UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended July 2, 2005
Commission File Number 1-11681
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FOOTSTAR, INC.
(Exact name of registrant as specified in its charter)
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DELAWARE 22-3439443
(State or other jurisdiction (IRS Employer Identification No.)
of incorporation for organization)
933 MACARTHUR BLVD., MAHWAH, NEW JERSEY 07430
(Address of principal executive offices)
(201) 934-2000
(Registrant's telephone number, including area code)
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Indicate by check mark whether registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities and 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 whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes X No
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Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes No X
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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
1
FOOTSTAR, INC.
QUARTERLY REPORT ON FORM 10-Q
TABLE OF CONTENTS
Part I
Item 1. Financial Statements
Consolidated Statements of Operations - For the Three and Six Months
Ended July 2, 2005 and July 3, 2004 ................................ 3
Consolidated Balance Sheets - As of July 2, 2005 and January 1, 2005 .. 4
Condensed Consolidated Statements of Cash Flows - For the Six Months
Ended July 2, 2005 and July 3, 2004 ................................ 5
Notes to Consolidated Financial Statements ............................ 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations .............................................. 14
Item 3. Quantitative and Qualitative Disclosures about Market Risk ............ 25
Item 4. Controls and Procedures ............................................... 25
SIGNATURES...................................................................... 27
EX. 31.1 CERTIFICATIONS
EX. 31.2 CERTIFICATIONS
EX. 32.1 CERTIFICATIONS
2
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE AND SIX MONTHS ENDED JULY 2, 2005 AND JULY 3, 2004
(Unaudited)
(amounts in millions)
Six Months Ended
-----------------------
Three Months Ended Six Months Six Months
------------------ Ended Ended
July 2, July 3, July 2, July 3,
2005 2004 2005 2004
------- ------- ---------- ----------
Net sales $192.6 $216.5 $347.4 $393.4
Cost of sales 130.0 144.0 240.5 265.5
------ ------ ------ ------
GROSS PROFIT 62.6 72.5 106.9 127.9
Store operating, selling, general and administrative expenses 47.0 62.6 94.6 121.5
Depreciation and amortization 1.8 7.2 3.7 12.0
Interest expense 1.2 3.9 2.0 7.5
------ ------ ------ ------
INCOME (LOSS) BEFORE REORGANIZATION ITEMS 12.6 (1.2) 6.6 (13.1)
Reorganization items 5.9 3.9 9.6 8.4
------ ------ ------ ------
INCOME (LOSS) BEFORE INCOME TAXES, MINORITY INTERESTS AND
DISCONTINUED OPERATIONS 6.7 (5.1) (3.0) (21.5)
Income tax (provision) benefit (5.8) (0.5) 2.6 0.9
------ ------ ------ ------
INCOME (LOSS) BEFORE MINORITY INTERESTS AND DISCONTINUED OPERATIONS 0.9 (5.6) (0.4) (20.6)
Minority interests in net (income) loss -- (2.1) -- 1.0
------ ------ ------ ------
INCOME (LOSS) FROM CONTINUING OPERATIONS 0.9 (7.7) (0.4) (19.6)
(Loss) income from discontinued operations -- (31.2) (0.1) (57.2)
(Loss) gain from disposal of discontinued operations -- 34.8 -- 13.9
------ ------ ------ ------
NET INCOME (LOSS) $ 0.9 $ (4.1) $ (0.5) $(62.9)
====== ====== ====== ======
NET INCOME (LOSS) PER SHARE:
Basic:
Income (loss) from continuing operations $ 0.04 $(0.38) $(0.02) $(0.95)
(Loss) income from discontinued operations -- 0.18 -- (2.11)
------ ------ ------ ------
Net income (loss) $ 0.04 $(0.20) $(0.02) $(3.06)
====== ====== ====== ======
Diluted:
Income (loss) from continuing operations $ 0.04 $(0.38) $(0.02) $(0.95)
(Loss) income from discontinued operations -- (0.18) -- (2.11)
------ ------ ------ ------
Net income (loss) $ 0.04 $(0.20) $(0.02) $(3.06)
====== ====== ====== ======
Average common shares outstanding:
Basic 20.5 20.5 20.5 20.5
====== ====== ====== ======
Diluted 20.5 20.5 20.5 20.5
====== ====== ====== ======
See accompanying notes to condensed consolidated financial statements.
