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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended January 2, 1999
Commission File Number 1-11681
FOOTSTAR, INC.
(Exact name of registrant as specified in its charter)
Delaware 22-3439443
(State of incorporation) (IRS Employer Identification No.)
933 MacArthur Boulevard, Mahwah, New Jersey 07430
(Address of principal executive offices)
Registrant's telephone number, including area code: (201) 934-2000
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
Title of each class on which registered
- -------------------------------------- -----------------------
Common Stock (par value $.01 per share) New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
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Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No ____
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in the definitive proxy statement incorporated
by reference in Part III of this Form 10-K, or any amendment to this Form
10-K. [ ]
The aggregate market value of the Common Stock held by non-affiliates of the
Registrant as of January 2, 1999 was approximately $577 million.*
Number of shares outstanding of Common Stock, par value $.01 per share, at
January 2, 1999: 23,522,750.
Documents Incorporated by Reference
1. Portions of the Registrant's Annual Report to Shareholders for the fiscal
year ended January 2, 1999: Part I, Item 1; Part II, Items 5, 6, 7 and 8;
and Part IV, Item 14.
2. Portions of the Registrant's definitive Proxy Statement expected to be
filed pursuant to Regulation 14A not later than 120 days after the end of
the fiscal year (January 2, 1999): Part III, Items 10, 11, 12 and 13.
Forward-Looking Statements
This Report on Form 10-K and the documents incorporated by reference
contain statements which constitute forward-looking statements within the
meaning of The Private Securities Litigation Reform Act of 1995. These
statements appear in a number of places in this Report as well as the documents
incorporated by reference and can be identified by the use of forward-looking
terminology such as "believe," "expect," "estimate," "plans," "may," "will,"
"should," "anticipates" or similar statements or the negative thereof or other
variations. Such forward-looking statements include, without limitation,
statements relating to cost savings, capital expenditures, future cash needs,
improvements in infrastructure, Year 2000 matters and operating efficiencies.
Such forward-looking statements involve known and unknown risks, uncertainties
and other factors which may cause the actual results, performance or
achievements to be materially different from any future results, performance or
achievements expressed or implied by such forward-looking statements. Such risks
and uncertainties include, but are not limited to; uncertainties related to
consumer demand for footwear, warmer than expected weather, consumer acceptance
of the Company's merchandise mix, retail locations, product availability and the
effect of competitive products and pricing. Consequently, all of the
forward-looking statements, internal and external, Year 2000 risks and
uncertainties, are qualified by these cautionary statements, and there can be no
assurance that the actual results, performance or achievement will be realized.
The information contained in this Report and the documents incorporated by
reference as well as information contained under the caption "Risk Factors" in
other Company filings with the Securities and Exchange Commission, identifies
important factors that could cause such results, performance or achievement not
to be realized. The Company undertakes no obligation to update forward-looking
statements to reflect events or circumstances after the date such statements
were made.
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* For purposes of this calculation, only voting stock beneficially owned by
directors and executive officers or members of their immediate families
has been excluded. In making such a calculation, the Registrant does not
determine the affiliate or non-affiliate status of any shares for any
other purpose.
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PART I
ITEM 1. BUSINESS
GENERAL
Footstar, Inc. (the "Company" or the "Registrant") is a holding company,
which directly or indirectly, through its wholly-owned subsidiaries, owns the
capital stock of the subsidiaries that operate its Footaction and Meldisco
businesses and its discontinued Thom McAn segment. The Company was organized in
Delaware on March 21, 1996 and became a publicly traded company as part of the
overall restructuring of Melville Corporation ("Melville"). As part of that
restructuring plan, Melville divested its ownership interest in the Company by
means of a tax-free distribution to its stockholders on October 12, 1996 of all
of the outstanding shares of common stock of the Company.
The Company is principally a specialty retailer conducting business in the
branded athletic footwear and apparel and discount footwear segments through its
Footaction and Meldisco businesses, respectively. The financial information
concerning industry segments required by Item 101(b) of Regulation S-K is set
forth on page 30 of the Company's Annual Report to Shareholders for the year
ended January 2, 1999 and is incorporated herein by reference.
In general, the retailing business is seasonal in nature, with peak sales
periods during the Easter, "Back-to-School" and Christmas selling periods.
Competition is generally based upon such factors as price, style, quality,
design of product and location and design of stores.
FOOTACTION: THE BRANDED ATHLETIC FOOTWEAR AND APPAREL BUSINESS
Footaction, which opened its first store in 1976, is a leading mall-based
specialty retailer of branded athletic footwear, apparel and related
accessories. Its primary customers are 12 to 24 year olds for whom having the
most up-to-date athletic footwear and apparel is an important consideration. As
of January 2,1999, Footaction operated 572 stores in 45 states and the Caribbean
region. During 1998, the Company opened 42 new Footaction stores and remodeled,
relocated or expanded 66 existing Footaction stores.
Footaction's stores are located predominantly in enclosed regional malls
anchored by major department stores to take advantage of customer traffic and
the shopping preferences of Footaction's target customers. The athletic footwear
industry, as well as Footaction, had a difficult year in 1998 with Footaction
posting flat same store sales. Total sales increased 8% to $654 million and
operating profit before non-recurring charges decreased 26% to $39 million. For
the fiscal year ended January 2, 1999, Footaction accounted for approximately
36% of the Company's net sales and approximately 28% of the Company's operating
profit.
The ability of Footaction to maintain a high level of sales is dependent
in part on a high volume of mall traffic, fashionability of branded athletic
footwear and apparel, and the continued popularity of mall shopping among
Footaction's primary customers. Its future growth is also dependent on its
ability to open new stores in desirable mall locations. Unfavorable developments
with respect to any of these factors could have a material adverse effect on the
Company.
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Footaction--Merchandising
Footaction seeks to be one of the first to offer the most current and
innovative brand-name athletic footwear and apparel available to its target
customer group. Footaction constantly monitors product trends to help identify
styles which are, or may become, popular. Footaction carries the leading
athletic footwear brands, including Nike, Adidas, Reebok, Fila, And 1, Converse,
New Balance, Asics, K Swiss and Saucony. Footaction offers a selection of
brand-name apparel and accessories including warm-up suits, T-shirts, athletic
shorts, caps, socks and shoe care products. Athletic apparel and accessory
brands include Nike, Adidas, Reebok, And 1 and Fila, among others. Footaction
also offers footwear, apparel and accessories in fashion brands such as FUBU,
DADA and Lugz. The following table sets forth the approximate percentage of
Footaction's net sales attributable to footwear, apparel and accessories:
Approximate Percentage of Footaction's Net Sales
1998 1997 1996
---- ---- ----
Footwear 79% 78% 77%
Apparel 16% 16% 17%
Accessories 5% 6% 6%
---- ---- ----
100% 100% 100%
==== ==== ====
Footaction also seeks to differentiate itself from other branded
athletic footwear and apparel retailers by increasing consumer awareness and
name recognition of Footaction and establishing in the minds of its target
customer group the perception that Footaction is one of the first to offer the
latest styles. As part of this strategy, Footaction works with leading vendors
such as Nike, Adidas, Reebok and Fila to design and develop product line
exclusives, either unique designs or color variations.
Footaction tailors merchandise assortments and store space allocations to
customer preferences at each store location. This is accomplished by recognizing
subtle differences in fashion preferences and demographic factors in the region
or market in which each store is located. This store-by-store merchandising
results in differences in brands, classifications, sizes, colors, and timing of
the assortment and space allocated to present such merchandise. Footaction
maintains information systems designed to manage aged inventory, assuring that
its product lines remain current.
Footaction--Marketing
Footaction believes that its core customers--teens and young adults, age
12 to 24--constitute 54% of total branded athletic footwear sales. Within the
target age group, male and female teens (age 12-17) are over-represented among
Footaction customers, accounting for 32% of Footaction shoppers and 41% of
sales.
