "Income Taxes," for information on the deferred income taxes.
F-24
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. ASSETS AND LIABILITIES RELATED TO DISCONTINUED OPERATIONS
Assets and liabilities related to discontinued operations as of January 1, 2005
and January 3, 2004 consisted of the following (in millions). See Note 1
"Business Risks - Bankruptcy Filing," Note 3 "Discontinued Operations" and Note
15 "Liabilities Subject to Compromise" for a further discussion of Athletic
Segment liabilities. .
2004 2003
---- ------
ASSETS
Cash and cash equivalents $ -- $ 10.5
Accounts receivable, net 5.9 5.2
Inventories -- 167.6
Prepaid expenses and other current assets 0.3 2.5
Property and equipment, net -- 79.0
Goodwill -- 18.0
Intangible assets, net -- 0.3
Deferred charges and other non current assets -- 1.4
---- ------
$6.2 $284.5
==== ======
LIABILITIES
Accounts payable $ -- $ 41.3
Accrued expenses 3.5 57.4
Income taxes payable -- 0.1
Other long-term liabilities -- 11.7
---- ------
$3.5 $110.5
==== ======
12. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following (in millions):
Useful lives (in yrs.) 2004 2003
------------------------------ ------ ------
Land $ 3.2 $ 13.2
Buildings and improvements 10-40 21.1 65.5
Computer hardware and software, equipment and furniture 5-10 74.0 166.0
Capital leases 5-10 2.4 2.4
Leasehold improvements 10 or life of lease, whichever
is shorter 0.2 8.2
Construction in progress -- 0.7
------ ------
100.9 256.0
------ ------
Less: Accumulated depreciation and amortization 65.5 108.8
------ ------
Total $ 35.4 $147.2
====== ======
Depreciation expense was $21.1 million, $17.8 million and $16.6 million in 2004,
2003 and 2002, respectively.
F-25
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
13. GOODWILL AND OTHER INTANGIBLE ASSETS
FASB Statement No. 142 requires that goodwill and intangible assets with
indefinite useful lives no longer be amortized, but instead be tested for
impairment annually. Statement No. 142 also requires that intangible assets with
definite useful lives be amortized over their respective estimated useful lives
to their estimated residual values.
Statement No. 142 requires the annual testing for the impairment of goodwill at
a reporting unit level. The Standard also required a goodwill impairment test as
of the adoption date. We identified our reporting units under Statement No. 142
to be the Meldisco Segment and, prior to its sale, the Athletic Segment. We
maintained goodwill at the Meldisco Segment relating to the assets acquired from
J. Baker in the amount of $24.3 million. The fair value of these reporting units
was estimated using the present value of expected future cash flows or market
values of related businesses, where appropriate. We completed our impairment
test during the second quarter of fiscal year 2002 and determined that the $24.3
million of unamortized goodwill of the Meldisco Segment relating to the assets
acquired from J. Baker was impaired.
This impairment was the result of sequential periods of decreased operating
profit and the exit of most of the leases acquired. Accordingly, we recognized a
charge for the cumulative change of adopting the accounting standard as shown in
the accompanying consolidated statements of operations.
In connection with the adoption of Statement No. 142, we reassessed the useful
lives of our amortizable intangible assets; there were no changes from previous
years. Additionally, a trademark with a net book value of $9.9 million was
determined to have an indefinite useful life due to its expected ability to
generate cash flows indefinitely.
During fiscal year 2003, we evaluated the fair value of our intangible assets
and determined that certain trade names of approximately $1.1 million were
impaired and written off. During fiscal year 2004, we evaluated the fair value
of our intangible assets and determined that there were no changes from the
prior year and we continue to amortize a trade name with a carrying value of
$0.4 million over a ten year period.
14. ACCRUED EXPENSES
Accrued expenses consisted of the following (in millions):
2004 2003
----- -----
Rent $ -- $ 4.8
Taxes other than federal income taxes 7.7 7.6
Salaries and bonus 13.8 11.1
Other - individually not in excess of 5% 26.5 27.9
----- -----
Total $48.0 $51.4
===== =====
F-26
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
15. 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 in the Chapter 11
Cases. Pursuant to Court orders, we have been authorized to pay certain
pre-petition operating liabilities incurred in the ordinary course of business
and reject certain of our pre-petition obligations. We have 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 filed by
creditors are being reconciled and, if necessary, the Court will make a final
determination of allowable claims.
Liabilities subject to compromise as of January 1, 2005 consisted of the
following (in millions):
Accounts payable $ 75.9
Accrued expenses 69.8
Long-term liabilities 6.6
------
Total $152.3(a)
======
(a) Includes approximately $112.5 million of discontinued operations
liabilities subject to compromise.
16. THE AMENDED DIP AND EXIT CREDIT FACILITY
Effective March 4, 2004, we entered into a two year, $300.0 million senior
secured Debtor-in-Possession Credit Agreement ("DIP Credit Agreement") with a
syndicate of lenders co-led by Fleet National Bank ("Fleet") and GECC Capital
Markets Group, Inc. The DIP Credit Agreement was subsequently amended (the "DIP
and Exit Facility"), which, among other things, reduced the amount of DIP
commitments to $100.0 million, including a sub-limit for letters of credit with
availability determined by a borrowing base formula based upon inventory and
accounts receivable.
Pursuant to the DIP and Exit Facility, upon emergence from Chapter 11, we had
the option, subject to satisfaction of certain conditions, to convert the DIP
and Exit Facility to post-emergence financing, which would have provided us with
up to $160.0 million in revolving commitments, including a $75.0 million
sub-limit for letters of credit.
Effective July 1, 2005, we entered into an amendment to the DIP and Exit
Facility (the "Amended DIP and Exit Facility"). The Amended DIP and Exit
Facility, among other things, reflects a change in the maturity date for the
debtor-in-possession portion of the facility from the earlier of (a)(i) March 4,
2006 or (ii) fifteen days following confirmation of the Plan to the earlier of
(b)(i) October 31, 2006 or (ii) emergence from Chapter 11. The maturity date of
the exit portion of the Amended DIP and Exit Facility is the earlier of (c)(i)
thirty-six months after our emergence from Chapter 11 or (ii) March 4, 2009.
Borrowings under the Amended DIP and Exit Facility bear interest at the same
rates as under the DIP and Exit Facility.
Our borrowing availability under the Amended DIP and Exit Facility continues to
be determined by a formula based upon accounts receivable and inventory.
However, pursuant to the amendment, revolving commitments upon emergence from
Chapter 11 have been reduced from the aforementioned
F-27
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
$160.0 million to $100.0 million, including a $40.0 million sub-limit for
letters of credit at our option and upon satisfaction of certain conditions.
The conditions to be satisfied prior to emergence from Chapter 11 include the
absence of any default or event of default, confirmation of the Amended Plan and
occurrence of all conditions related thereto, resolution of all issues related
to our assumption of the Amended Master Agreement, our delivery of forward
looking projections acceptable to the lender illustrating required availability
levels. Borrowings under the Amended DIP and Exit Facility bear interest at
either Fleet's prime rate plus 0.0% to 0.5% or LIBOR plus 1.75% to 2.50%, at our
option, with the applicable margin based on quarterly excess availability
levels. A quarterly fee of 0.3% per annum is payable on the unutilized balance.
Pursuant to the Amended DIP and Exit Facility we are required to maintain
minimum excess availability equal to at least 10% of the borrowing base, as
defined, provided, however, that prior to our emergence from Chapter 11, in the
event that loans are outstanding, the minimum excess availability requirement
will be an amount equal to at least (i) 10% of the borrowing base plus (ii)
$20.0 million.
The Amended DIP and Exit 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, as
defined, including certain financial covenants and restrictions such as
limitations on additional indebtedness, other liens, dividends, stock
repurchases and capital expenditures.