3
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
CONSOLIDATED BALANCE SHEETS
(in millions, except share amounts)
July 2, 2005 January 1, 2005
------------ ---------------
(unaudited)
ASSETS
Current Assets:
Cash and cash equivalents $ 218.5 $ 189.6
Accounts receivable, net 14.7 22.1
Inventories 103.7 98.9
Prepaid expenses and other current assets 29.9 28.4
Assets of discontinued operations -- 6.2
------- -------
Total current assets 366.8 345.2
------- -------
Property and equipment, net 32.1 35.4
Intangible assets, net 10.3 10.3
Deferred charges and other assets 2.2 3.2
------- -------
Total assets $ 411.4 $ 394.1
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities not subject to compromise:
Accounts payable 66.6 $ 48.0
Accrued expenses 41.1 48.0
Amount due under Kmart Settlement 57.0 45.0
Income taxes payable -- 2.0
Liabilities of discontinued operations 3.0 3.5
Liabilities subject to compromise 150.2 152.3
------- -------
Total current liabilities 317.9 298.8
Other long-term liabilities 37.3 38.5
Amount due under Kmart Settlement 5.5 5.5
------- -------
Total liabilities 360.7 342.8
Shareholders' Equity:
Common stock $.0l par value: 100,000,000 shares authorized,
31,061,545 and 31,018,065 shares issued 0.3 0.3
Additional paid-in capital 342.9 343.1
Treasury stock: 10,711,569 shares at cost (310.6) (310.6)
Unearned compensation (0.3) (0.4)
Retained earnings 18.4 18.9
------- -------
Total shareholders' equity 50.7 51.3
------- -------
Total liabilities and shareholders' equity $ 411.4 $ 394.1
======= =======
See accompanying notes to condensed consolidated financial statements.
4
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JULY 2, 2005 AND JULY 3, 2004
(Unaudited)
(amounts in millions)
Six Months Ended
---------------------------
July 2, 2005 July 3, 2004
------------ ------------
Net cash provided by operating activities $ 26.7 $ 29.4
------ -------
Cash flows provided by investing activities:
Additions to property and equipment (0.8) (1.7)
Proceeds from sale of furniture and equipment 0.3 --
Proceeds from the sale of Athletic Division -- 215.7
------ -------
Net cash provided by investing activities (0.5) 214.0
------ -------
Cash flows used in financing activities:
Repayments on notes payable -- (198.0)
Other 0.1 0.4
------ -------
Net cash provided by (used in) financing activities 0.1 (197.6)
------ -------
Cash provided by discontinued operations 2.6 34.3
------ -------
Net increase in cash and cash equivalents 28.9 80.1
Cash and cash equivalents, beginning of period 189.6 1.1
------ -------
Cash and cash equivalents, end of period $218.5 $ 81.2
====== =======
See accompanying notes to condensed consolidated financial statements.
5
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
THE COMPANY
Footstar, Inc., ("Footstar", the "Company", "we", "us", or "our") is a holding
company in which our businesses are operated through its subsidiaries. We are
principally a retailer conducting business through our Meldisco Segment and,
prior to our sale of certain stores to certain affiliates of Foot Locker, Inc.
("Foot Locker") on May 2, 2004 and the closing of underperforming stores, its
Athletic Segment. The Meldisco Segment sells family footwear through licensed
footwear departments and wholesale arrangements. 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.
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.