Footaction's marketing strategy is to build traffic, sales, and brand
awareness with its primary customers by increasing awareness of Footaction among
individuals in the target customer group and by increasing the perception among
these individuals that Footaction is one of the first to have the latest styles.
Footaction's media advertisements typically feature both Footaction and a
branded product, and may include celebrity endorsements. A portion of the cost
of such advertising is offset by co-operative advertising allowances.
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Footaction focuses its mass media advertising during key selling periods on core
customers in the 12 to 24 year old age group.
In-store visual merchandising programs are also an important part of
Footaction's marketing effort. Footaction believes these initiatives create
excitement at the store level and support the marketplace message that
Footaction carries the latest products. Footaction enhances the presentation of
new product with a "New Arrivals" tower for the latest lines, and uses
"exclusive tags" to highlight products only available at Footaction.
Another key component of Footaction's marketing strategy is its direct
marketing effort aimed at increasing customer loyalty. Footaction has created a
preferred customer card, called the Star Card, which is designed to build a
marketing database that enables the chain to communicate directly with customers
and gain more information about their buying habits. Star Card members receive
individualized birthday greetings, selected vendor mailings and the Footaction
Star magazine. As of the end of 1998 there were 3.7 million Star Card members.
The Footaction Star magazine is a magazine/catalog combination that is mailed to
Star Card holders at least four times a year. It is an entertaining and
informative marketing tool featuring the latest in athletic footwear and apparel
along with product availability dates. It also includes interviews with popular
athletes who appear in current Footaction advertising campaigns, vendor profiles
and other teen-relevant sports features.
Footaction has a web site at www.footaction.com, which allows customers to
view the latest in athletic footwear and apparel.
Footaction--Competitive Environment
Historically, the athletic footwear industry has been served by a variety
of distribution channels, including mall-based specialty athletic footwear
retailers, department stores, discount retailers, traditional shoe stores,
sporting goods stores, and "category killers" (i.e. retailers providing a
dominant assortment of selected lines of merchandise at competitive prices).
Footaction competes in the brand-name segment of the athletic footwear market,
and faces competition primarily from other mall-based athletic footwear and
sporting goods stores.
Within the mall-based specialty athletic footwear retail environment,
Footaction's primary competitors are Venator Athletic, The Finish Line and
Athletes Foot. Venator Athletic is the largest athletic footwear retailer,
offering multiple formats designed to compete in this market segment including
Foot Locker, Lady Foot Locker, Kids Foot Locker, Champs, Athletic Express and
Going To The Game. Footaction believes that it differentiates itself from its
competitors by offering the latest styles demanded by fashion-conscious,
status-oriented consumers in an exciting shopping environment. With the slower
demand for athletic footwear, principally "hero" shoes associated with star
athletes, there has been an increase in promotional activity among this group of
retailers as compared to prior years. Footaction has also experienced
competition from outside the malls, such as big box strip mall retailer Just for
Feet and sporting goods super stores such as Sports Authority.
As part of its restructuring plans, the Company announced that it would be
closing approximately 30 underperforming Footaction Stores, reconfiguring
Footaction merchandise assortments and refining store layouts to place greater
emphasis on better-performing, higher-potential categories. There can be no
assurances, however, that these measures will be successful or that in the
future the above or other competitors will not have a material adverse effect on
the Company.
MELDISCO: THE DISCOUNT FOOTWEAR BUSINESS
Meldisco has operated leased footwear departments in discount chains since
1961 and is the leading operator of leased footwear departments today. As of
January 2, 1999, Meldisco operated leased footwear departments in 2,161 Kmart
department stores, 357 former PayLess Drug Stores and Thrifty Drug Stores now
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operated under the name "Rite Aid stores," and 20 Tesco department stores
located in the Czech Republic, Slovakia, Hungary, and Poland. As part of its
restructuring plans, the Company announced it will be exiting the Central
European business prior to the 1999 Christmas selling season. In its Kmart
leased footwear departments, Meldisco sells a wide variety of family footwear,
including men's, women's and children's dress, casual and athletic footwear,
work shoes and slippers. The majority of the shoes offered by Meldisco in its
leased footwear departments are private label brands, although Meldisco also
sells some national brand merchandise at discounted prices.
For the fiscal year ended January 2, 1999, Meldisco's net sales from
Kmart's operations accounted for approximately 62% of the Company's net sales
and 97% of Meldisco's net sales.
Pursuant to an agreement between the Company and Kmart Corporation
("Kmart") entered into effective July 1, 1995, and amended as of March 1996
(collectively, the "Kmart Agreement"), and an agreement between the Company and
Thrifty PayLess, Inc. a wholly owned subsidiary of Rite Aid Corporation, entered
into in principle effective January 1, 1999, the Company has the exclusive right
to operate the footwear departments in Kmart and in the former Payless/Thrifty
drug stores now operated under the name Rite Aid ("Rite Aid stores"). All
license agreements relating to the Kmart leased departments expire July 1, 2012
and all agreements relating to certain TPI stores have an initial term that
expires December 31, 2001 with the option to extend the term until either party
terminates upon six months prior written notice. The Kmart Agreement is subject
to certain performance standards. Payments by the Company under all such license
agreements are based on a percentage of sales, with additional payments under
the Kmart Agreement to be made based on profits. The Company has a 51 percent
equity interest and Kmart has a 49 percent equity interest in all the
subsidiaries which operate leased departments in Kmart stores, with the
exception of 40 such subsidiaries in which the Company has a 100 percent equity
interest ("the Meldisco Subsidiaries"). The Company has a 100 percent equity
interest in all the subsidiaries which operate leased departments in certain TPI
stores.
The business relationship between Meldisco and Kmart is very significant
to the Company, and the loss of Meldisco's Kmart operations would have a
material adverse effect on the Company. The Kmart Agreement or any license
agreement for a particular Kmart store, may only be terminated: (i) by Kmart
with respect to any Kmart store with a footwear department which is to cease to
operate and be open for business to the public; (ii) by Kmart or Meldisco with
respect to any affected Kmart store, in the event that any footwear department
premises become unfit for use and occupancy by reason of material damage or
destruction, or as a result of condemnation; (iii) by Kmart or Meldisco if the
other party shall fail to make any material payments when due or to deliver any
material accounting reports as required by the Kmart Agreement, or in the event
of a material breach of any covenant, representation or warranty of the other
party, subject to the right of the party so charged to cure the breach or
failure within a specified period; (iv) by either party if Kmart or Meldisco
shall fail to pay its debts when due or becomes subject to certain insolvency,
bankruptcy or similar events; (v) at the option of the non-selling or
non-transferring party, in the event of a sale or transfer of a majority of the
outstanding shares of the other party to a single person or entity or an
affiliated group under common control; or (vi) in the event that the Meldisco
Subsidiaries fail to achieve the performance standards outlined in the Kmart
Agreement.
Meldisco--Merchandising
Meldisco's merchandising strategy focuses on solidifying and building upon
its current industry position while attracting Kmart shoppers who do not
currently purchase their footwear at Kmart. The essence of this two-pronged
strategy is to satisfy Meldisco's core customer with high in-stock availability
rates of its footwear products while generating interest among Kmart's
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non-footwear shoppers by providing a wider selection of well-known national
brands.
Meldisco seeks to attract more affluent Kmart non-footwear shoppers into
the footwear department from other areas of the store. To this end, Meldisco
increasingly offers selected high-quality footwear licensed by well-known
national brands at prices significantly lower than comparable merchandise sold
by full-price retailers. These branded products are also intended to change
customer perceptions of "sameness" among discount footwear retailers. Licensed
brands available only at Meldisco include "Route 66," "Texas Steer," and "Cobbie
Cuddlers," a brand name licensed from Nine West. Meldisco also launched in
November 1997 the "Thom McAn" line of premium-quality shoes for men. The Thom
McAn line for men was very successful in 1998 and was extended to include
Women's and Children's styles. Meldisco is currently conducting consumer
research to assess the fit of additional brands in terms of price, positioning,
and discount category suitability.