After our emergence from Chapter 11, if minimum excess availability falls below
20% of the borrowing base, we will be subject to a fixed charge coverage
covenant. The Amended DIP and Exit Facility also includes representations and
warranties, that, on an ongoing basis, there are no material adverse events
affecting our business, operations, property, assets, or condition, and that the
Amended Master Agreement underlying the agreements that we maintain with Kmart
is in full force and effect and not in default.
A failure by us to satisfy any of the covenants, representations or warranties
would result in default or other adverse impact under the Amended DIP and Exit
Facility. Upon the request of the Company, the lenders have extended the time
for the delivery of the 2004 annual consolidated financial statements and
certain compliance certifications until we exit from Chapter 11.
As of January 1, 2005, we had no loans outstanding and $22.1 million of
outstanding letters of credit under the DIP and Exit Facility.
17. THE PRE-PETITION CREDIT FACILITY
Effective October 18, 2002, we entered into a three-year $325.0 million senior
secured credit facility (the "Credit Facility") with a syndicate of lenders led
by Fleet, which replaced our then existing $325.0 million senior revolving
credit facility.
F-28
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of September 24, 2003, the Company and the syndicate of lenders entered into
an amendment to the Credit Facility which, among other things, increased the
amount of the term loan portion of the Credit Facility to $90.0 million (with
the aggregate Credit Facility thereby increased to $345.0 million).
The Credit Facility was secured by substantially all our assets and contained
various obligations, affirmative and negative covenants, representations,
warranties, and events of default to which we were subject, all as specified in
the Credit Facility, including, among other things, certain financial covenants
as well as limits and restrictions on additional indebtedness, other liens,
dividends, stock repurchases, and capital expenditures.
As of January 3, 2004, there was $108.0 million outstanding under the Credit
Facility, excluding outstanding letters of credit amounting to $15.4 million,
and $90.0 million outstanding under the term loan. As borrowings under the
Credit Facility were repaid in fiscal 2004, such borrowings were classified as
current notes payable in the fiscal 2003 consolidated balance sheets. On March
4, 2004, we entered into the DIP Credit Agreement (See Note 16 "The Amended DIP
and Exit Credit Facility").
The Credit Facility had a weighted average interest rate of 8.7% on outstanding
borrowings as of January 3, 2004. The weighted average interest rate on
outstanding borrowings was 7.7% in fiscal 2003. Interest on the term loan was
fixed at 15.0% through September 24, 2004 and was thereafter subject to
fluctuating rates. A facility fee was paid based on the aggregate commitments.
Up-front fees paid were amortized over the life of the Credit Facility.
18. INTEREST RATE SWAP AGREEMENTS
We incurred variable rate debt through the revolving portion of our Credit
Facility. This debt exposed us to variability in interest expense due to changes
in interest rates. In order to limit the variability of a portion of our
interest expense, effective January 8, 2002, we entered into four interest rate
swap agreements with a total notional amount of $60.0 million and a weighted
average fixed rate of 3.6%. The four interest rate swap agreements expired on
January 8, 2004. For the year ended January 3, 2004, interest rate cash flow
hedges were highly effective. As of January 3, 2004, the fair value of the
interest rate swap is reflected in accrued expenses in the accompanying
consolidated balance sheet and totaled approximately $0.4 million.
For the year ended January 3, 2004, we recorded interest expense of $1.5 million
related to the interest rate swap agreements. There were no net gains or losses
from cash flow hedge ineffectiveness arising from differences between the
critical terms of the interest rate swap and the hedged debt obligation.
Since the interest rate swaps qualified as cash flow hedges and were determined
to be highly effective, the changes in the fair value were recorded in other
comprehensive loss. We do not enter into derivative instruments for any purpose
other than to manage our interest rate exposure. That is, we do not hold
derivative financial investments for trading or speculative purposes. No cash
flow hedges were discontinued during fiscal 2003.
F-29
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
19. OTHER LONG-TERM LIABILITIES
Other long-term liabilities consisted of the following (in millions):
2004 2003
----- -----
Employee benefit costs $32.8 $33.3
Kmart reserve -- 10.9
Mortgage -- 6.2
Other 5.7 8.5
----- -----
Total $38.5 $58.9
----- -----
In connection with our purchase of the Meldisco headquarters building in Mahwah,
New Jersey, in September 2000, we assumed a 10-year term mortgage, of which $7.1
million was outstanding as of both January 1, 2005 and January 3, 2004. As of
January 1, 2005, $5.6 million of the mortgage is included as a long-term
liability and $1.5 million is included as in accrued expense in liabilities
subject to compromise (see Note 15 "Liabilities Subject to Compromise"). Under
the terms of the mortgage agreement, we are required to make quarterly payments
of approximately $350,000, representing both principal and interest, through May
1, 2010, when the mortgage will be repaid.
The mortgage bears a fixed annual rate of interest of 8.08%. The long-term
portion of the mortgage is included in other long-term liabilities. As of
January 1, 2005, the future principal payments under the mortgage are as
follows:
2005 $1.8
2006 1.0
2007 1.1
2008 1.2
2009 1.3
Thereafter 0.7
20. LEASES
We leased a warehouse and office facilities through operating leases over
periods ranging from five to 15 years. We also lease automobiles, computer
hardware and various equipment for shorter periods. Net rental expense for all
operating leases for each of the fiscal years in the three-year period ended
January 1, 2005 was as follows (in millions):
2004 2003 2002
----- ----- --------
(Note 3) (Note 3)
Minimum rentals $ 6.8 $ 7.9 $ 13.3
Percentage rentals 67.3 84.7 142.5
----- ----- ------
Total $74.1 $92.6 $155.8
----- ----- ------
F-30
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Percentage rentals include excess rent fees under the Master Agreement, which,
prior to the Kmart Settlement, were contingently based on store profitability.
As of January 1, 2005, the future minimum rental payments under operating leases
were as follows (in millions):
2005 $2.9
2006 2.3
2007 1.7
2008 1.0
2009 0.3
21. INCOME TAXES
The (benefit) provision for income taxes was comprised of the following (in
millions):
2004 2003 2002
----- ----- -----
Federal $(3.3) $ 7.1 $59.4
State 0.4 2.9 11.5
----- ----- -----
Total $(2.9) $10.0 $70.9
----- ----- -----
Included in the consolidated (benefit) provision for income taxes are net
deferred tax (benefit) provision of $1.6 million, $(0.9) million and $50.8
million for the fiscal years ended January 1, 2005, January 3, 2004 and December
28, 2002, respectively.
Income tax (benefit) expense differs from the "expected" income tax (benefit)
expense computed by applying the U.S. federal income tax of 35% to income before
income taxes as follows (in millions):
2004 2003 2002
------ ----- ------
(Note 3) (Note 3)
Computed "expected" income tax (benefit) $(13.5) $ 8.0 $ 21.4
expense
Increases (decreases) in income taxes
resulting from:
State income taxes, net of
federal tax benefit 0.4 2.3 6.1
51% owned subsidiaries 4.6 (4.0) (13.2)
Other 0.1 0.1 0.1
Valuation allowance 5.5 3.6 56.5
------ ----- ------
Net income tax (benefit) expense $ (2.9) $10.0 $ 70.9
------ ----- ------
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes.
F-31
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Significant components of our deferred tax asset and liabilities for the 2004
and 2003 fiscal years were as follows (in millions):
2004 2003
------- ------
DEFERRED TAX ASSETS:
Bankruptcy rejection claims $ 20.1 $ --
Kmart Settlement Agreement 2.4 --
Restructuring reserves 0.4 1.6
Inventories 4.0 9.1
Postretirement benefits 10.9 11.3
Employee benefits 12.8 16.8
NOL carryforward 63.2 50.4
Intangible assets 6.2 9.3
Other 1.8 3.5
------- ------
Total gross deferred tax assets 121.8 102.0
Less valuation allowance (116.2) (94.9)
------- ------
Total deferred tax assets 5.6 7.1
DEFERRED TAX LIABILITIES:
Property and equipment (2.9) (2.8)
------- ------
NET DEFERRED TAX ASSETS $ 2.7 $ 4.3
------- ------
As of January 1, 2005, we have net operating loss carry forwards for federal
income tax purposes of approximately $164.2 million which, if not utilized, will
begin expiring for federal purposes in 2022 and in 2007 for state income tax
purposes. Utilization of the net operating loss carry forwards may be subject to
an annual limitation in the event of a change in ownership in future years as
defined by Section 382 of the Internal Revenue Code and similar state
provisions.