On November 12, 2004, we filed a proposed joint plan of reorganization with the
Court. Following the Kmart Settlement, as defined below, 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 Securities and Exchange Commission ("SEC") this periodic report as 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 takes effect beginning January 2,
6
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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 4. Kmart footwear department sales were as
follows (in millions):
Three Months Ended Six Months Ended
--------------------------- ---------------------------
July 2, 2005 July 3, 2004 July 2, 2005 July 3, 2004
------------ ------------ ------------ ------------
$183.2 $206.7 $324.2 $370.9
2. BASIS OF PRESENTATION
The consolidated financial statements contained herein have been prepared on a
going concern basis, which assumes continuity of operations and realization of
assets and satisfaction of liabilities in the ordinary course of business, and
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 consolidated balance
sheets 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 our bankruptcy filing as
reorganization items (see Notes 6 and 8).
The accompanying consolidated financial statements are unaudited but, in the
opinion of management, contain all adjustments (which are of a normal recurring
nature) necessary to present fairly the financial position, results of
operations and cash flows for the periods presented. All significant
intercompany accounts and transactions have been eliminated.
Detailed footnote information is not included in this report. The financial
information set forth herein should be read in conjunction with the Notes to
Consolidated Financial Statements contained in our fiscal 2004 Annual Report on
Form 10-K for the period ended January 1, 2005 filed with the SEC.
The results of operations for the six months ended July 2, 2005 are not
necessarily indicative of results to be expected for the entire fiscal year
ended December 31, 2005.
3. DISCONTINUED OPERATIONS
The disposition of our Athletic Segment and within our Meldisco Segment, the
sale or liquidation of all our Shoe Zone stores as well as our exit from the
footwear departments in 44 Gordmans, Inc. stores and the footwear departments in
87 stores operated by subsidiaries of Federated Department Stores, Inc. has been
accounted for as discontinued operations in accordance with FASB Statement No.
144, "Accounting for the Impairment or Disposal of Long Lived Assets".
Accordingly, we have reported our results of the discontinued operations as a
separate component of operations. As of July 2, 2005 the estimated gain from
disposal of the Athletic Segment was approximately $21.4 million.
7
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Net sales and operating loss from discontinued operations for the three and six
months ended July 2, 2005 and July 3, 2004 were as follows (in millions):
Three Months Ended Six Months Ended
--------------------------- ---------------------------
July 2, 2005 July 3, 2004 July 2, 2005 July 3, 2004
------------ ------------ ------------ ------------
Net sales $ -- $ 40.6 $ -- $241.2
Operating income (loss) from
discontinued operations $0.2 $(21.7) $0.1 $(38.6)
4. MELDISCO'S RELATIONSHIP WITH KMART
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. 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%
interest, other than 23 of the Shoemart Corporations which were wholly-owned by
us. 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 takes effect beginning January 2, 2005, allows us to continue operating
the footwear departments in Kmart stores pursuant to the Amended Master
Agreement. 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. A loss of $6.3 million resulting from the Kmart Settlement
was recorded in December 2004.
8
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
- 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
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.
9
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
- 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.
5. ASSETS AND LIABILITIES RELATED TO DISCONTINUED OPERATIONS
Assets and liabilities related to discontinued operations consisted of the
following (in millions):
July 2, 2005 January 1, 2005
------------ ---------------
ASSETS
Accounts receivable, net $ -- $6.2
---- ----
LIABILITIES
Accrued expenses $3.0 $3.5
---- ----
6. 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.
10
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Liabilities subject to compromise consisted of the following (in millions):
July 2, January 1,
2005 2005
------ ----------
Accounts payable $ 75.5 $ 75.9
Accrued expenses 68.1 69.8
Long-term liabilities 6.6 6.6
------ ------
Total $150.2(a) $152.3(a)
====== ======
(a) Includes approximately $109.4 and $112.5 of liabilities subject to
compromise from discontinued operations as of July 2, 2005 and January 1,
2005, respectively.
7. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
As of July 2, 2005, there have been no material changes to any of the
significant accounting policies described in our Annual Report on Form 10-K for
the year ending January 1, 2005.
8. REORGANIZATION ITEMS
Reorganization items, which consist of income and expenses that are related to
our bankruptcy proceedings, were comprised of the following for the three and
six months ended July 2, 2005 and July 3, 2004 (in millions):
Three Months Ended Six Months Ended
--------------------------- ---------------------------
July 2, 2005 July 3, 2004 July 2, 2005 July 3, 2004
------------ ------------ ------------ ------------
Store and distribution center closing
and related asset impairment costs $ 0.1 $ 2.2 $ 0.1 $ 2.2
Professional fees 6.2 0.5 10.1 2.4
Trustee fees 1.0 1.3 2.0 3.9
Interest income (1.4) (0.1) (2.6) (0.1)
----- ----- ----- -----
Total $ 5.9 $ 3.9 $ 9.6 $ 8.4
===== ===== ===== =====
9. 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.
11
The following table reflects average shares outstanding used to compute basic
and diluted loss per share (in millions):
Three Months Ended Six Months Ended
--------------------------- ---------------------------
July 2, 2005 July 3, 2004 July 2, 2005 July 3, 2004
------------ ------------ ------------ ------------
Average shares outstanding 20.3 20.2 20.3 20.2
Contingently issuable shares (1) 0.2 0.3 0.2 0.3
---- ---- ---- ----
Average shares outstanding - basic 20.5 20.5 20.5 20.5
==== ==== ==== ====
Average shares outstanding - diluted (2) 20.5 20.5 20.5 20.5
==== ==== ==== ====
----------
(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 three months ended July 3, 2004, and the six months ended July 2, 2005
and July 3, 2004, 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. There were no assumed shares having an
anti-dilutive effect on EPS in any period.
10. INCOME TAXES
Although the Kmart Settlement was effective as of January 2, 2005, the effective
date for tax purposes is August 25, 2005, the date the Kmart Settlement was
approved by the Court. As a result, two tax periods are required for fiscal
2005. Due to the minority interests in each Shoemart store for the period
January 2, 2005 through August 25, 2005, we can not file a consolidated federal
tax return. As losses from stores cannot therefore be offset against profits
from other stores, this has resulted in an unusually high estimated tax rate of
approximately 88% for 2005. As the minority interests are eliminated as of
August 25, 2005, subsequent federal tax returns will be filed on a consolidated
basis.
11. 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.
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.
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
12
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 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 the proceeding.
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 use of four stripes as a design element on
footwear which Adidas alleges infringes on its registered three strip 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.
Pursuant to an agreement between the Company and FMI International ("FMI") for
warehouse and distribution services, we are obligated to pay to FMI a minimum of
$15.1 million in both 2005 and 2006.
13
ITEM 2. 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 Chapter 11 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;
- 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;
- any adverse developments in existing commercial disputes or legal
proceedings; and
- intense competition in the markets in which we compete.
14
Additionally, due to material uncertainties, 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 Report on Form 10-Q is based solely on data
currently available, it is subject to change and should not be viewed as
providing any assurance regarding our future performance. Actual results and
performance may differ from our current projections, estimates and expectations
and the differences may be material, individually or in the aggregate, to our
business, financial condition, results of operations, liquidity 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 Quarterly Report on Form 10-Q.
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 this
business, we will be forced to liquidate our business when the Kmart
relationship ends.
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.
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 353 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.
15
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 sale
price was 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 2, 2005, Foot Locker entered into new leases
for 12 of the above-mentioned 14 store locations and one store location was
leased by the landlord to a third party. As of July 2, 2005, approximately $9.2
million of the above-mentioned $13.0 million escrow amount was released to us,
approximately $2.2 million was released to Foot Locker and approximately $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
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". Accordingly, we have reported the results of the
discontinued Athletic Segment as a separate component of operations.