Meldisco's traditional strength has been in seasonal, work, value-priced
athletic, women's casuals and children's shoes. Meldisco works to solidify its
strength in these segments by ensuring high levels of customer service and
satisfaction. Meldisco's "narrow and deep" merchandising strategy and its
planned systems innovations are designed to ensure that each store is well
stocked in product lines that are particularly popular with Meldisco's core
customers. Meldisco's demand-driven merchandise replenishment system has been
designed to permit inventory management at the store, style and size level.
Meldisco is taking steps to increase customer perception of assortment
availability without increasing store inventories. Meldisco believes that
customer satisfaction and perception of assortment availability should improve
as Meldisco develops and implements systems enabling it to offer the optimal
product mix at the individual store level.
Meldisco--Marketing
Meldisco believes that Kmart's typical footwear shopper generally
parallels the average Kmart softlines shopper who is a "busy, budget-conscious
mom" in the 25 to 49 age group, employed at least part-time, has at least one
child under the age of 18 and reports a total annual household income between
$25,000 and $65,000. Meldisco's marketing initiatives are designed to support
its overall business strategy of increasing purchases among traditional Kmart
footwear shoppers while attracting more affluent current Kmart non-footwear
shoppers into the footwear department from softlines and other areas of the
store.
Meldisco's marketing strategy is designed to convey to prospective Kmart
customers that Meldisco carries the right combination of product selection,
quality, and price to position Meldisco-operated Kmart leased footwear
departments as their discount footwear destination of choice.
This message is communicated through weekly advertising in Kmart's
newspaper insert. Meldisco currently pays Kmart a sales promotional fee that
Kmart applies toward its footwear advertisements in the Kmart weekly newspaper
insert, a publication with a circulation of approximately 68 million. Meldisco
advertises primarily through the Kmart newspaper insert but continuously
evaluates other alternatives for promotion of its products. Meldisco's marketing
strategy was supported by the announced Kmart "Big K" concept remodeling program
which includes the relocation of the footwear department to an improved location
near the center of the softlines area of the store. Meldisco shoe departments
within Big K locations have out performed non-converted stores
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throughout 1998. As of January 2, 1999, Kmart had converted 57% of their chain
to the Big K format.
Meldisco--Competitive Environment
The discount footwear industry is a highly competitive environment that
has experienced significant consolidation. Competition within the discount
segment is heavily concentrated among four retailers including Meldisco.
Payless ShoeSource, Inc. ("Payless") (which is not affiliated with PayLess
Thrifty Drug Stores), and two discount department stores, Wal-Mart and Dayton
Hudson's Target, are Meldisco's primary retail footwear competitors. These
competitors have grown more rapidly and have substantially greater resources
than the Company. The Company believes that it has been able to maintain its
overall unit market share during this period of rapid growth by its primary
competitors due to the relative strength of Meldisco's business. There can be no
assurance however that in the future the operations of competitors will not have
a material effect on the Company.
J. Baker,Inc.'s JBI footwear division is Meldisco's primary competitor
among operators of leased footwear departments. JBI footwear, through its
subsidiaries, operates leased self-selection footwear departments in discount
and promotional department store chains located throughout the U. S., including
footwear departments at Bradlees, Ames and ShopKo stores. JBI footwear
constitutes a competitor insofar as Meldisco is seeking to expand its leased
footwear department operations. Neither JBI footwear nor any other operator,
however, is a competitor with respect to Kmart since the Meldisco agreement with
Kmart provides for Meldisco's continued operation of Kmart's footwear
departments through 2012, unless terminated earlier in the case of breach or
certain other limited circumstances.
The Meldisco business competes with the other discounters on the basis of
price and that product selection, style and brand recognition are important
factors that differentiate Meldisco from other discount footwear retailers.
Fashion Trends
The success of the Company depends in part on its ability to anticipate
and respond to changing fashion and merchandise trends and consumer demands in a
timely manner. Accordingly, any failure by the business segments to identify and
respond to emerging trends could adversely affect consumer acceptance of the
merchandise which in turn could adversely affect the Company's business.
Key Vendors
Footaction's product sourcing is driven by its relationships with athletic
footwear and apparel vendors. In 1998, approximately 80% of Footaction's net
sales were generated by merchandise purchased from Nike, Adidas, Reebok and Fila
with the most significant percentage attributable to Nike. The loss of the
Company's relationship with certain key vendors could have a materially adverse
impact on the Company.
Foreign Purchasing
The Company's sourcing and purchasing of product is conducted by the
merchandising department of each of its segments. A significant percentage of
the Company's products are sourced or manufactured offshore, with China
accounting for approximately 91% of all sources. There are risks inherent in
foreign sourcing and manufacturing and although the Company has not historically
experienced any material adverse effects from these risks, there
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can be no assurances that they will not have a material adverse effect in the
future.
Trademarks and Service Marks
The Company or its subsidiaries own all rights to "Footaction" for use as
a trademark or service mark in connection with footwear and related products and
services. The Company or its subsidiaries have registered or have common law
rights to over 100 trademarks and/or service marks under which the Company
markets private label merchandise or its services. The Company either has
registered or is in the process of registering its trademarks and service marks
in foreign countries in which it operates or may operate in the future. As
necessary, the Company vigorously protects its trademarks and service marks both
domestically and internationally.
Employees
As of January 2, 1999, the Company had approximately 14,979 employees
including approximately 8,738 at Meldisco and 6,068 at Footaction. As of January
2, 1999 Meldisco had approximately 3,276 full-time and 5,462 part-time employees
and Footaction had approximately 1,595 full-time and 4,473 part-time employees.
Discontinuation of Thom McAn Segment
Thom McAn, which had been part of Melville since 1922, was primarily a
mall-based, specialty retailer, marketing moderately-priced men's and women's
private label footwear and accessories. As a result of extreme competitive
pressures in the moderately-priced footwear retail market, Melville decided to
exit the Thom McAn business in 1996 by converting 76 Thom McAn stores to
Footaction stores, and selling or closing the remaining locations. As of January
2, 1999, all Thom McAn stores are closed.
ITEM 2. PROPERTIES
Footaction has a nationwide presence. As of January 2, 1999, it operated
572 stores in 45 states and the Caribbean. Footaction's prototype store design
is a 4,000 to 6,500 square foot large store format, which the Company believes
operates more profitably while satisfying the needs of its customers more
effectively than its 2,500 square foot traditional store format. At January 2,
1999, 389 of the Company's 572 Footaction stores were of the large store format
and 183 were of the traditional store format. Footaction stores are all leased
with a typical lease term of 10 years. These leases call for minimum annual rent
subject to periodic adjustments, plus other charges, including a proportionate
share of taxes, insurance and common area maintenance, and percentage rent based
on the store's sales volume.
At January 2, 1999, Meldisco operated leased footwear departments in 2,538
stores. Collectively, these leased departments are located in all 50 states,
Guam, the Caribbean, the Czech Republic, Slovakia, Hungary and Poland. All but
377 of the leased departments operated at January 2, 1999 were located in Kmart
discount department stores. Of these 377 stores, 357 leased departments were
located in Rite Aid stores and 20 in Tesco department stores.
Kmart and Rite Aid stores provide Meldisco with store space to sell
footwear in exchange for certain payments. Meldisco-operated footwear
departments in traditional Kmart stores average 2,900 square feet and 3,600
square feet in Super Kmart Centers. Meldisco's footwear departments in Rite Aid
stores generally occupy approximately 100 linear feet of selling space.