In assessing the realizability of deferred taxes, we consider whether it is more
likely than not that some portion or all of the deferred tax assets will not be
realized based on projections of our future taxable earnings. The ultimate
realization of deferred tax assets is dependent upon the generation of future
taxable income during the periods in which those temporary differences become
deductible.
As a result of our historical losses and projected results, for accounting
purposes we cannot rely on anticipated long term future profits to utilize
certain of our deferred tax assets. As a result, we could not conclude that it
is more likely than not that the deferred tax assets will be realized and have
recorded in fiscal year 2004 an additional non-cash valuation allowance of $21.4
million and recorded in fiscal 2003 an additional non-cash valuation allowance
of $24.7 million and in fiscal 2002 recorded $70.2 million.
Earnings of our 51%-owned subsidiaries are distributed and, accordingly, we
provide for federal and state income taxes on their undistributed taxable
earnings.
F-32
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
22. REORGANIZATION ITEMS
Reorganization items, which consist of income and expenses that are related to
our bankruptcy were comprised of the following for 2004 (in millions):
Store and distribution center closing and related asset impairment costs $24.5
Professional fees 7.9
Trustee fees 5.8
Interest income (1.1)
-----
Total $37.1
=====
SOP 90-7 requires that interest income earned on cash accumulated during
bankruptcy proceedings be included as a reorganization item. During fiscal 2004,
interest income of $1.1 million was earned on cash that would otherwise have
been used to pay such pre-petition liabilities.
23. STOCK INCENTIVE PLANS
Our stock incentive plans include the shareholder-approved 1996 Incentive
Compensation Plan (the "1996 Plan") and the shareholder-approved 1996
Non-Employee Director Stock Plan (the "Director Plan and the
non-shareholder-approved 2000 Equity Incentive Plan (the "2000 Plan"), which is
to be used exclusively for non-executive officers of the Company. Under the 1996
Plan, a maximum of 3,100,000 shares may be issued in connection with stock
options, restricted stock, deferred stock and other stock-based awards. Under
the 2000 Plan, a maximum of 2,000,000 shares may be issued in connection with
stock options, restricted stock, deferred stock and other stock-based awards. No
executive officers of the Company are eligible for awards under the 2000 Plan. A
total of 200,000 shares of our common stock were reserved for issuance under the
Director Plan.
Under both the 1996 Plan and the 2000 Plan, employee stock options may not be
awarded with an exercise price less than fair market value on the date of grant.
Generally, options are exercisable in installments of 20 percent beginning one
year from date of grant and expire ten years after the grant date, provided the
optionee continues to be employed by us.
We may grant deferred restricted stock units under both the 1996 Plan and the
2000 Plan. Deferred restricted stock units were granted to certain officers and
key employees. Restricted stock units vest generally five years from date of
grant, provided the executive continues to be employed by us.
In connection with the grant of these deferred restricted stock units, we
recorded a net increase to unearned compensation of $0 million, $0 million and
$0.3 million in fiscal 2004, 2003 and 2002, respectively. We amortized $0
million, $0 million and $0.4 million in 2004, 2003 and 2002, respectively, which
is recorded as a component of store operating, selling, general and
administrative expenses in the accompanying consolidated statements of
operations. We may also grant performance-based stock awards under both the 1996
Plan and the 2000 Plan. Performance-based stock awards include the granting of
deferred stock units, representing rights to receive cash and/or common stock of
the Company, at our discretion, based upon certain performance criteria
generally over a three-year performance period.
F-33
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
These performance-based stock awards vest over a period of time ranging from a
minimum of three years to a maximum of the employee's attainment of retirement
age. Compensation expense related to grants under these provisions is based on
the current market price of our common stock at the date of grant and the extent
to which performance criteria are being met. The 1996 Plan and 2000 Plan also
offer incentive opportunities based upon performance results against
pre-established earnings targets and other selected measures for each fiscal
year. We also make cash award payments which employees may elect to defer up to
75% of such payment in deferred shares and receive a matching Company grant. The
elective deferrals and matched amounts are deferred for a five year vesting
period. The amount deferred will be paid in shares.
In connection with the grant of these performance-based stock awards, we
recorded an increase to unearned compensation of $0 and $0.3 million in 2004 and
2003, respectively. We also amortized $0, $0.7 million and $0 into expense in
2004, 2003 and 2002, respectively, which is recorded as a component of store
operating, selling, general and administrative expenses in the accompanying
consolidated statements of operations. We made no payments in 2004, 2003 and
2002.
The following table provides information relating to the potential dilutive
effect and shares available for grant under each of our stock compensation
plans.
Number of
Shares to be Weighted
Issued upon Average Number of Shares Number of Shares Number of Shares
Exercise of Exercise Price Issued, Remaining Available Remaining Available
Outstanding of Outstanding Inception to Date for Future Issuance, for Future Issuance,
Plan Category Options/Awards Options as of 1/1/2005 as of 1/1/2005 as of 1/3/2004
------------- -------------- -------------- ----------------- -------------------- --------------------
1996 Incentive
Compensation Plan 596,676 $28 885,372 1,617,952 392,463
2000 Equity
Incentive Plan 474,099 $30 70,593 1,455,308 1,071,059
1996 Non-Employee
Director Stock Plan 119,350 $29 22,606 58,044 58,044
--------- --- ------- --------- ---------
Total 1,190,125 $29 978,571 3,131,304 1,521,566
========= === ======= ========= =========
The tables below provide information relating to employee stock options,
deferred restricted stock units and performance-based stock awards:
Employee Stock Options
----------------------------------------------------------------
2004 2003 2002
-------------------- ------------------- -------------------
EMPLOYEE AVERAGE Employee Average Employee Average
STOCK OPTION Stock Option Stock Option
OPTIONS PRICE Options Price Options Price
---------- ------- --------- ------- --------- -------
Outstanding,
beginning of year 2,374,836 $30 2,630,379 $30 2,286,050 $31
Granted -- -- -- -- 559,200 $26
Cancelled (1,500,101) $29 (255,543) $30 (179,061) $33
Shares issued -- -- -- -- (35,810) $22
Outstanding,
end of year 874,735 $30 2,374,836 $30 2,630,379 $30
---------- --------- ---------
Exercisable, end of year 662,098 1,449,251 1,114,457
---------- --------- ---------
F-34
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Deferred Restricted Stock Units and Shares and Performance-Based Stock Awards
-----------------------------------------------------------------------------
2004 2003 2002
-------------------- -------------------- --------------------
DEFERRED Deferred Deferred
SHARES AND AVERAGE Shares and Average Shares and Average
UNITS PRICE Units Price Units Price
---------- ------- ---------- ------- ---------- -------
Outstanding,
beginning of year 373,663 $23 427,739 $30 518,397 $29
Granted -- -- 119,273 $ 8 49,352 $26
Cancelled (109,620) $27 (119,583) $30 (54,000) $27
Shares issued (68,003) $24 (53,766) $29 (86,010) $27
-------- --- -------- --- ------- ---
Outstanding, end of year 196,040 $21 373,663 $23 427,739 $30
======== === ======== === ======= ===
Summarized information about stock options outstanding as of January 1, 2005 is
as follows:
Options Outstanding Options Exercisable
------------------------------------- ----------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Number Contractual Exercise Number Exercise
Exercise Price Range Outstanding Term (Years) Price Exercisable Price
-------------------- ----------- ------------ -------- ----------- --------
$7 - 9 -- -- -- -- --
$10 - 19 1,330 0.3 $12 820 $12
$20 - 29 550,570 4.2 $24 420,104 $24
$30 - 39 146,265 2.9 $33 124,644 $33
$40 - 47 176,570 5.1 $46 116,530 $46
------- --- --- ------- ---
Total 874,735 4.1 $30 662,098 $29
======= === === ======= ===
DIRECTOR STOCK PLAN
The Director Plan is intended to assist us in attracting and retaining highly
qualified persons to serve as non-employee directors. Any person who becomes an
eligible director receives an initial option to purchase 2,000 shares of common
stock. All options are awarded with an exercise price equal to the fair market
value of the common stock on the date of grant. Generally, options are
exercisable in installments of 20% beginning one year from date of grant and
expire ten years after the grant date, provided the non-employee director is
still a member of the board.