We have sold other assets, including our distribution centers in Mira Loma,
California ("Mira Loma") in July 2004 and Gaffney, South Carolina in September
2004. The purchaser of Mira Loma, Thrifty Oil Co. has leased Mira Loma to FMI,
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 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 systems 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 the Meldisco headquarters building in Mahwah, New Jersey.
On November 12, 2004, we filed a proposed joint plan of reorganization with the
Court. In connection with 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
16
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 are current in filing periodic reports with the SEC. Although we expect that
creditors will be paid in full, the timing of such payments is 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.
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.
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 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
17
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.
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
above. However, upon the expiration of the Amended Master Agreement or upon
early termination of that agreement other than as a result of our breach, all
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.
OUR BUSINESS RELATIONSHIP WITH WAL-MART
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 - THREE MONTHS ENDED JULY 2, 2005 VERSUS
THREE MONTHS ENDED JULY 3, 2004
The following is a discussion of the results of operations for the three months
ended July 2, 2005 compared with the three months ended July 3, 2004.
18
2005 VERSUS 2004
Meldisco represents substantially all of our operations. Corporate (income)
expense, net of royalties and commissions, was approximately $(2.5) million in
2005 and $9.3 million in 2004.
2005 VERSUS 2004 - CORPORATE
Royalties and commissions, which were approximately $3.2 million and $3.7
million in 2005 and 2004, respectively, 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 $0.7 million in 2005 and $13.0 million in 2004. With
the disposition of our Athletic Segment, corporate expenses were substantially
reduced as the remaining corporate activities were transferred to Meldisco at
the end of fiscal 2004.
MELDISCO
2005 2004 % SALES - 2005 % SALES - 2004
------ ------ -------------- --------------
Net Sales $192.6 $216.5 100.0 100.0
------ ------ ----- -----
Gross Profit 59.3 68.8 30.8 31.8
SG&A Expenses 46.3 51.3 24.0 23.7
Depreciation/Amortization 1.8 5.5 1.0 2.5
------ ------ ----- -----
Operating Profit $11.2 $12.0 5.8 5.5
------ ------ ----- -----
As part of the Kmart Settlement, effective January 2, 2005 the fees paid to
Kmart were revised and Kmart's equity interests in the Shoemart Corporations
were eliminated. The effect of the Kmart Settlement in 2005 compared with 2004
is as follows:
Increase in cost of sales $9.0 million
Decrease in SG&A expenses $4.8 million
The minority interests share in 2004 income were $2.1 million.
NET SALES
Net sales decreased $23.9 million, or 11.0%, to $192.6 million in 2005 compared
with $216.5 million in 2004. This sales decrease was primarily due to an 8.2%
comparable store sales decline in Shoemart during 2005 and fewer open Kmart
stores.
Shoemart sales were approximately $183.3 million in 2005 and $206.7 million in
2004.
19
Shoemart sales are largely dependent on the number of open Kmart stores and
Kmart comparable store sales.
Open Kmart Kmart Store Shoemart Store
Three Months Ended Stores Comps (A) Comps
------------------ ---------- ----------- --------------
July 2, 2005 1,454 (0.3%) (8.2%)
July 3, 2004 1,504 (14.9%) (11.3%)
(A) For quarter ended July of each year
In 2005, Shoemart comparable sales declined significantly relative to Kmart
primarily due to weaker performance in approximately 900 lower volume stores. In
2004, we moved to aggressively clear aged product. Deep discounts on aged
inventory drove 2004 sales which resulted in the decrease in comparable store
sales being less than that experienced by Kmart. As there were significantly
less clearance sales in 2005, the decrease in comparable store sales was greater
than that experienced by Kmart.