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Company headquarters and Meldisco's corporate offices are located in 190,000
square feet of leased office space in Mahwah, New Jersey. Footaction's corporate
offices are located in 50,000 square feet of leased office space in Irving,
Texas. The new Shared Service Center, that was opened in the fall of 1998, is
located in 57,000 square feet of leased office space in Irving, Texas. Meldisco
operates out of its two new distribution facilities located in Mira Loma,
California and Gaffney, South Carolina, with a total of 906,500 square feet. In
1998 Footaction's Distribution facility was closed in Dallas, Texas.
Footaction's distribution needs are now being handled by the distribution center
in Gaffney, South Carolina.
ITEM 3. LEGAL PROCEEDINGS
The Company is from time to time involved in routine litigation incidental
to the conduct of its business, none of which, the Company believes, will have a
material adverse effect on its financial position or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders, through
solicitation of proxies or otherwise, during the fourth quarter of the fiscal
year ended January 2, 1999.
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EXECUTIVE OFFICERS OF THE REGISTRANT
The following information sets forth the name, age and business experience
during the past five years of the executive officers of the Registrant. For each
officer named below, the term of office extends to the date of the Board of
Directors Meeting following the next Annual Meeting of Stockholders of the
Company.
J.M. Robinson, age 53, is and has been the Chairman, Chief Executive
Officer and President of the Company since October 12, 1996. Mr. Robinson was
President and Chief Executive Officer of the Meldisco division of Melville since
June 1988.
Carlos E. Alberini, age 43, is and has been the Senior Vice President,
Chief Financial Officer of the Company since October 12, 1996. From February,
1996 to July 10, 1996, Mr. Alberini was the Acting Chief Financial Officer of
Melville, having joined Melville in May 1995 as Vice President of Finance. Prior
to that time, Mr. Alberini served as the Chief Financial Officer and Senior Vice
President (1990-1995) of The Bon Ton Stores Inc., a chain of 64 department
stores.
Maureen Richards, age 42, is and has been the Vice President, General
Counsel and Corporate Secretary of the Company since October 12, 1996. From
October 1995, Ms. Richards had been Vice President, Corporate Counsel and
Assistant Secretary of Melville and its Corporate and Trademark Counsel and
Assistant Secretary from October 1991 to October 1995.
Robert D. Ravener, Jr., age 40, is and has been the Vice President and
Chief Personnel Officer of the Company since March 1998. From February 1997 to
March 1998, Mr. Ravener was Director of Safety and Risk, and from February 1994
to February 1997, a Director of Human Resources for Pepsi-Cola Company.
PART II
ITEM 5. MARKET PRICES OF AND DIVIDENDS ON THE REGISTRANT'S COMMON EQUITY AND
RELATED STOCKHOLDER MATTERS
The information required by this item is included in the Company's
Annual Report to Shareholders for the year ended January 2, 1999 on pages 9, 12
and 28 and is incorporated herein by reference.
ITEM 6. SELECTED FINANCIAL DATA
The information required by this item is included in the Company's Annual
Report to Shareholders for the fiscal year ended January 2, 1999 on page 32 and
is incorporated herein by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The information required by this item is included in the Company's Annual
Report to Shareholders for the fiscal year ended January 2, 1999 on pages 9
through 13 and is incorporated herein by reference.
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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Derivatives
The Company is not materially exposed to changes in the underlying values
of its assets or liabilities nor is it materially exposed to changes in the
value of expected foreign currency cashflows. Therefore, the Company has not
engaged in the purchase or sale of any derivative instruments.
Interest Rates
The Company's investment and debt portfolios are short-term, seasonal in
nature. The Company's investment portfolio consists of highly rated short-term
marketable securities with peak amounts coinciding with the year-end peak
selling season. The Company, from time to time, undertakes short-term borrowings
to finance working capital. The Company's peak borrowing periods coincide with
peak inventory purchases. The Company had no borrowings outstanding as of the
fiscal year end.
Foreign Exchange
International operations constitute approximately 0.6% of 1998 net sales.
Translating the income statements of these operations for the affects of foreign
currency changes does not have a material impact on the Company's financial
positions. The Company does not have material exposure to cash flows denominated
in foreign currency nor have net foreign exchange gains or losses been material
to operating results in the past three reporting periods.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this item is included in the Company's Annual
Report to Shareholders for the fiscal year ended January 2, 1999 on pages 14
through 32 and is incorporated herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding the executive officers is furnished under the
heading "EXECUTIVE OFFICERS OF THE REGISTRANT" in Part I of this report since
such information will not be furnished in the Company's definitive proxy
statement other than for Mr. Robinson.
Any other information required by this Part III (Items 10, 11, 12 and 13)
will be included in the Company's definitive proxy statement to be filed with
the Securities and Exchange Commission pursuant to Regulation 14A and is
incorporated herein by reference. The Compensation Committee report on executive
compensation and the performance graph included in such proxy statement shall
not be deemed incorporated herein by reference.
12
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(l) Financial Statements
The following financial statements and reports are incorporated by
reference to pages 14 through 32 of the Company's Annual Report to Shareholders
for the fiscal year ended January 2, 1999.
Independent Auditors' Report 14
Consolidated Statements of Operations for the fiscal years
ended January 2, 1999, January 3, 1998 and
December 28, 1996 15
Consolidated Balance Sheets as of January 2, 1999
and January 3, 1998 16
Consolidated Statements of Shareholders' Equity and
Comprehensive Income for the fiscal years ended
January 2, 1999, January 3, 1998 and December 28, 1996 17
Consolidated Statements of Cash Flows for the fiscal
years ended January 2, 1999, January 3, 1998 and
December 28, 1996 18
Notes to Consolidated Financial Statements 19
(a)(2) Schedules
The following schedules are included in Part IV of this Report: Page
Independent Auditors' Report on Schedule F-1
Schedule II - Valuation and Qualifying Accounts for the
fiscal years ended January 2, 1999, January 3, 1998 and
December 28, 1996 F-2
13
<PAGE>
Schedules not included above have been omitted because they are not applicable
or the required information is shown in the consolidated financial statements or
related notes.
(a)(3) Exhibits
The exhibits to this Report are listed in the Exhibit Index included elsewhere
herein.
(b) Reports on Form 8-K
Current Report on Form 8-K dated October 25, 1998 was filed by the Company with
the SEC relating to the stock repurchase program, third quarter results and
outlook.
Current Report on Form 8-K dated December 4, 1998 was filed by the Company with
the SEC relating to earnings.
14
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized.
FOOTSTAR, INC.
By /s/ J. M. ROBINSON
-----------------------------------------
J. M. Robinson, Chairman of the Board,
Chief Executive Officer and President
Pursuant to the requirements of the Securities Act of 1934, this Report
has been signed by the following persons in the capacities and on the date
indicated.
Signature Title Date
--------- ----- ----
/s/ CARLOS E. ALBERINI Senior Vice President and March 29, 1999
- ----------------------- Chief Financial Officer
Carlos E. Alberini
/s/ ROBERT A. DAVIES, III Director March 29, 1999
- -------------------------
Robert A. Davies, III
/s/ GEORGE S. DAY Director March 29, 1999
- -------------------------
George S. Day
/s/ STANLEY P. GOLDSTEIN Director March 29, 1999
- -------------------------
Stanley P. Goldstein
/s/ TERRY R. LAUTENBACH Director March 27, 1999
- -------------------------
Terry R. Lautenbach
/s/ BETTYE MARTIN MUSHAM Director March 29, 1999
- -------------------------
Bettye Martin Musham
/s/ KENNETH S. OLSHAN Director March 27, 1999
- -------------------------
Kenneth S. Olshan
15
<PAGE>
Independent Auditor's Report on Schedule
To the Board of Directors and Shareholders of Footstar, Inc.:
Under the date of February 8, 1999, we reported on the consolidated balance
sheets of Footstar, Inc. and Subsidiary Companies as of January 2, 1999 and
January 3, 1998, and the related consolidated statements of operations,
shareholders' equity and comprehensive income and cash flows for each of the
years in the three-year period ended January 2, 1999, as contained in the 1998
Annual Report to Shareholders. These consolidated financial statements and our
report thereon are incorporated by reference in the Annual Report on Form 10-K
for the year ended January 2, 1999. In connection with our audits of the
aforementioned consolidated financial statements, we also have audited the
related financial statement schedule listed in answer to Part IV, Item 14(a)(2)
of Form 10-K. This financial statement schedule is the responsibility of the
Company's management. Our responsibility is to express an opinion on this
financial statement schedule based on our audits.