Commencing in 2003, the Director Plan also provides for automatic grants of
4,000 stock units ("Stock Units") to each non-employee director on the date of
the annual meeting of our shareholders. Prior to fiscal 2003, the Director Plan
provided for automatic amounts of 2,000 stock units. Each Stock Unit represents
the right to receive one share of our common stock at the end of a specified
period and vests six months and a day after the grant date. Fifty percent of
such Stock Units are payable upon vesting, provided the non-employee director
has not ceased to serve as a director for any reason other than death,
disability or retirement. The remaining fifty percent of such Stock Units are
payable upon the latter of ceasing to be a director or attaining age 65,
provided that settlement of such Stock Units shall be accelerated in the event
of death, disability or a change in control.
F-35
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following tables provide information relating to the status of, and changes
in, options and Stock Units granted under the Director Plan:
Director Plan Stock Options
---------------------------------------------------------
2004 2003 2002
----------------- ----------------- -----------------
AVERAGE Average Average
STOCK OPTION Stock Option Stock Option
OPTIONS PRICE Options Price Options Price
------- ------- ------- ------- ------- -------
Outstanding, at beginning of year 16,000 $26 16,000 $26 16,000 $26
Granted -- -- -- -- -- --
Shares Issued -- -- -- -- -- --
------ --- ------ --- ------ ---
Outstanding, at end of year 16,000 $26 16,000 $26 16,000 $26
====== === ====== === ====== ===
Options exercisable, at end of year 16,000 15,200 14,400
Director Plan Stock Units
----------------------------------------------------------
2004 2003 2002
------------------ ------------------ ----------------
AVERAGE Average Average
STOCK UNIT Stock Unit Stock Unit
UNITS(1) PRICE Units(1) Price Units Price
-------- ------- -------- ------- ------ -------
Outstanding, at beginning of year 66,000 $32 66,000 $32 56,000 $33
Granted -- N/A -- N/A 14,000 27
Shares Issued -- N/A -- N/A (4,000) 27
------ --- ------ --- ------ ---
Outstanding, at end of year 66,000 $32 66,000 $32 66,000 $32
====== === ====== === ====== ===
(1) Since there was no annual meeting in fiscal 2004 or 2003 no Stock Units
were granted.
ASSOCIATE STOCK PURCHASE PLAN
An Associate Stock Purchase Plan ("ASPP") provides substantially all employees
who have completed service requirements an opportunity to purchase shares of our
common stock through payroll deductions, up to 10% of eligible compensation to a
maximum of $25,000 (in fair market value of common stock purchased) annually.
Quarterly, participant account balances are used to purchase shares of stock at
85% of the lower of the fair market value of the shares at the beginning of the
offering period or the purchase date. A total of 1,600,000 shares were available
for purchase under the plan, with 949,768 available as of January 1, 2005. There
were 0, 180,276 and 168,187 shares purchased under this plan in fiscal years
2004, 2003 and 2002, respectively.
On December 29, 2003, the New York Stock Exchange ("NYSE") suspended trading in
our common stock and, at a later date, our common stock was delisted. As a
result of the NYSE action, we have suspended purchases of our common stock
through the ASPP effective December 29, 2003.
24. TREASURY STOCK
From May 1997 through the end of fiscal year 2002, our Board of Directors
authorized five stock repurchase programs of approximately 3,050,000, 3,000,000,
2,450,000, 2,210,000 and 2,000,000 shares. As of January 1, 2005, an aggregate
of 11,218,200 shares for an aggregate purchase amount of $325.3 million, or
approximately 37% of the total common stock outstanding prior to the repurchase
programs, have been repurchased in the open market during this period.
F-36
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The treasury shares may be used under our equity incentive plans and for other
corporate purposes. During fiscal years 2004 and 2003, we issued no shares out
of treasury in connection with our stock incentive plans.
25. 401(K) PROFIT SHARING PLAN
We have a tax qualified 401(k) Profit Sharing Plan available to full-time
employees who meet the plan's eligibility requirements. This plan, which is also
a defined contribution plan, contains a profit sharing component, with
tax-deferred contributions to each employee based on certain performance
criteria, and also permits employees to make contributions up to the maximum
limits allowed by the Internal Revenue Code Section 401(k).
Under the 401(k) profit sharing component, we match a portion of the employee's
contribution under a pre-determined formula based on the level of contribution
and years of vesting service. Our contributions to the plan are made in cash.
Our stock is not used to fund the plan, nor is it an investment option for
employees under the plan.
Contributions to the plan by us for both profit sharing and matching of employee
contributions were approximately $ 1.9 million, $2.3 million and $2.6 million
for fiscal years 2004, 2003 and 2002, respectively.
26. POSTRETIREMENT BENEFITS
We provide postretirement health benefits for current retirees and a "closed"
group of active employees who meet certain eligibility requirements. For an
active employee to be eligible for future retiree medical benefits, they must
meet all of the following criteria:
- have a minimum of 10 years of full time active service as of December
31, 1992, and have been enrolled in the medical plan on that date,
- have continuously participated in the medical plan since that date,
and,
- continue employment with us until at least age 60, or have been
terminated by us involuntarily due to job elimination and had a
minimum of 30 years of continuous service and be at least 50 years of
age on the actual termination date.
F-37
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table represents our change in benefit obligations (in
millions):
2004 2003
----- -----
Benefit obligation at beginning of year $21.5 $19.8
Service cost 0.2 0.3
Interest cost 1.0 1.3
Amendments (1.9) --
Actuarial (gain) loss (1.6) 1.4
Benefits paid (1.4) (1.6)
Participant contributions 0.3 0.3
----- -----
Benefit obligation at end of year 18.1 21.5
Unrecognized net actuarial gain 2.0 0.5
Unrecognized prior service cost 7.8 7.3
----- -----
Accrued benefit cost (unfunded) $27.9 $29.3
----- -----
2004 2003
---- ----
Weighted-average assumptions as of
December 31
Discount Rate 5.5% 6.25%
---- ----
Effective January 1, 2004, deductibles, office visits, co-payments and
out-of-pocket maximums were revised. In addition, prescription drugs were
replaced with co-insurance levels subject to a minimum co-payment amount.
For measurement purposes, an 11.5% annual rate of increase in the per capita
cost of covered health care benefits was assumed for fiscal year 2004. The rate
was assumed to decrease gradually to 5.0% for fiscal year 2013 and remain at
that level thereafter. The components of our net periodic benefit cost were as
follows (in millions):
2004 2003 2002
----- ----- -----
Service cost $ 0.2 $ 0.3 $ 0.3
Interest cost 1.0 1.3 1.3
Amortization of prior service cost (1.4) (1.3) (1.2)
Recognized net actuarial gain (0.2) -- (0.2)
----- ----- -----
Net periodic benefit cost $(0.4) $ 0.3 $ 0.2
----- ----- -----
Assumed health care cost trend rates have a significant effect on the amounts
reported for the health care plans. A one-percentage point change in assumed
health care cost trend rates would have the following effects:
1-PERCENTAGE 1-PERCENTAGE POINT
POINT INCREASE DECREASE
-------------- -------------------
Effect on total of service and interest cost
components 0.2 (0.1)
Effect on postretirement benefit obligation 2.3 (1.9)
--- ----
F-38
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Our estimate of our future postretirement health benefit payments, net of
participant contributions and estimated medical drug subsidies of approximately
$2.4 million for 2006 through 2014, is as follows (in millions):
2005 $ 1.2
2006 1.1
2007 1.1
2008 1.1
2009 1.1
2010-2014 6.0
-----
$11.6
=====
27. SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN
We have an unfunded Supplemental Executive Retirement Plan ("SERP"). The SERP is
designed to provide competitive retirement benefits to selected executives with
at least ten years of credited service.
