FOOT LOCKER INC – 10-Q – Management’s Discussion and Analysis of Financial Condition and Results of Operations

BUSINESS OVERVIEW

Foot Locker, Inc., through its subsidiaries, operates in two reportable segments - Athletic Stores and Direct-to-Customers. The Athletic Stores segment is one of the largest athletic footwear and apparel retailers in the world, whose formats include Foot Locker, Lady Foot Locker, Kids Foot Locker, Champs Sports, Footaction, and CCS. The Direct-to-Customers segment is multi-branded and multi-channeled. This segment sells, through its affiliates, directly to customers through its internet websites, mobile devices, and catalogs. Eastbay, one of the affiliates, is among the largest direct marketers in the United States. The Direct-to-Customers segment operates the website for eastbay.com, final-score.com, and teamsales.eastbay.com. Additionally, this segment operates websites aligned with the brand names of its store banners (footlocker.com, ladyfootlocker.com, kidsfootlocker.com, footaction.com, champssports.com, and ccs.com).  STORE COUNT  At October 29, 2011, the Company operated 3,402 stores as compared with 3,426 and 3,474 stores at January 29, 2011 and October 30, 2010, respectively. During the thirty-nine weeks ended October 29, 2011, the Company opened 52 stores, remodeled or relocated 147 stores and closed 76 stores.  A total of 32 franchised stores were operating at October 29, 2011, as compared with 26 and 24 stores at January 29, 2011 and October 30, 2010, respectively. Revenue from the franchised stores was not significant for any of the periods presented. These stores are not included in the Company's operating store count above.                                          14

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SALES AND OPERATING RESULTS

  All references to comparable-store sales for a given period relate to sales of stores that are open at the period-end, that have been open for more than one year, and exclude the effect of foreign currency fluctuations. Accordingly, stores opened and closed during the period are not included. Sales from the Direct-to-Customers segment are included in the total Company calculation of comparable-store sales for all periods presented. Division profit reflects income before income taxes, corporate expense, net interest expense, and net non-operating income.  

The following table summarizes results by segment:

                                      Sales                            Thirteen weeks ended         Thirty-nine weeks ended                       October 29,     October 30,    October 29,     October 30, (in millions)             2011            2010           2011            2010 Athletic Stores       $      1,268    $      1,171   $      3,773    $      3,367 Direct-to-Customers            126             109            348             290 Total sales           $      1,394    $      1,280   $      4,121    $      3,657                                   Operating Results                                                   Thirteen weeks ended                 Thirty-nine weeks ended                                             October 29,         October 30,      October 29,          October 30, (in millions)                                  2011                2010              2011                 2010 Athletic Stores                            $         119       $          91     $        360         $        225 Direct-to-Customers                                   12                   9               32                   22 Restructuring charge (1)                               -                   -               (1 )                  - Division profit                                      131                 100              391                  247 Less: Corporate expense, net                          25                  26               76                   75 Operating profit                                     106                  74              315                  172 Interest expense, net                                  1                   2                4                    7 Other income (2)                                       -                   1                1                    2 Income before income taxes                 $         105       $          73     $        312         $        167   

(1) During the first quarter of 2011, the Company increased its 1993

Repositioning and 1991 Restructuring reserve by $1 million for repairs

necessary to one of the locations comprising this reserve. This amount is

included in selling, general and administrative expenses in the Condensed

Consolidated Statement of Operations.

(2) Other income includes non-operating items, such as gains from insurance

recoveries, gains on the repurchase and retirement of bonds, royalty income,

the changes in fair value, premiums paid and realized gains associated with

foreign currency option contracts. Other income for the thirty-nine weeks

ended October 29, 2011 primarily represents lease termination gains related

to the sale of leasehold interests and royalty income from the Company's

franchised operations. Other income for the thirteen weeks ended October 30,

      2010 primarily represents lease termination gains related to sales of       leasehold interests in Europe and royalty income. Other income for the       thirty-nine weeks ended October 30, 2010 primarily represents royalty

income, lease termination gains, and realized gains associated with foreign

currency option contracts.