In our opinion, such financial statement schedule, when considered in relation
to the basic consolidated financial statements taken as a whole, presents fairly
in all material respects the information set forth therein.
/s/KPMG LLP
Short Hills, NJ
February 8, 1999
F-1
16
<PAGE>
Schedule II
FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
Valuation and Qualifying Accounts
Years ended January 2, 1999, January 3, 1998 and December 28, 1996
($ in Millions)
Additions
Balance at Charged to Balance
Beginning Costs and at End
Description of Year Expenses Deductions(1) of Year
----------- ---------- ---------- ------------- -------
Accounts Receivable:
Allowance for Doubtful Accounts:
Year Ended January 2, 1999 $1.5 $ 1.7 $(2.0) $1.2
==== ===== ===== ====
Year Ended January 3, 1998 $0.4 $ 1.1 $ 0.0 $1.5
==== ===== ===== ====
Year Ended December 28, 1996 $1.0 $(0.3) $(0.3) $0.4
==== ===== ===== ====
(1) Write-offs, net of recoveries
F-2
17
<PAGE>
Exhibit Index
Exhibit
Number DESCRIPTION
2.1 Form of Distribution Agreement among Melville Corporation
("Melville"), Footaction Center, Inc., and Footstar, Inc.
(incorporated by reference to Exhibit 2.1 to Footstar, Inc.'s Form
10/A Information Statement dated September 26, 1996).
3.1 Amended and Restated Articles of Incorporation of Footstar, Inc.
(incorporated by reference to Exhibit 3.1 to Footstar, Inc.'s Form
10/A Information Statement dated September 26, 1996).
3.2 Amended and Restated Bylaws of Footstar, Inc. (incorporated by
reference to Exhibit 3.2 to Footstar, Inc.'s Form 10/A Information
Statement dated September 26, 1996).
4.1 Rights Agreement, dated as of March 8, 1999 between Footstar, Inc.
and ChaseMellon Shareholder Services, L.L.C., as Rights Agent, which
includes, as Exhibit A the Certificate of Designation, Preferences
and Rights of Series A Junior Participating Preferred Stock of
Footstar, Inc., as Exhibit B the Form of Right Certificate, and as
Exhibit C the Summary of Rights to Purchase Preferred Shares
(incorporated by reference to Exhibit 1 to Footstar, Inc.'s Form
8-A dated March 9, 1999).
10.1 Master Agreement, dated as of June 9, 1995, between Kmart
Corporation and Footstar, Inc., as amended (incorporated by
reference to Exhibit 10.1 to Footstar, Inc.'s Form 10/A Information
Statement dated September 26, 1996. Certain portions of this Exhibit
have been accorded confidential treatment).
10.2 Tax Disaffiliation Agreement between Melville and Footstar, Inc.
(incorporated by reference to Exhibit 10.2 to Footstar, Inc.'s Form
10/A Information Statement dated September 26, 1996).
10.3 1996 Incentive Compensation Plan of Footstar, Inc. (incorporated by
reference to Exhibit 10.3 to Footstar, Inc.'s Form 10/A Information
Statement dated September 26, 1996).*
10.4 1996 Non-Employee Director Stock Plan of Footstar, Inc.
(incorporated by reference to Exhibit 10.4 to Footstar, Inc.'s Form
10/A Information Statement dated September 26, 1996).*
10.5 Employment Agreements with Executive Officers (incorporated by
reference to Exhibit 10.5 to Footstar, Inc.'s 1996 Annual Report on
Form 10-K).*
10.6 Credit Agreement, dated as of September 18, 1997, among the Banks
listed therein, the Bank of New York, as Issuing Bank, Morgan
Guaranty Trust Company of New York, as Administrative Agent and
Swingline Lender, and Footstar, Inc. (incorporated by reference to
Exhibit 10.6 to Footstar, Inc.'s Form 10-Q dated November 10, 1997).
18
<PAGE>
10.7(a) Amendment dated as of April 30, 1998 to Credit Agreement dated as of
September 18, 1997, among the Banks listed therein, The Bank of New
York, as Issuing Bank, Morgan Guaranty Trust Company of New York, as
Administrative Agent and Swingline Lender, and Footstar, Inc.
10.7(b) Amendment dated as of October 23, 1998 to Credit Agreement dated
as of September 18, 1997, among the Banks listed therein, The
Bank of New York, as Issuing Bank, Morgan Guaranty Trust Company of
New York, as Administrative Agent and Swingline Lender, and
Footstar, Inc.
10.8 Footstar Deferred Compensation Plan (incorporated by reference to
Exhibit 10.8 to Footstar, Inc.'s 1996 Annual Report on Form 10-K).*
10.9 Supplemental Retirement Plan for select senior management
(incorporated by reference to Exhibit 10.9 to Footstar, Inc.'s 1996
Annual Report on Form 10-K).*
13.1 Portions of Annual Report to Shareholders for the fiscal year ended
January 2, 1999.
21.1 A list of subsidiaries of Footstar, Inc.
23.1 Consent of KPMG LLP.
27.1 Financial Data Schedule for the fiscal year ended January 2, 1999.
* Management contract or compensatory plan.
19
EXHIBIT 10.7(a)
EXECUTION COPY
AMENDMENT dated as of April 30, 1998, to the Credit Agreement
dated as of September 18, 1997 (the "Credit Agreement"), among
FOOTSTAR, INC. (the "Company"), the BANKS party thereto, THE BANK OF
NEW YORK, as Issuing Bank, and MORGAN GUARANTY TRUST COMPANY OF NEW
YORK, as Administrative Agent and Swingline Lender. Capitalized
terms used herein and not defined herein shall have the meanings
assigned thereto in the Credit Agreement.
A. The Company, the Banks and the Agent have heretofore entered into the
Credit Agreement.
B. The Company wishes, and the undersigned Banks and the Agent are
willing, upon the terms and subject to the conditions set forth herein, to amend
Section 5.15 of the Credit Agreement as set forth herein.
Accordingly, in consideration of the mutual agreements herein contained
and other good and valuable consideration, receipt of which is hereby
acknowledged, the Company, the Banks and the Agent hereby agree as follows:
SECTION 1. Amendment of the Credit Agreement. Section 5.15 of the Credit
Agreement is hereby amended as of the Amendment Effective Date (as defined
below) by replacing the amount "$110,000,000" in clause (d) thereof with the
amount "$135,000,000".
SECTION 2. Representations and Warranties. The Borrower hereby represents
and warrants on and as of the Amendment Effective Date that (i) the
representations and warranties of the Company contained in the Credit Agreement
and the other Loan Documents are true in all material respects and (ii) no
Default has occurred and is continuing.
SECTION 3. Effectiveness. This Amendment shall become effective on the
date (the "Amendment Effective Date") of receipt by the Agent (or its counsel)
of counterparts hereof signed by the Company and the Required Banks or, in the
case of any such party as to which an executed counterpart shall not have been
received, receipt by the Agent in form satisfactory to it of telegraphic,
<PAGE>
2
telex or other written confirmation from such party of execution of a
counterpart hereof by such party.