The major provisions and assumptions of the SERP are:
- The normal retirement benefit commencing at age 60 is equal to 2% of
the average of the three highest salary amounts received by the
executive in the preceding ten years, plus the target annual
incentive, as defined, for each full year of service with the Company.
In the case of retirement before age 60, a reduced benefit is
provided.
- The maximum annual benefit available under the plan is 50% of
compensation, as defined.
- The benefits are generally payable in annual installments for the life
of the executive, but, other forms of payment equivalent to actuarial
value may be elected.
- The assumed discount rate was 6.25% and 6.75% in fiscal 2004 and 2003,
respectively.
- The assumed salary rate of increase was 5.0% in both fiscal 2004 and
2003.
Expense (income) related to the SERP was $1.0 million, $(5.3) million and $1.5
million in fiscal years 2004, 2003 and 2002, respectively. The SERP liability
was approximately $4.5 million and $3.5 million as of January 1, 2005 and
January 3, 2004, respectively.
Effective September 12, 2003, J.M. Robinson was terminated as Chairman,
President and Chief Executive Officer of the Company as a result of the
investigation of the restatement. Mr. Robinson is no longer eligible for
benefits under the SERP. Accordingly, during fiscal 2003 we reduced our SERP
liability by $7.2 million in connection with his termination (see Note 28
"Commitments and Contingencies").
28. COMMITMENTS AND CONTINGENCIES
On the Petition Date, we commenced the Chapter 11 Cases under the Bankruptcy
Code. We have continued to manage our business as debtors-in-possession, subject
to the supervision of the Court and in accordance with the provisions of the
Bankruptcy Code.
F-39
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
An immediate effect of the filing of the Chapter 11 Cases was the imposition of
the automatic stay under section 362 of the Bankruptcy Code, which, with limited
exceptions, enjoins the commencement or continuation of all collection efforts
by creditors, enforcement of liens against any assets of the Company and
litigation against us arising prior to the Petition Date. However, the automatic
stay is applicable only to litigation against us, and not against any of our
officers and directors.
Restatement Related Litigation
Prior to our November 13, 2002 announcement that management had discovered
discrepancies in the reporting of our accounts payable balances, we notified the
Staff of the SEC concerning the discovery of the accounting discrepancies.
Following that notification, the SEC began an enforcement proceeding captioned,
In the Matter of Footstar, Inc., MNY-7122, including an investigation into the
facts and circumstances giving rise to the discrepancies. On November 25, 2003
the SEC issued a Formal Order in that enforcement proceeding, authorizing an
investigation and empowering certain members of the SEC staff to take certain
actions in the course of the investigation, including requiring testimony and
the production of documents. We cannot predict the outcome of this proceeding.
The enforcement investigation includes determining whether the Company and
certain of its present or former directors, officers and employees may have
engaged in violations of the federal securities laws in connection with: the
purchase or sale of the securities of the Company; required filings with the
SEC; maintenance of our books, records and accounts; implementation and
maintenance of internal accounting controls; making of false or misleading
statements or omissions in connection with required audits or examinations of
our consolidated financial statements or the preparation and filing of documents
or reports we are required to file with the SEC. We have been and intend to
continue cooperating fully with the SEC.
The Company and certain of its directors and officers were defendants in two
derivative suits (consolidated into a single action as described below) and
several purported class action lawsuits (also consolidated into a single action
as described below) alleging violations of federal securities laws and breaches
of fiduciary duties. Messrs. Stearns, Day, Davies and Olshan, members of the
Company's Board of Directors, and J.M. Robinson, its former Chairman, President
and Chief Executive Officer, Stephen Wilson, an officer of the Company, were
named as defendants in two derivative complaints filed by individual shareowners
on behalf of the Company, one in the United States District Court for the
Southern District of New York and one in the Supreme Court of the State of New
York, Rockland County. In New York, the Supreme Court is a trial level court.
The complaints alleged that these directors and officers breached their
fiduciary duties to us by failing to implement and maintain an adequate internal
accounting control system, sought unspecified damages against the defendants in
and in favor of the Company, as well as costs and expenses associated with
litigation. These complaints were consolidated in a single action in the United
States District Court for the Southern District of New York captioned Barry Lee
Bragger v J.M. Robinson, et al., Civil Action No. 02 Civ. 9163 (SCR).
With Court approval, Footstar and the relevant parties mutually agreed to
resolve the claims made in the derivative complaints without any admission of
liability, for $9.2 million, all of which has been funded with insurance
proceeds paid to us. This amount has been recorded as other income in the
accompanying fiscal 2004 statement of operations. An order has been issued by
the court before which this litigation was pending dismissing the matter with
prejudice.
F-40
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company and certain of its directors and officers were defendants in several
purported shareholder class action lawsuits for alleged violations of securities
laws. These actions sought unspecified monetary damages and costs and expenses
associated with the litigation. These initial complaints allege that beginning
mid-May 2000, the Company and its officers named above misrepresented our
financial performance. The cases were consolidated into a single action in the
United States District Court for the Southern District of New York, captioned,
Stephen Rush v. Footstar, Inc., et al., 02 Civ. 9130 (SRC) (Consolidated).
Footstar and the named plaintiffs mutually agreed to resolve the claims made in
the several purported class action lawsuits, without any admission of liability,
for the amount of $14.3 million, all of which was funded with insurance
proceeds. On June 14, 2005, the court approved the settlement and dismissed the
action with prejudice.
Proceedings Involving Kmart
In connection with the Kmart Settlement, all outstanding litigation between
Kmart and us has been settled. See Note 5 "Meldisco's Relationship with Kmart."
Adidas Litigation
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 seeks injunctive relief and unspecified monetary damages for 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 alleges infringes on its registered three
stripe trademark. While it is too early in litigation to predict the outcome of
the claims against us, we believe that we have meritorious defenses to the
claims asserted by Adidas and have filed an answer denying the allegations.
Other Litigation Matters
Mr. Robinson's employment as our Chairman, President and Chief Executive Officer
was terminated on September 12, 2003. Mr. Robinson had an employment agreement
with us and initiated arbitration proceedings against us for benefits under such
agreement. In July 2004, the parties agreed to settle such matter for $5.1
million. This amount was accrued in fiscal 2003, and was offset by the reversal
of his $7.2 million SERP liability. See Note 27 "Supplemental Executive
Retirement Plan."
We are involved in other various 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
Pursuant to the FMI Agreement, we are obligated to pay to FMI a minimum of $15.1
million in both 2005 and 2006.
F-41
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
29. SUPPLEMENTAL CASH FLOW INFORMATION
Cash payments for income taxes and interest from continuing operations for the
fiscal years ended January 1, 2005, January 3, 2004 and December 28, 2002 were
as follows (in millions):
2004 2003 2002
----- ----- -----
(Note 3) (Note 3)
Income taxes $ 1.2 $ 4.9 $24.7
Interest $10.2 $16.1 $ 8.6
----- ----- -----
30. VENDOR CONCENTRATION
In general, the retailing business is highly competitive. Price, quality and
selection of merchandise, reputation, store location, advertising and customer
service are important competitive factors in our business. In fiscal 2004,
approximately 96% of Meldisco's products were manufactured in China.