    Sales increased by $114 million, or 8.9 percent, to $1,394 million for the thirteen weeks ended October 29, 2011, from $1,280 million for the thirteen weeks ended October 30, 2010. For the thirty-nine weeks ended October 29, 2011, sales of $4,121 million increased 12.7 percent from sales of $3,657 million for the thirty-nine week period ended October 30, 2010. Excluding the effect of foreign currency fluctuations, total sales for the thirteen-week and thirty-nine week periods increased 7.3 percent and 10.3 percent, respectively, as compared with the corresponding prior-year periods. Comparable-store sales increased by 7.4 percent and 10.6 percent, for the thirteen and thirty-nine weeks ended October 29, 2011, respectively.  Gross margin, as a percentage of sales, increased by 220 basis points to 32.5 percent for the thirteen weeks ended October 29, 2011, as compared with the corresponding prior-year period. For the thirty-nine weeks ended October 29, 2011, gross margin, as a percentage of sales, increased by 220 basis points to 31.9 percent, as compared with the corresponding prior-year period.                                          15 --------------------------------------------------------------------------------   The cost of merchandise rate for the thirteen and thirty-nine weeks ended October 29, 2011 decreased by 130 and 90 basis points, respectively, as compared with the corresponding prior-year periods, primarily reflecting a lower markdown rate. The Company was less promotional during the current year, reflecting an improved inventory position and better merchandise flow. The thirteen and thirty-nine weeks ended October 29, 2011 also reflected higher apparel sales and improved apparel gross margins, as compared with the corresponding prior-year periods. The effect of vendor allowances was not significant for any of the periods presented.  For the thirteen and thirty-nine weeks ended October 29, 2011, the occupancy and buyers' salary expense rate decreased by 90 and 130 basis points, respectively, as a percentage of sales, as compared with the corresponding prior-year periods, reflecting improved leverage.  Segment Analysis  Athletic Stores     Athletic Stores sales increased by 8.3 percent and 12.1 percent for the thirteen and thirty-nine weeks ended October 29, 2011, respectively, as compared with the corresponding prior-year periods. Excluding the effect of foreign currency fluctuations, sales from athletic stores increased 6.6 percent and 9.4 percent for the thirteen and thirty-nine weeks ended October 29, 2011, respectively, as compared with the corresponding prior-year periods. Comparable-store sales increased by 6.6 percent and 9.8 percent for the thirteen and thirty-nine weeks ended October 29, 2011, respectively. These increases were principally from the U.S. operations, with all formats except Lady Foot Locker reflecting an increase. Lady Foot Locker sales declined principally due to lower store count, coupled with a decline in toning footwear sales, which has negatively affected the results earlier in the year. During the third quarter, the Company commenced a strategic review of the Lady Foot Locker operations to develop initiatives to improve its future performance. Overall, the increased sales reflect the continued favorable athletic footwear trend, an improved in-stock position, and new receipts of more compelling assortments of athletic footwear and apparel, including expanded offerings of technical and light-weight running footwear styles. Internationally, each region increased for both the quarter and year-to-date periods. The increase in international sales was led by our stores in Europe, which continue to benefit from improved apparel offerings that coordinate with key footwear styles.     Athletic Stores division profit for the thirteen weeks ended October 29, 2011 increased to $119 million, or 9.4 percent, as a percentage of sales, as compared with division profit of $91 million, or 7.8 percent, as a percentage of sales, for the thirteen weeks ended October 30, 2010. Athletic Stores division profit for the thirty-nine weeks ended October 29, 2011 increased to $360 million, or 9.5 percent, as a percentage of sales, as compared with division profit of $225 million, or 6.7 percent, as a percentage of sales, for the thirty-nine weeks ended October 30, 2010. These increases were mainly attributable to improved sales, as well as a higher gross margin rate as the Company was less promotional during the current year, coupled with the continued leverage of the fixed expenses within gross margin.  