SECTION 4. Expenses. The Company shall pay all reasonable out-of-pocket
expenses of the Agent, including the reasonable fees and disbursements of
Cravath, Swaine & Moore, special counsel for the Agent, in connection with the
preparation of this Amendment.
SECTION 5. New York Law. THIS AMENDMENT SHALL BE GOVERNED BY AND CONSTRUED
IN ACCORDANCE WITH THE LAWS OF THE STATE OF NEW YORK.
SECTION 6. Counterparts. This Amendment may be signed in any number of
counterparts, each of which shall be an original, with the same effect as if the
signatures thereto and hereto were upon the same instrument.
SECTION 7. Headings. The headings of this Amendment are for convenience of
reference only and are not part of this Amendment and are not to be taken into
consideration in interpreting this Amendment.
<PAGE>
3
SECTION 8. Effect of Amendment. Unless and until this Amendment becomes
effective, the Credit Agreement shall continue in effect on the terms thereof in
effect on the date hereof.
IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be
duly executed by their respective authorized officers as of the day and year
first above written.
FOOTSTAR, INC.,
by /s/ BRIAN M. SZAMES
------------------------------
Name: Brian M. Szames
Title: Vice President and
Treasurer
MORGAN GUARANTY TRUST COMPANY
OF NEW YORK, individually and
as Administrative Agent and
Swingline Lender,
by /s/ DOUG MAHER
------------------------------
Name: Doug Maher
Title: Vice President
THE BANK OF NEW YORK,
individually and as Issuing
Bank,
by /s/ HOWARD F. BASCOM, JR.
------------------------------
Name: Howard F. Bascom, Jr.
Title: Vice President
<PAGE>
4
THE ASAHI BANK, LTD.,
by /s/ DOUGLAS PRICE
------------------------------
Name: Douglas Price
Title: Senior Vice President
BANK OF AMERICA NATIONAL TRUST &
SAVINGS ASSOCIATION,
by /s/ SANDRA S. OBER
------------------------------
Name: Sandra S. Ober
Title: Managing Director
BANKBOSTON, N.A.,
by /s/ NANCY FULLER
------------------------------
Name: Nancy Fuller
Title: Director
CIBC, INC.,
by /s/ ELIZABETH FISCHER
------------------------------
Name: Elizabeth Fischer
Title: Executive Director
CORESTATES BANK, N.A.,
by /s/ THOMAS MCDONNELL
------------------------------
Name: Thomas McDonnell
Title: Vice President
<PAGE>
5
CREDIT LYONNAIS NEW YORK BRANCH,
by /s/ VLADIMIR LABUN
------------------------------
Name: Vladimir Labun
Title: First Vice President
- Manager
CREDIT SUISSE FIRST BOSTON,
by /s/ CHRIS T. HORGAN
------------------------------
Name: Chris T. Horgan
Title: Vice President
by /s/ KRISTIN LEPRI
------------------------------
Name: Kristin Lepri
Title: Associate
FLEET NATIONAL BANK,
by /s/ THOMAS J. BULLARD
------------------------------
Name: Thomas J. Bullard
Title: Vice President
NATIONAL AUSTRALIA BANK LIMITED,
by /s/ R. ADAMS PERRY III
------------------------------
Name: R. Adams Perry III
Title: SVP & Head of Corporate
Banking & Finance
by /s/ BILL SCHMID
------------------------------
Name: Bill Schmid
Title: Relationship Manager
<PAGE>
6
PNC BANK, NATIONAL ASSOCIATION,
by /s/ MICHAEL RICHARDS
------------------------------
Name: Michael Richards
Title: Vice President
THE SAKURA BANK, LTD.,
by /s/ YASUMASA KIKUCHI
------------------------------
Name: Yasumasa Kikuchi
Title: Senior Vice President
STANDARD CHARTERED BANK,
by /s/ LEONARDO TEE
------------------------------
Name: Leonardo Tee
Title: Vice President
by /s/ KRISTINA MCDAVID
------------------------------
Name: Kristina McDavid
Title: Vice President
UNION BANK OF CALIFORNIA, N.A.,
by /s/ ROBERT C. PILER
------------------------------
Name: Robert C. Piler
Title: Vice President
EXHIBIT 10.7(b)
EXECUTION COPY
AMENDMENT dated as of October 23, 1998, to the Credit
Agreement dated as of September 18, 1997, as amended (the "Credit
Agreement"), among FOOTSTAR, INC. (the "Company"), the BANKS party
thereto, THE BANK OF NEW YORK, as Issuing Bank, and MORGAN GUARANTY
TRUST COMPANY OF NEW YORK, as Administrative Agent and Swingline
Lender. Capitalized terms used herein and not defined herein shall
have the meanings assigned thereto in the Credit Agreement.
A. The Company, the Banks and the Agent have heretofore entered into the
Credit Agreement and the Amendment thereto dated as of April 30, 1998.
B. The Company wishes, and the undersigned Banks and the Agent are
willing, upon the terms and subject to the conditions set forth herein, to amend
Sections 5.15 and 5.16 of the Credit Agreement as set forth herein.
Accordingly, in consideration of the mutual agreements herein contained
and other good and valuable consideration, receipt of which is hereby
acknowledged, the Company, the Banks and the Agent hereby agree as follows:
SECTION 1. Amendments of the Credit Agreement. (a) Section 5.15 of the
Credit Agreement is hereby amended as of the Amendment Effective Date (as
defined below) by replacing the amount "$135,000,000" in clause (d) thereof with
the amount "$205,000,000".
(b) Section 5.16 of the Credit Agreement is hereby amended as of the
Amendment Effective Date by inserting, following clause (f) thereof, the
following sentence:
Notwithstanding the foregoing, Footstar Corporation may incur Debt in
excess of that which is otherwise permitted by this Section 5.16; provided that
at any time that Footstar Corporation has outstanding Debt in excess of that
which is otherwise permitted by this Section 5.16, then any and all Loans
outstanding hereunder must be Loans made by the Banks to Footstar Corporation,
in its capacity as a Borrower, and any and all Letters of Credit outstanding
hereunder must be Letters of Credit issued for the account of Footstar
Corporation, in its capacity as a Borrower.
<PAGE>
2
SECTION 2. Representations and Warranties. The Company hereby represents
and warrants on and as of the Amendment Effective Date that (i) the
representations and warranties of the Company contained in the Credit Agreement
and the other Loan Documents are true in all material respects and (ii) no
Default has occurred and is continuing.
SECTION 3. Effectiveness. This Amendment shall become effective on the
date (the "Amendment Effective Date") of receipt by the Agent (or its counsel)
of counterparts hereof signed by the Company and the Required Banks or, in the
case of any such party as to which an executed counterpart shall not have been
received, receipt by the Agent in form satisfactory to it of telecopy or other
written confirmation from such party of execution of a counterpart hereof by
such party.
SECTION 4. Expenses. The Company shall pay all reasonable out-of-pocket
expenses of the Agent, including the reasonable fees and disbursements of
Cravath, Swaine & Moore, special counsel for the Agent, in connection with the
preparation of this Amendment.
SECTION 5. New York Law. THIS AMENDMENT SHALL BE GOVERNED BY AND CONSTRUED
IN ACCORDANCE WITH THE LAWS OF THE STATE OF NEW YORK.
SECTION 6. Counterparts. This Amendment may be signed in any number of
counterparts, each of which shall be an original, with the same effect as if the
signatures thereto and hereto were upon the same instrument.
SECTION 7. Headings. The headings of this Amendment are for convenience of
reference only and are not part of this Amendment and are not to be taken into
consideration in interpreting this Amendment.
<PAGE>
3
SECTION 8. Effect of Amendment. Unless and until this Amendment becomes
effective, the Credit Agreement shall continue in effect on the terms thereof in
effect on the date hereof.
IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be
duly executed by their respective authorized officers as of the day and year
first above written.