GROSS PROFIT
Gross profit decreased $9.5 million to $59.3 million in 2005 compared with $68.8
million in 2004. This dollar decrease was partly due to the aforementioned $9.0
million effect of the Kmart Settlement. The overall gross margin rate declined
1% as the effect of the Kmart Settlement was offset by the higher margin on 2005
sales resulting from a reduction in clearance sales that occurred in 2004.
SG&A EXPENSES
SG&A expenses decreased $5.0 million, or 9.7%, to $46.3 million in 2005 compared
with $51.3 million in 2004. $4.8 million of this decrease was due to the
aforementioned Kmart Settlement. $0.2 million of this decrease is attributable
to a reduction in miscellaneous expense fees due to fewer open Kmart stores in
2005.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization decreased $3.7 million to $1.8 million in 2005
compared with $5.5 million in 2004 due to a significant write-off of assets
during 2004.
OPERATING PROFIT
Operating profit decreased $0.8 million to $11.2 million in 2005 compared with
$12.0 million in 2004 primarily due to the reasons noted above.
RESULTS OF OPERATIONS - SIX MONTHS ENDED JULY 2, 2005 VERSUS
SIX MONTHS ENDED JULY 3, 2004
The following is a discussion of the results of operations for the six months
ended July 2, 2005 compared with the six months ended July 3, 2004.
20
2005 VERSUS 2004
Meldisco represents substantially all of our operations. Corporate (income)
expense, net of royalties and commissions, was approximately $(5.5) million in
2005 and $16.9 million in 2004.
2005 VERSUS 2004 - CORPORATE
Royalties and commissions, which were approximately $6.7 million and $6.9
million in 2005 and 2004, respectively, 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 $1.2 million in 2005 and $23.8 million in 2004. With
the disposition of our Athletic Segment, corporate expenses were substantially
reduced as the remaining corporate activities were transferred to Meldisco at
the end of fiscal 2004.
MELDISCO
2005 2004 % SALES - 2005 % SALES - 2004
------ ------ -------------- --------------
Net Sales $347.4 $393.4 100.0 100.0
------ ------ ----- -----
Gross Profit 100.1 121.1 28.8 30.8
SG&A Expenses 93.4 100.6 26.9 25.6
Depreciation/Amortization 3.6 9.1 1.0 2.3
------ ------ ----- -----
Operating Profit $ 3.1 $ 11.4 0.9 2.9
------ ------ ----- -----
As part of the Kmart Settlement, effective January 2, 2005 the fees paid to
Kmart were revised and Kmart's equity interests in the Shoemart Corporations
were eliminated. The effect of the Kmart Settlement in 2005 compared with 2004
is as follows:
Increase in cost of sales $15.5 million
Decrease in SG&A expenses $ 8.5 million
The minority interests share in 2004 losses were $(1.0) million.
NET SALES
Net sales decreased $46.0 million, or 11.7%, to $347.4 million in 2005 compared
with $393.4 million in 2004. This sales decrease was primarily due to a 9.4%
comparable store sales decline in Shoemart during 2005 and fewer open Kmart
stores. Shoemart sales were approximately $324.2 million in 2005 and $370.9
million in 2004.
21
Shoemart sales are largely dependent on the number of open Kmart stores and
Kmart comparable store sales.
Kmart Store
Six Months Ended Open Kmart Stores Comps (A) Shoemart Store Comps
---------------- ----------------- ----------- --------------------
July 2, 2005 1,454 (1.8%) (9.4%)
July 3, 2004 1,504 (13.9%) (10.4%)
(A) For six months ended July of each year
In 2005, Shoemart comparable sales declined significantly relative to Kmart
primarily due to weaker performance in approximately 900 lower volume stores. In
2004, we moved to aggressively clear aged product. Deep discounts on aged
inventory helped drive 2004 sales which resulted in the decrease in comparable
store sales being less than that experienced by Kmart. As there were
significantly less clearance sales in 2005, the decrease in comparable store
sales was greater than that experienced by Kmart.