Direct-to-Customers

     Direct-to-Customers sales increased by 15.6 percent to $126 million for the thirteen weeks ended October 29, 2011, as compared with the corresponding prior-year period sales of $109 million. For the thirty-nine weeks ended October 29, 2011, sales increased by 20.0 percent to $348 million, as compared with the corresponding prior-year period of $290 million. Internet sales increased by 16.8 percent to $111 million and by 23.1 percent to $309 million for the thirteen and thirty-nine weeks ended October 29, 2011, respectively, as compared with the corresponding prior-year periods. These increases were primarily a result of the continued strong sales performance of Eastbay's website, as well as enhancements made to the Company's store banner websites, all of which benefited from improved and fresh product offerings.     Direct-to-Customers division profit increased 33.3 percent to $12 million, and increased 45.5 percent to $32 million, for the thirteen and thirty-nine weeks ended October 29, 2011, respectively, as compared with the corresponding prior-year periods. Division profit, as a percentage of sales, increased to 9.5 percent and 9.2 percent for the thirteen and thirty-nine weeks ended October 29, 2011, respectively, as compared with 8.3 percent and 7.6 percent, respectively, in the corresponding prior-year periods. These increases primarily reflect the improvement in sales and additional expense leverage. The operating results of the CCS business continue to be disappointing. The Company has developed various merchandising initiatives, such as shifting the apparel assortment to a more lifestyle look, and expanded size offerings, intended to improve results for CCS during the holiday selling season; accordingly, management will monitor the results of this format, which may include an analysis of the recoverability of its intangible assets.                                          16

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Corporate Expense

  Corporate expense consists of unallocated general and administrative expenses, as well as depreciation and amortization related to the Company's corporate headquarters, centrally managed departments, unallocated insurance and benefit programs, certain foreign exchange transaction gains and losses, and other items. Corporate expense for the thirteen weeks ended October 29, 2011 decreased by $1 million to $25 million from the corresponding prior-year period. Corporate expense for the thirty-nine weeks ended October 29, 2011 increased by $1 million to <money>$76 million from the corresponding prior-year period.  

Selling, General and Administrative

     Selling, general and administrative expenses ("SG&A") of $320 million increased by $33 million, or 11.5 percent, for the thirteen weeks ended October 29, 2011 as compared with the corresponding prior-year period. SG&A, as a percentage of sales, increased to 23.0 percent for the thirteen weeks ended October 29, 2011, as compared with 22.4 percent in the corresponding prior-year period. For the thirty-nine weeks ended October 29, 2011, SG&A increased by $84 million, or 10.1 percent, as compared with the corresponding prior-year period. SG&A, as a percentage of sales, decreased to 22.3 percent for the thirty-nine weeks ended October 29, 2011, as compared with 22.8 percent in the corresponding prior-year period. Excluding the effect of foreign currency fluctuations, SG&A increased by $28 million and $63 million for the thirteen and thirty-nine weeks ended October 29, 2011, respectively, as compared with the corresponding prior-year periods. These increases principally reflect increased variable costs to support sales, such as store wages and banking expenses. The Company also continues to increase its marketing costs to support the strategic plan. Wage expense for the third quarter of 2011 includes a $7 million adjustment to properly state accruals for compensated absences related to our European operations. The Company determined that this amount was not material to any previously issued financial statements or to the current period; accordingly, it was corrected during the third quarter of 2011.  

Depreciation and Amortization

     Depreciation and amortization was $27 million for both the thirteen weeks ended October 29, 2011 and the thirteen weeks ended October 30, 2010. For the thirty-nine weeks ended October 29, 2011, depreciation and amortization increased by $3 million to $82 million as compared with $79 million for the thirty-nine weeks ended October 30, 2010. The effect of foreign currency fluctuations, primarily related to the euro, was not significant for thirteen weeks and represented an increase of $2 million for the thirty-nine weeks ended October 29, 2011.  Interest Expense                                                             Thirteen weeks ended                          Thirty-nine weeks ended                                                   October 29,               October 30,          October 29,                October 30, (in millions)                                        2011                       2010                2011                       2010 Interest expense                                 $           2             $            3       $           9             $            10 Interest income                                             (1 )                       (1 )                (5 )                        (3 ) Interest expense, net                            $           1             $            2       $           4             $             7    The decrease in net interest expense for the thirty-nine weeks ended October 29, 2011, as compared with the corresponding prior-year period, primarily reflects income earned on higher cash and cash equivalents balances.  