FOOTSTAR, INC.,
by /s/ MARC A. COMITO
------------------------------
Name: Marc A. Comito
Title: Assistant Treasurer
MORGAN GUARANTY TRUST COMPANY
OF NEW YORK, individually and as
Administrative Agent and
Swingline Lender,
by /s/ ROBERT BOTTAMEDI
------------------------------
Name: Robert Bottamedi
Title: Vice President
THE BANK OF NEW YORK,
individually and as Issuing
Bank,
by /s/ HOWARD F. BASCOM, JR.
------------------------------
Name: Howard F. Bascom, Jr.
Title: Vice President
THE ASAHI BANK, LTD.,
by /s/ TATSUO KASE
------------------------------
Name: Tatsuo Kase
Title: Senior Manager
<PAGE>
4
BANK OF AMERICA NATIONAL TRUST & SAVINGS
ASSOCIATION,
by /s/ JODY A. PRITCHARD
-----------------------------------
Name: Jody A. Pritchard
Title: Vice President
BANKBOSTON, N.A.,
by /s/ NANCY E. FULLER
-----------------------------------
Name: Nancy E. Fuller
Title: Director
CIBC, INC.,
by /s/ KATHERINE BASS
-----------------------------------
Name: Katherine Bass
Title: Executive Director
CREDIT LYONNAIS NEW YORK BRANCH,
by /s/ DEBORAH E. BRADLEY
-----------------------------------
Name: Deborah E. Bradley
Title: First Vice President
CREDIT SUISSE FIRST BOSTON,
by /s/ CHRIS T. HORGAN
-----------------------------------
Name: Chris T. Horgan
Title: Vice President
by /s/ JOEL GLODOWSKI
-----------------------------------
Name: Joel Glodowski
Title: Managing Director
<PAGE>
5
FLEET NATIONAL BANK,
by /s/ THOMAS J. BULLARD
------------------------------
Name: Thomas J. Bullard
Title: Vice President
FIRST UNION BANK,
by /s/ THOMAS MCDONNELL
------------------------------
Name: Thomas McDonnell
Title: Vice President
NATIONAL AUSTRALIA BANK LIMITED,
by /s/ R. ADAMS PERRY III
------------------------------
Name: R. Adams Perry III
Title: SVP & Head of Corporate
Banking & Finance
by /s/ BILL SCHMID
------------------------------
Name: Bill Schmid
Title: Relationship Manager
PNC BANK, NATIONAL ASSOCIATION,
by /s/ MICHAEL RICHARDS
------------------------------
Name: Micheal Richards
Title: Vice President
THE SAKURA BANK, LTD.,
by /s/ YASUMASA KIKUCHI
------------------------------
Name: Yasumasa Kikuchi
Title: Senior Vice President
<PAGE>
6
STANDARD CHARTERED BANK,
by /s/ PETER G.R. DODDS
------------------------------
Name: Peter G.R. Dodds
Title: Senior Vice President
by /s/ JOHN BISCETTE
------------------------------
Name: John Biscette
Title: Assistant Vice President
UNION BANK OF CALIFORNIA, N.A.,
by /s/ TERRY ROCHA
------------------------------
Name: Terry Rocha
Title: Vice President
EXHIBIT 13.1
MANAGEMENT'S DISCUSSION & ANALYSIS
FORWARD-LOOKING STATEMENTS
This Annual Report to Shareholders contains statements which constitute
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. These statements appear in a number of places in
this Annual Report as well as the documents incorporated by reference and can be
identified by the use of forward-looking terminology such as "believe,"
"expect," "estimate," "plans," "may," "will," "should," "anticipates" or similar
statements or the negative thereof or other variations. Such forward-looking
statements include, without limitation, statements relating to cost savings,
capital expenditures, future cash needs, improvements in infrastructure, Year
2000 matters and operating efficiencies. Such forward-looking statements involve
known and unknown risks, uncertainties and other factors which may cause the
actual results, performance or achievements to be materially different from any
future results, performance or achievements expressed or implied by such
forward-looking statements. Such risks and uncertainties include, but are not
limited to; uncertainties related to consumer demand for footwear, warmer than
expected weather, consumer acceptance of the Company's merchandise mix, retail
locations, product availability and the effect of competitive products and
pricing. Consequently, all of the forward-looking statements internal and
external, Year 2000 risks and uncertainties, are qualified by these cautionary
statements, and there can be no assurance that the actual results, performance
or achievement will be realized. The information contained in this Annual Report
including information included under this section captioned "Management's
Discussion and Analysis," as well as information contained under the caption
"Risk Factors" in other Company filings with the Securities and Exchange
Commission, identifies important factors that could cause such results,
performance or achievements not to be realized. The Company undertakes no
obligation to update forward-looking statements to reflect events or
circumstances after the date such statements were made.
THE COMPANY
Footstar, Inc. (the "Company") became an independent company in 1996 after the
Board of Directors of Melville Corporation ("Melville") approved the spin-off of
its footwear segments. These businesses were comprised of Meldisco, a leading
operator of leased footwear departments nationwide and abroad; Footaction, a
mall-based branded athletic footwear and apparel chain; and Thom McAn, which has
been reported as a discontinued operation. The spin-off was completed with the
distribution (the "Distribution") on October 12, 1996, to Melville shareholders
of record on October 2, 1996, of all the shares of the Company. The Distribution
was made on the basis of .2879 shares of the Company's common stock for every
one share of Melville common stock. A total of 30,533,883 shares of common stock
were issued.
GENERAL
The historical financial information presented herein for years prior to fiscal
1997 reflects periods during which the Company did not operate as an independent
company, and accordingly, certain assumptions were made in preparing such
financial information. Such information, therefore, may not necessarily reflect
the results of operations or the financial condition of the Company which would
have resulted had the Company been an independent, public company during the
reporting periods, and are not necessarily indicative of the Company's future
operating results or financial condition.
Fiscal Year 1998
As part of its long-term strategy, the Company announced a non-recurring
plan designed to increase profitability in its two footwear businesses and
generate greater long-term value for shareholders. The primary components of the
plan include closing approximately 30 underperforming Footaction stores,
reconfiguring Footaction merchandise assortments and refining store layouts to
place greater emphasis on better-performing, higher-potential categories and
exiting Meldisco's Central European business. In conjunction with these actions,
Footstar recorded pre-tax, non-recurring charges of $34.4 million ($22.7 million
after taxes) in the fourth quarter of fiscal 1998. These non-recurring charges
included lease buyouts, inventory markdowns and asset impairment charges.
In 1998, the Company also successfully consolidated its logistics network
and centralized several accounting operations.
Footaction's distribution operations were relocated from its Dallas
facility and combined with those of Meldisco in the Company's state-of-the-art
distribution center located in Gaffney, South Carolina. Prior to the
consolidation, this center only served Meldisco's distribution needs.
The Company also established a shared accounting operations service center
("Shared Service Center") in the Dallas area, to support both its Meldisco and
Footaction businesses. This Shared Service Center currently supports the
accounts payable, store accounting, inventory management, asset protection and
payroll functions of both businesses.
Beginning in 1999, these initiatives are expected to generate considerable
annual cost savings and reduce the need for substantial capital expenditures to
expand Footaction's distribution network.
Fiscal Year 1997
In preparation for the distribution center and accounting operations
consolidations in 1998, the Company recorded a one-time, pre-tax charge of $15.7
million in the fourth quarter of 1997.
The Company also reversed $34.0 million, or $21.4 million after taxes, of
a reserve balance created as a result of the discontinuance of the Thom
McAn(R) chain in 1996. This reversal was recorded in the fourth quarter of
1997 as discontinued operations.
Footstar, Inc. and Subsidary Companies 9
<PAGE>
MANAGEMENT'S DISCUSSION & ANALYSIS
Fiscal Year 1996
In connection with the discontinuation of Thom McAn, the Company recorded a
pre-tax charge of approximately $85.0 million in the first quarter of 1996. The
charge primarily related to future operating losses during the wind-down period,
lease buyouts, asset write-offs and severance costs.