F-42
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
31. SUMMARY OF QUARTERLY RESULTS - UNAUDITED
(in millions, except per share data) 1ST QTR 2ND QTR 3RD QTR(2) 4TH QTR(3)
------------------------------------ ------- ------- ---------- ----------
NET SALES(1)
2004 $176.9 $216.5 $186.0 $220.8
2003 $232.8 $250.0 $225.1 $254.5
GROSS PROFIT(1)
2004 $ 55.4 $ 72.5 $ 49.0 $ 87.5
2003 $ 66.2 $ 86.9 $ 69.2 $ 89.8
(LOSS) INCOME FROM CONTINUING OPERATIONS(1)
2004(6)(7) $(11.9) $ (7.7) $ (8.4) $ 3.3
2003(2)(3)(4) $ (2.5) $ 15.9 $ 6.2 $(23.9)
(LOSS) INCOME FROM DISCONTINUED
OPERATIONS(1)
2004 $(46.9) $ 3.6 $ (7.3) $ 5.3
2003(5) $ (8.4) $ (6.2) $ (5.4) $(30.1)
NET (LOSS) INCOME
2004 $(58.8) $ (4.1) $(15.8) $ 8.7
2003 $(10.9) $ 9.7 $ 0.8 $(54.0)
(LOSS) EARNINGS PER SHARE(8)
2004 Basic
Continuing operations $(0.57) (0.38) $(0.41) $ 0.16
Discontinued operations (2.29) 0.18 (0.36) 0.26
Net (loss) income $(2.86) $(0.20) $(0.77) $ 0.42
2004 Diluted
Continuing operations $(0.57) $(0.38) $(0.41) $ 0.16
Discontinued operations (2.29) 0.18 (0.36) 0.26
Net (loss) income $(2.86) $(0.20) $(0.77) $ 0.42
2003 Basic
Continuing operations $(0.12) $ 0.77 $ 0.29 $(1.15)
Discontinued operations (0.41) (0.30) (0.26) (1.47)
Net (loss) income $(0.53) $ 0.47 $ 0.03 $(2.62)
2003 Diluted
Continuing operations (0.12) $ 0.77 0.29 $(1.15)
Discontinued operations (0.41) (0.30) (0.26) (1.47)
Net (loss) income $(0.53) $ 0.47 $ 0.03 $(2.62)
(1) The Athletic Segment, which consisted of certain Footaction stores sold to
Foot Locker together with the closure of the underperforming Just For Feet
and Footaction stores and the exited Meldisco businesses have been
accounted for as discontinued operations.
(2) During the first quarter of 2003, we recorded restructuring and asset
impairment charges totaling $18.2 million related to inventory write-downs,
employee severance and asset impairments in connection with the closing of
316 Kmart stores.
F-43
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(3) During the third quarter of 2003, we recorded a reversal of SERP liability
of $7.2 million and other income of $5.4 million related to the Land Rover
trademark.
(4) During the fourth quarter of 2003, we recorded charges totaling $14.5
million related to the write-off of deferred financing costs, returns and
allowances, fixed assets and taxes other than income taxes.
(5) During the fourth quarter of 2003, we recorded charges in discontinued
operations totaling $10.5 million related to the write-off of Just For Feet
intangible assets and the write-down of inventory.
(6) During the fourth quarter of 2004, we recorded a $6.2 million charge in
connection with the Kmart Settlement.
(7) During the fourth quarter of 2004, we recorded $9.2 million as other income
in connection with the settlement of our derivative action lawsuits.
(8) Computations for each quarter are independent. EPS data would neither be
restated retroactively nor adjusted currently to obtain quarterly (or other
period) amounts to equal the amount computed for the year to date due to
fluctuations in stock price.
F-44
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
FOOTSTAR, INC.
By /s/ DALE W. HILPERT
-------------------------------------
DALE W. HILPERT
Chairman of the Board,
Chief Executive Officer and President
Pursuant to the requirements of the Securities Act of 1934, this report has
been signed by the following persons in the capacities and on the date
indicated.
Signature Title Date
--------- ----- ----
/s/ DALE W. HILPERT Chairman of the Board and September 26, 2005
---------------------------- Chief Executive Officer
Dale W. Hilpert (Principal Executive
Officer)
/s/ NEELE E. STEARNS, JR. Interim Vice Chairman and September 26, 2005
---------------------------- Director
Neele E. Stearns, Jr.
/s/ JEFFREY A. SHEPARD Executive Vice President September 26, 2005
---------------------------- and Director
Jeffrey A. Shepard
/s/ RICHARD L. ROBBINS Senior Vice President September 26, 2005
---------------------------- Financial Reporting and
Richard L. Robbins Control (Principal Financial
Officer and Principal
Accounting Officer)
/s/ ROBERT A. DAVIES, III Director September 26, 2005
----------------------------
Robert A. Davies, III
/s/ GEORGE S. DAY Director September 25, 2005
----------------------------
George S. Day
/s/ STANLEY P. GOLDSTEIN Director September 26, 2005
----------------------------
Stanley P. Goldstein
/s/ BETTYE MARTIN MUSHAM Director September 26, 2005
----------------------------
Bettye Martin Musham
/s/ KENNETH S. OLSHAN Director September 26, 2005
----------------------------
Kenneth S. Olshan
84
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
Valuation and Qualifying Accounts for the Fiscal Years ended
January 1, 2005, January 3, 2004 and December 28, 2002
(in millions)
Schedule II
Additions
Balance at Charged to
Beginning Costs and Balance at
Description of Fiscal Year Expenses(1) Deductions(2)(3) End of Fiscal Year
----------- -------------- ----------- ---------------- ------------------
Fiscal Year Ended January 1, 2005
Allowance for Doubtful Accounts $0.3 $0.1 $ -- $0.4
Aged Inventory Reserve $1.0 $ -- $ (0.9) $0.1
Allowance for Sales Returns $1.8 $ -- $ (0.6) $1.2
Fiscal Year Ended January 3, 2004
Allowance for Doubtful Accounts $2.3 $0.2 ($2.2) $0.3
Aged Inventory Reserve $0.5 $0.5 -- $1.0
Allowance for Sales Returns $0.4 $1.4 -- $1.8
Fiscal Year Ended December 28, 2002
Allowance for Doubtful Accounts $1.9 $9.7(1) $ (9.3) $2.3
Aged Inventory Reserve $0.9 -- ($0.4) $0.5
Allowance for Sales Returns $0.5 -- ($0.1) $0.4
This Schedule II reflects continuing operations only.
(1) Additions include $9.2 million of expense relating to uncollectible
receivables from Ames Department Stores.
(2) Deductions of allowance for doubtful accounts include write-offs, net of
recoveries.
(3) We determine the aged inventory reserve and allowance for sales returns as
of the end of each reporting period. Accordingly, the above schedule
reflects net additions (deductions) for each period, as applicable.
85
EXHIBIT INDEX
Exhibit
Number DESCRIPTION
-------- -----------
2.1 Form of Distribution Agreement among Melville Corporation
("Melville"), Footaction Center, Inc., and Footstar, Inc.
(incorporated by reference to Exhibit 2.1 to Footstar, Inc.'s Form
10/A Information Statement filed on September 13, 1996).
3.1 Amended and Restated Certificate of Incorporation of Footstar, Inc.
(incorporated by reference to Exhibit 3.1 to Footstar, Inc.'s Form
10/A Information Statement filed on September 13, 1996).
3.2 Bylaws of Footstar, Inc. (incorporated by reference to Exhibit 3.2(a)
to Footstar, Inc.'s Annual Report on Form 10-K filed on March 30,
2001).