Income Taxes

  The Company's quarterly provision for income taxes is measured using an annual effective tax rate, adjusted for discrete items that occur within the periods presented. The significant factor that affects the effective tax rate relates to the difference between the U.S. federal statutory rate and the rates in foreign jurisdictions.  For the thirteen weeks and thirty-nine weeks ended October 29, 2011, the Company recorded income tax provisions of $39 million and $115 million, which represent effective tax rates of 37.3 percent and 36.9 percent, respectively. For the thirteen weeks and thirty-nine weeks ended October 30, 2010, the Company recorded income tax provisions of $21 million and $55 million, which represent effective tax rates of 29.3 percent and 33.1 percent, respectively.                                          17 --------------------------------------------------------------------------------   The Company regularly assesses the adequacy of the Company's provisions for income tax contingencies in accordance with the applicable authoritative guidance on accounting for income taxes. As a result, the Company may adjust the reserves for unrecognized tax benefits as a result of new facts and developments, such as changes to interpretations of relevant tax law, assessments from taxing authorities, settlements with taxing authorities, and lapses of statutes of limitation. The effective tax rate for the thirteen weeks ended October 29, 2011 includes a reserve release of $1 million due to the lapse of a foreign statute of limitations. The effective tax rate for the thirteen weeks ended October 30, 2010 included a tax benefit of $7 million from settlements of tax examinations. Excluding these items, the effective tax rate for the thirteen weeks and thirty-nine weeks ended October 29, 2011 was essentially unchanged.  

The Company currently expects its fourth quarter tax rate to approximate 37 percent, excluding the effect of any nonrecurring items that may occur. The actual rate will primarily depend on the percentage of income earned in the United States as compared with international operations.

Net Income

     For the thirteen weeks ended October 29, 2011, net income was $66 million, or $0.43 per diluted share, as compared with net income of $52 million, or $0.33 per diluted share for the corresponding prior-year period. Net income for the thirty-nine weeks ended October 29, 2011 was $197 million, or $1.27 per diluted share. This compares with net income of $112 million, or $0.71 per diluted share for the thirty-nine weeks ended October 30, 2010. Strong sales and improved gross margin results contributed to an overall flow-through of sales to income before income taxes of 28.1 percent and 31.3 percent, for the thirteen and thirty-nine week periods ended October 29, 2011, respectively.  