GROSS PROFIT
Gross profit decreased $21.0 million to $100.1 million in 2005 compared with
$121.1 million in 2004. This dollar decrease and resulting decrease in the
overall gross margin rate was partly due to the aforementioned $15.5 million
effect of the Kmart Settlement.
SG&A EXPENSES
SG&A expenses decreased $7.2 million, or 7.2%, to $93.4 million in 2005 compared
with $100.6 million in 2004. $8.5 million of this decrease was due to the
aforementioned Kmart Settlement, which was partially offset by an overall
increase in SG&A expenses.
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 addition to other
improved payment terms, accounts payable also increased due to higher inventory
levels at July 2, 2005 compared with January 1, 2005. Inventory is usually at
its lowest level at year end.
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 January 2, 2005 through
August 27, 2005 retroactive to January 2, 2005. On September 6, 2005, we paid an
additional $1.5 million to Kmart for the final determination of the amount due.
22
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. 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 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 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 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 lenders illustrating required availability levels.
23
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 (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. 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 2, 2005, we had no loans outstanding and $19.7 million of outstanding
letters of credit under the DIP and Exit Facility. Letters of credit reduce the
borrowing capacity of the 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.
CRITICAL ACCOUNTING ESTIMATES
Our discussion of results of operations and financial condition relies on our
consolidated financial statements that are prepared based on certain critical
accounting estimates that require management to make judgments and estimates
that are subject to varying degrees of uncertainty. We believe that investors
need to be aware of these policies and how they impact our financial statements
as a whole, as well as our related discussion and analysis presented herein.
While we believe that these accounting estimates are based on sound measurement
criteria, actual future events can and often do result in outcomes that can be
materially different from these estimates or forecasts.
24
The accounting estimates and related risks described in our fiscal 2004 Annual
Report on Form 10-K for the year ended January 1, 2005 are those that depend
most heavily on these judgments and estimates. As of July 2, 2005, there have
been no material changes to any of the critical accounting estimates contained
therein.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
DERIVATIVES
As of July 2, 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 July 2, 2005, we had no borrowings outstanding under the DIP and Exit
Facility, other than approximately $19.7 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 our 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.
ITEM 4. CONTROLS AND PROCEDURES
Under the supervision of our Chief Executive Officer and Senior Vice President
of Financial Reporting and Control, management conducted an evaluation of the
effectiveness of the design and operation of our disclosure controls and
procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934, as amended (the "Exchange Act")) as of the end
of the period covered by this report (the "Evaluation Date"). There are inherent
limitations to the effectiveness of any system of disclosure controls and
procedures, including the possibility of human error and the circumvention or
overriding of the controls and procedures. Accordingly, even effective
disclosure controls and procedures can only provide reasonable assurance of
achieving
25
their control objectives. Based on such evaluation, the Chief Executive Officer
and Senior Vice President of Financial Reporting and Control concluded that, as
of the Evaluation Date, our disclosure controls and procedures were effective at
a reasonable assurance level with the filing of our first and second quarter
2005 Form 10-Q's.
Commencing January 2, 2005, an analysis of the components of our landed cost
accrual is performed monthly and we have corrected the design deficiency in our
controls over in-transit inventory to ensure that inventory and accounts payable
will be properly stated for all periods presented. With the filing of our first
and second quarter 2005 Form 10-Q's we will be current in filings required under
the Exchange Act.
There were no other changes in our internal control over financial reporting
during the quarterly period covered by this report that has materially affected,
or is reasonably likely to materially affect, our internal control over
financial reporting.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Footstar, Inc.
Date: September 27, 2005 By: /s/ Dale W. Hilpert
------------------------------------
Dale W. Hilpert
Chairman of the Board,
Chief Executive Officer and
President
Date: September 27, 2005 By: /s/ Richard L. Robbins
------------------------------------
Richard L. Robbins
Senior Vice President Financial
Reporting and Control
(Principal Financial Officer and
Principal Accounting Officer)
27