4.1 Rights Agreement, dated as of March 8, 1999, between Footstar, Inc.
and Chase Mellon Shareholder Services, L.L.C. (now Mellon Investor
Services LLC), as Rights Agent, which includes, as Exhibit A, the
Certificate of Designation, Preferences and Rights of Series A Junior
Participating Preferred Stock of Footstar, Inc., as Exhibit B, the
Form of Right Certificate, and as Exhibit C, the Summary of Rights to
Purchase Preferred Shares (incorporated by reference to Exhibit 1 to
Footstar, Inc.'s Form 8-A filed on March 9, 1999) and Amendment No. 1
dated as of May 31, 2002 (incorporated by reference to Exhibit 2 to
Footstar, Inc.'s Form 8-A filed on June 4, 2002).
10.1 Master Agreement, dated as of June 9, 1995, as amended, between the
Kmart Corporation and Footstar, Inc. (incorporated by reference to
Exhibit 10.1 to Footstar, Inc.'s Form 10/A Information Statement
filed on May 24, 1996 and the exhibits filed with Exhibit 10.1 to
Footstar, Inc.'s Form 10/A Information Statement filed on July 23,
1996. Certain portions of these Exhibits have been accorded
confidential treatment).
10.1(a) Amended and Restated Master Agreement dated as of August 24, 2005 by
and between Kmart Corporation, Sears Holding Corporation as guarantor
of payments to be made by Kmart Corporation and Footstar, Inc.
(incorporated by reference to Exhibit 10.1 to Footstar, Inc.'s
Current Report on From 8-K filed on August 26, 2005).
10.2 Form of Tax Disaffiliation Agreement between Melville and Footstar,
Inc. (incorporated by reference to Exhibit 10.2 to Footstar, Inc.'s
Form 10/A Information Statement filed on September 13, 1996).
10.3 1996 Incentive Compensation Plan of Footstar, Inc. (incorporated by
reference to Exhibit 10.3 to Footstar, Inc.'s Form 10/A Information
Statement filed on September 13, 1996).*
10.4 1996 Non-Employee Director Stock Plan of Footstar, Inc. (incorporated
by reference to Exhibit 10.4 to Footstar, Inc.'s Form 10/A
Information Statement filed on September 13, 1996).*
10.5 Motion of the Registrant to Assume the Employment Contract with Dale
W. Hilpert and Establish a Retention Plan for Key Employees with
Related Orders Dated May 6, 2004 and May 27, 2004 (incorporated by
reference to Exhibit 10.5 of Footstar, Inc.'s 2002 Annual Report on
Form 10-K filed on September 3, 2004).*
86
Exhibit
Number DESCRIPTION
-------- -----------
10.5(a) Amended and restated Employment Agreement for Dale W. Hilpert as
amended by Court order dated May 27, 2004 (incorporated by reference
to Exhibit 10.5(a) of Footstar, Inc.'s 2003 Annual Report on Form
10-K filed on April 8, 2005).*
10.5(b) Employment Agreement with Neele E. Stearns, Jr. (incorporated by
reference to Exhibit 99.2 to Footstar, Inc.'s 8-K filed on February
18, 2004). *
10.5(c) Employment Agreement with Stephen R. Wilson (incorporated by
reference to Exhibit 10.5(d) of Footstar, Inc.'s 2002 Annual Report
on Form 10-K filed on September 3, 2004).*
10.5(d) Settlement Agreement with J.M. Robinson (incorporated by reference to
Exhibit 99.2 to Footstar, Inc.'s Form 8-K filed on July 7, 2004).*
10.5(e) Agreement and General Release with R. Shawn Neville (incorporated by
reference to Exhibit 10.5(k) of Footstar, Inc.'s 2002 Annual Report
on Form 10-K filed on September 3, 2004).*
10.5(f) Agreement and General Release with Mark G. Morrison (incorporated by
reference to Exhibit 10.1 to Footstar Inc.'s Form 8-K filed on
February 22, 2005).*
10.5(g) Agreement and General Release with James DeVeau (incorporated by
reference to Exhibit 10.5(g) of Footstar, Inc.'s 2003 Annual Report
on Form 10-K filed on April 8, 2005).*
10.5(h) Confidentiality and Non-Competition Agreement with Jeff Shepard
(incorporated by reference to Exhibit 10.5(h) of Footstar, Inc.'s
2003 Annual Report on Form 10-K filed on April 8, 2005).*
10.5(i) Confidentiality and Non-Competition Agreement with Maureen Richards
(incorporated by reference to Exhibit 10.5(i) of Footstar, Inc.'s
2003 Annual Report on Form 10-K filed on April 8, 2005).*
10.5(j) Confidentiality and Non-Competition Agreement with Richard Robbins
(incorporated by reference to Exhibit 10.5(j) of Footstar, Inc.'s
2003 Annual Report on Form 10-K filed on April 8, 2005).*
10.5(k) Amendment to Employment Agreement with Dale W. Hilpert (incorporated
by reference to Footstar, Inc.'s Current Report on Form 8-K filed on
January 28, 2005).*
10.6 Footstar Deferred Compensation Plan (incorporated by reference to
Exhibit 10.8 to Footstar, Inc.'s 1996 Annual Report on Form 10-K
filed on March 28, 1997).*
10.7(a) Supplemental Retirement Plan for Footstar, Inc., as Amended and
Restated effective on June 19, 2002 (incorporated by reference to
Exhibit 10.9(a) to Footstar, Inc.'s Quarterly Report on Form 10-Q
filed on August 13, 2002).*
10.7(b) Compensation program covering executive officers (incorporated by
reference to Footstar, Inc.'s Current Report on Form 8-K filed on
December 20, 2004). *
10.7(c) Performance Criteria under 2005 Annual Bonus Plan (incorporated by
reference to Footstar, Inc.'s Current Report on Form 8-K filed on
January 28, 2005). *
87
Exhibit
Number DESCRIPTION
-------- -----------
10.8(a) Credit Agreement, dated as of October 18, 2002, by and among
Footstar, Inc., Footstar Corporation, the Lenders listed therein,
Fleet National Bank, as Swingline Lender and Administrative Agent,
Fleet Retail Finance, Inc., as Collateral Agent, Congress Financial
Corporation and Wells Fargo Retail Finance, LLC, as Syndication
Agents and JPMorgan Chase Bank, as Documentation Agent ("Credit
Agreement") (incorporated by reference to Exhibit 99.1 of Footstar,
Inc.'s Current Report on Form 8-K filed on October 23, 2002).
10.8(b) Amendment No. 1, dated as of January 3, 2003, to Credit Agreement
(incorporated by reference to Exhibit 10.2 of Footstar, Inc.'s
Current Report on Form 8-K filed on September 16, 2003).
10.8(c) Amendment No. 2, dated as of March 21, 2003, to Credit Agreement
(incorporated by reference to Exhibit 10.3 of Footstar, Inc.'s
Current Report on Form 8-K filed on September 16, 2003).
10.8(d) Amendment No. 3, dated as of June 28, 2003, to Credit Agreement
(incorporated by reference to Exhibit 10.6 of Footstar, Inc.'s
Current Report on Form 8-K filed on September 16, 2003).
10.8(e) Amendment No. 4, dated as of September 24, 2003, to Credit Agreement
(incorporated by reference to Exhibit 99.1 of Footstar, Inc.'s
Current Report on Form 8-K filed on September 29, 2003).
10.8(f) Amendment No. 5 dated as of October 31, 2003 to Credit Agreement
(incorporated by reference to Exhibit 99.1 of Footstar, Inc.'s
Current Report on Form 8-K filed on November 3, 2003).
10.8(g) Amendment No. 6 dated as of January 30, 2004 to Credit Agreement
(incorporated by reference to Exhibit 10.8(g) of Footstar, Inc.'s
2002 Annual Report on Form 10-K filed on September 3, 2004).*
10.8(h) Amendment No. 7 dated as of February 11, 2004 to Credit Agreement
(incorporated by reference to Exhibit 10.8(h) of Footstar, Inc.'s
2002 Annual Report on Form 10-K filed on September 3, 2004).*
10.8(i) Waiver, dated as of November 12, 2002, to Credit Agreement
(incorporated by reference to Exhibit 10.1 of Footstar, Inc.'s
Current Report on Form 8-K filed on September 16, 2003).