LIQUIDITY AND CAPITAL RESOURCES

  The Company's primary source of liquidity has been cash flow from operations, while the principal uses of cash have been to: fund inventory and other working capital requirements; finance capital expenditures related to store openings, store remodelings, internet and mobile sites, information systems, and other support facilities; make retirement plan contributions, quarterly dividend payments, and interest payments; and fund other cash requirements to support the development of its short-term and long-term operating strategies. The Company generally finances real estate with operating leases.  Management believes its cash, cash equivalents, future cash flow from operations, and the Company's current revolving credit facility will be adequate to fund these requirements. The Company may also from time to time repurchase its common stock or seek to retire or purchase outstanding debt through open market purchases, privately negotiated transactions, or otherwise. Such repurchases, if any, will depend on prevailing market conditions, liquidity requirements, contractual restrictions, and other factors. The amounts involved may be material.  Any material adverse change in customer demand, fashion trends, competitive market forces, or customer acceptance of the Company's merchandise mix and retail locations, uncertainties related to the effect of competitive products and pricing, the Company's reliance on a few key vendors for a significant portion of its merchandise purchases and risks associated with foreign global sourcing, economic conditions worldwide, the effects of currency fluctuations, as well as other factors listed under the heading "Disclosure Regarding Forward-Looking Statements," could affect the ability of the Company to continue to fund its needs from business operations.     Net cash provided by operating activities was $265 million and $121 million for the thirty-nine weeks ended October 29, 2011 and October 30, 2010, respectively. These amounts reflect net income adjusted for non-cash items and seasonal working capital changes. The increase in operating cash flow in 2011 is primarily the result of strong sales during the first three quarters, and improved working capital management. During the first three quarters of 2011, the Company contributed $1 million to its Canadian qualified pension plan, whereas during the corresponding prior-year period the Company contributed $32 million to its U.S. and Canadian qualified plans. Additionally during 2010, the Company paid $24 million to settle the liability associated with the terminated European net investment hedge.     Net cash used in investing activities was $111 million and $72 million for the thirty-nine weeks ended October 29, 2011 and October 30, 2010, respectively, primarily reflecting capital expenditures. The Company's full year forecast for capital expenditures is $153 million, of which $109 million relates to the modernizations of existing stores and new store openings and $44 million for the development of information systems and other support facilities. Included in the investing activities for the thirty-nine weeks ended October 30, 2010 is a $1 million gain related to the sales of lease interests in Europe.                                          18 --------------------------------------------------------------------------------      Net cash used in financing activities was $157 million and $97 million for the thirty-nine weeks ended October 29, 2011 and October 30, 2010, respectively. During the thirty-nine weeks ended October 29, 2011, the Company repurchased 4,615,000 shares of its common stock for $97 million, as compared with 2,510,000 shares for $36 million purchased during the corresponding prior-year period. Additionally, the Company declared and paid dividends during the first three quarters of 2011 and 2010 of $76 million and $70 million, respectively. This represents a quarterly rate of $0.165 and $0.15 per share for 2011 and 2010, respectively. The Company received proceeds from the issuance of common stock in connection with employee stock programs of $13 million and $8 million for the thirty-nine weeks ended October 29, 2011 and October 30, 2010, respectively. In connection with stock option exercises and share-based compensation programs, the Company recorded excess tax benefits of $3 million and $1 million as a financing activity during the thirty-nine week periods ended October 29, 2011 and October 30, 2010, respectively.  

Recent Accounting Pronouncements

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

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

  There have been no significant changes to the Company's critical accounting policies and estimates from the information provided in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," included in the Annual Report on Form 10-K for the fiscal year ended January 29, 2011.  

DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS

  This report contains forward-looking statements within the meaning of the federal securities laws. Other than statements of historical facts, all statements which address activities, events, or developments that the Company anticipates will or may occur in the future, including, but not limited to, such things as future capital expenditures, expansion, strategic plans, financial objectives, dividend payments, stock repurchases, growth of the Company's business and operations, including future cash flows, revenues, and earnings, and other such matters, are forward-looking statements. These forward-looking statements are based on many assumptions and factors which are detailed in the Company's filings with the Securities and Exchange Commission</org>, including the effects of currency fluctuations, customer demand, fashion trends, competitive market forces, uncertainties related to the effect of competitive products and pricing, customer acceptance of the Company's merchandise mix and retail locations, the Company's reliance on a few key vendors for a majority of its merchandise purchases (including a significant portion from one key vendor), pandemics and similar major health concerns, unseasonable weather, further deterioration of global financial markets, economic conditions worldwide, further deterioration of business and economic conditions, any changes in business, political and economic conditions due to the threat of future terrorist activities in the United States or in other parts of the world and related U.S. military action overseas, the ability of the Company to execute its business and strategic plans effectively with regard to each of its business units, and risks associated with foreign global sourcing, including political instability, changes in import regulations, and disruptions to transportation services and distribution.  For additional discussion on risks and uncertainties that may affect forward-looking statements, see "Risk Factors" in Part I, Item 1A in our Annual Report on Form 10-K for the fiscal year ended January 29, 2011. Any changes in such assumptions or factors could produce significantly different results. The Company undertakes no obligation to update forward-looking statements, whether as a result of new information, future events, or otherwise.                                          19

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