10.8(j) Waiver, dated as of April 30, 2003, to Credit Agreement (incorporated
by reference to Exhibit 10.4 of Footstar, Inc.'s Current Report on
Form 8-K filed on September 16, 2003).
10.8(k) Waiver, dated as of May 29, 2003, to Credit Agreement (incorporated
by reference to Exhibit 10.5 of Footstar, Inc.'s Current Report on
Form 8-K filed on September 16, 2003).
10.10 Asset Purchase Agreement, dated as of February 16, 2000, by and among
Footstar, Inc. and Just For Feet, Inc., Just For Feet of Nevada,
Inc., Sneaker Stadium Inc., Just For Feet of Texas, Inc., Just For
Feet Specialty Stores, Inc., SNKR Holding Corp. and Athletic Attic
Marketing, Inc. (incorporated by reference to Exhibit 10.10 to
Footstar, Inc.'s Current Report on Form 8-K filed on March 22, 2000).
10.11 2000 Equity Incentive Plan (incorporated by reference to Exhibit
10.11 to Footstar, Inc.'s 1999 Annual Report on Form 10-K filed on
March 31, 2000). *
88
Exhibit
Number DESCRIPTION
-------- -----------
10.12 Asset Purchase Agreement, dated as of November 16, 2000, by and among
Footstar Corporation, J. Baker, Inc., JBI, Inc. and Morse Shoe, Inc.
(incorporated by reference to Exhibit 10.13 to Footstar, Inc.'s 2000
Annual Report on Form 10-K filed on March 30, 2001).
10.13(a) Debtor-In-Possession Credit Agreement dated as of March 4, 2004 among
Footstar, Inc., as Lead Borrower for Footstar, Inc. and Footstar
Corporation; the Lenders party thereto, Fleet National Bank, as
Administrative Agent and Swingline Lender; Fleet Retail Group, Inc.
as collateral Agent; General Electric Capital Corporation and
Congress Financial Corporation , as Syndication Agents; Back Bay
Capital Funding LLC, as Term Agent; and JP Morgan Chase Bank and
Wells Fargo Foothill, LLC, as Documentation Agents (incorporated by
reference to Exhibit 10.13(a) of Footstar, Inc.'s 2002 Annual Report
on Form 10-K filed on September 3, 2004).*
10.13(b) Amended and Restated Debtor-In-Possession Credit Agreement dated as
of May 11, 2004 among Footstar, Inc., as Lead Borrower for Footstar,
Inc. and Footstar Corporation; the Lenders party thereto; Fleet
National Bank, as Administrative Agent and Swingline Lender; Fleet
Retail Group , Inc., as Collateral Agent; General Electric Capital
Corporation as Syndication Agent; and Wells Fargo Foothill, LLC as
Documentation Agent (incorporated by reference to Exhibit 10.13(b) of
Footstar, Inc.'s 2002 Annual Report on Form 10-K filed on September
3, 2004).
10.13(c) Amended and Restated Debtor-In-Possession and Exit Credit Agreement
dated as of June 25, 2004 among Footstar, Inc., as Lead Borrower for
Footstar, Inc. and Footstar Corporation; the Lenders party thereto;
Fleet National Bank, as Administrative Agent and Swingline Lender;
Fleet Retail Group, Inc., as Collateral Agent; General Electric
Capital Corporation, as Syndication Agent; and Wells Fargo Foothill,
LLC, as Documentation Agent (incorporated by reference to Exhibit
10.13(c) of Footstar, Inc.'s 2002 Annual Report on Form 10-K filed on
September 3, 2004).
10.13(d) Waiver, dated as of January 24, 2005, to Amended and Restated
Debtor-in-Possession and Exit Credit Agreement (incorporated by
reference to Exhibit 10.13(d) of Footstar, Inc.'s 2003 Annual Report
on Form 10-K filed on April 8, 2005).*
10.13(e) First Amendment to Amended and Restated Debtor-in-Possession and Exit
Credit Agreement dated as of May 31, 2005 among Footstar, Inc., as
Lead Borrower for Footstar, Inc. and Footstar Corporation; the
Lenders party thereto; Fleet National Bank, as Administrative Agent
and Swingline Lender; Fleet Retail Group, as Collateral Agent; and
General Electric Capital Corporation, as Syndication Agent
(incorporated by reference to Exhibit 10.1 of Footstar, Inc.'s
Current Report on Form 8-K filed on June 3, 2005).
10.14 Receiving, Warehousing and Physical Distribution Services Agreement
dated as of July 8, 2004 by and between Footstar Corporation and FMI
International, LLC, as amended (incorporated by reference to Exhibits
99.2 and 99.3 to Footstar, Inc.'s Current Report on Form 8-K filed on
August 5, 2004).
10.14(a) Purchase and Sale Agreement and Escrow Instructions dated as of July
19, 2004 between Footstar Corporation, as Seller, and Thrifty Oil
Co., as Buyer (incorporated by reference to Exhibit 10.14(a) of
Footstar, Inc.'s 2002 Annual Report on Form 10-K filed on September
3, 2004).
89
Exhibit
Number DESCRIPTION
-------- -----------
10.15 Asset Purchase Agreement dated as of April 13, 2004 by and among
Footstar, Inc. and its subsidiaries set forth on the signature pages
thereto; FL Specialty Operations LLC; FL Retail Operations LLC; Foot
Locker Stores, Inc.; Foot Locker Retail, Inc. and Foot Locker, Inc.
as amended by First Amendment to Asset Purchase Agreement dated as of
April 28, 2004 and Second Amendment to Asset Purchase Agreement dated
as of May 7, 2004 (incorporated by reference to Exhibit 10.15 of
Footstar, Inc.'s 2002 Annual Report on Form 10-K filed on September
3, 2004).
10.16 First Amendment to Asset Purchase Agreement dated as of April 28,
2004 by and among Footstar, Inc. and its subsidiaries set forth on
the signature pages thereto; FL Specialty Operations LLC; FL Retail
Operations LLC; Foot Locker Stores, Inc.; Foot Locker Retail, Inc.
and Foot Locker, Inc. (incorporated by reference to Exhibit 10.16 of
Footstar, Inc.'s 2002 Annual Report on Form 10-K filed on September
3, 2004).
10.17 Second Amendment to Asset Purchase Agreement dated May 7, 2004 by and
among Footstar, Inc. and its subsidiaries set forth on the signature
pages thereto; FL Specialty Operations LLC; FL Retail Operations LLC;
Foot Locker Stores, Inc.; Foot Locker Retail, Inc. and Foot Locker,
Inc. (incorporated by reference to Exhibit 10.17 of Footstar, Inc.'s
2002 Annual Report on Form 10-K filed on September 3, 2004).
10.18 Agreement of Sale and Purchase dated as of August 16, 2004 between
Footstar Corporation, as Seller and ADS Logistics Services - Gaffney
LLC, as Buyer (incorporated by reference to Exhibit 10.18 of
Footstar, Inc.'s 2003 Annual Report on Form 10-K filed on April 8,
2005).
21.1 Description of subsidiaries of Footstar, Inc.
23.1 Consent of Independent Registered Public Accounting Firm.
23.2 Consent of Independent Registered Public Accounting Firm.
31.1 Certification of Chief Executive Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
31.2 Certification of Senior Vice President of Financial Reporting and
Control (Principal Financial Officer) pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32 Certifications pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
99 Joint Plan of Reorganization and related Disclosure Statement as
filed with the United States Bankruptcy Court for the Southern
District of New York (Case No. 04-22350(ASH)) on November 12, 2004
(incorporated by reference to Item 9.01 to Footstar, Inc.'s Form 8-K
filed on November 15, 2004 and to Footstar, Inc.'s Form 8-K filed on
November 23, 2004).
* Management contract or compensatory plan.
90