RESULTS OF OPERATIONS
Net Sales
Fiscal Year Ended
------------------------------------
($ in millions) 1998 1997 1996
- --------------------------------------------------------------------------
Company:
Net sales $ 1,829.1 $1,794.9 $1,672.3
Net sales % change from
prior year 1.9% 7.3% 3.5%
Same store sales % change (0.4%) 0.3% 2.8%
Meldisco:
Net sales $ 1,174.8 $1,187.2 $1,156.6
Net sales % change from
prior year (1.0%) 2.7% (2.9%)
Same store sales % change (0.5%) 1.4% (2.0%)
% of combined net sales 64.2% 66.1% 69.2%
Footaction:
Net sales $ 654.3 $607.7 $515.7
Net sales % change from
prior year 7.7% 17.8% 21.7%
Same store sales % change (0.1%) (2.5%) 16.8%
% of combined net sales 35.8% 33.9% 30.8%
- --------------------------------------------------------------------------
Fiscal Year 1998
Consolidated net sales for 1998 increased 1.9 percent over 1997. Meldisco's
total sales for 1998 decreased 1.0 percent while comparable store sales were
down 0.5 percent. Meldisco experienced positive results from the Thom McAn(R)
brand and growth at Kmart while seasonal footwear sales were relatively weak due
to adverse weather conditions. The Kmart growth was supported by an acquisition
of Venture store leases that added a net of 37 high volume shoe departments in
the fourth quarter. Kmart also continued to convert stores to the Big K format
in 1998. By year-end, the chain had converted 1,231 stores, or 57 percent of its
2,161 stores nationwide. Meldisco's Kmart operations accounted for 62.3 percent
and 96.9 percent of the net sales of the Company and Meldisco, respectively.
Footaction continued to face a difficult athletic footwear environment
that has seen consumer demand soften while retailers increased square footage.
Total sales in 1998 increased 7.7 percent over 1997 due to a 14 percent
expansion of square footage while comparable store sales were down slightly, 0.1
percent. Footaction opened 42 new stores and expanded 66 stores.
Weak consumer demand for athletic footwear and apparel, the NBA lockout, a
highly promotional marketplace and non-seasonal weather all had a significant
impact on sales. The Company announced a reorganization plan to strengthen
Footaction and position the chain to better compete in the current environment.
As part of this plan, approximately 30 underperforming stores are planned to be
closed. Expansion plans for 1999 have also been scaled back in response to the
over-stored environment. Estimated net cash outflow of this charge should not
exceed $5.5 million and Footstar's operating profit should be favorably impacted
by $2.0 million in 1999 and in excess of $3.5 million in future years.
Fiscal Year 1997
Consolidated net sales for 1997 increased $122.6 million, or 7.3 percent over
1996. Meldisco reported a 2.7 percent increase over 1996 net sales and had
increased same store sales of 1.4 percent. Meldisco experienced solid increases
in its women's segment, primarily due to the excellent performance of the Cobbie
Cuddlers(R) line of women's leather shoes, introduced in the fall of 1996. In
1997, Meldisco's shoe department in Kmart stores ("Shoemart") was relocated in
478 newly remodeled high-frequency stores operated under the name "Big Kmart."
Sales in these remodeled stores have outperformed those of the traditional Kmart
stores. Meldisco's Kmart operations accounted for 63.6 percent and 96.2 percent
of the net sales of the Company and Meldisco, respectively.
Footaction's results for 1997 were disappointing. Sales increased 17.8
percent for the year as a result of the rapid store expansion and conversion
program, but same store sales declined 2.5 percent. In 1997 Footaction opened 82
new stores and 52 stores were converted to our large store format, adding
approximately 472,000 square feet or 27 percent over 1996 square footage.
Footaction's sales were negatively impacted by a consumer shift to "brown
shoes." Although the running category produced strong results, it did not offset
weaker sales of basketball shoes, our largest merchandise category. Sales of
branded apparel were below expectations, primarily attributable to a wider
distribution of product by the main brands.
COSTS AND EXPENSES
Fiscal Year Ended
----------------------------
(As a % of net sales) 1998 1997 1996
- --------------------------------------------------------------------------------
Cost of sales(1) 69.9% 69.1% 68.5%
Store operating, selling, general
and administrative expenses(2) 21.1% 20.7% 21.3%
Depreciation and amortization 1.8% 1.9% 1.5%
- --------------------------------------------------------------------------------
(1) After non-recurring charges.
(2) Includes allocations from Melville in 1996.
- --------------------------------------------------------------------------------
10 Footstar, Inc. and Subsidary Companies
<PAGE>
COST OF SALES
Footstar's cost of sales in fiscal 1998 rose 80 basis points. This cost increase
is primarily attributable to higher markdowns recorded by Footaction as a result
of the highly promotional business environment, the under absorption of
occupancy expenses due to lower sales productivity, and the effect of
non-recurring charges representing inventory writedowns. Meldisco's cost of
sales decreased from last year as a result of better buying, lower distribution
costs and improved inventory management which contributed to lower markdowns.
In fiscal year 1997, consolidated cost of sales increased 60 basis points,
with the main source for the cost increase attributable to Footaction's
performance, where promotional markdowns were higher to drive sales in a very
competitive environment. In addition, Footaction's sales volume did not allow
this segment to leverage its fixed costs effectively. Meldisco's cost of sales
were slightly higher than in 1996 primarily due to increased delivery costs.
These higher costs were the result of consolidating all freight through two new
distribution centers, partially offset by lower inbound freight costs.
STORE OPERATING, SELLING, GENERAL
AND ADMINISTRATIVE EXPENSES
Store operating, selling, general and administrative expenses for fiscal 1998
increased 40 basis points. This increase was due primarily to the under
absorption of fixed expenses resulting from lower sales productivity.
For 1997, store operating, selling, general and administrative expenses as
a percentage of net sales decreased 60 basis points from 1996 on flat same store
sales. Several cost savings initiatives were implemented to accomplish this
reduction. Head count and benefit costs were reduced at both the stores and home
office. Major contracts were renegotiated at lower rates, including
telecommunications, health insurance, property, casualty and workers'
compensation insurance and freight agreements.
OPERATING PROFIT
Fiscal Year Ended
-------------------------------
($ in millions) 1998 1997 1996
- --------------------------------------------------------------------------------
Operating profit
Meldisco(1) $ 108.5 $ 105.0 $ 102.7
Footaction(1) 39.4 53.0 49.6
General corporate expenses(1) (8.9) (8.5) (5.0)
Restructuring and asset
impairment charges (34.4) (15.7) --
- --------------------------------------------------------------------------------
Operating profit $ 104.6 $ 133.8 $ 147.3
================================================================================
Operating profit as a % of net sales 5.7% 7.5% 8.8%
- --------------------------------------------------------------------------------
(1) Calculated before non-recurring charges.
- --------------------------------------------------------------------------------
Fiscal 1998 operating profit decreased from 1997 due primarily to the
$34.4 million in non-recurring charges related to the planned closing of
approximately 30 Footaction stores, reconfiguring merchandise assortments at
Footaction and exiting Meldisco's Central European business. Excluding this
charge, operating profit would have been $139.0 million. Also contributing to
the decrease was the decline in Footaction's operating profit resulting from
gross margin pressure due to the highly promotional environment and higher fixed
expenses, primarily rent, that Footaction could not absorb efficiently due to
the lower sales productivity of the existing space. In 1998, Meldisco continued
to improve its operating profit through improved gross margins and effective
expense control in spite of lower same store sales due to unseasonable weather.
Operating profit for 1997 decreased from 1996 due primarily to the
recording of $15.7 million in restructuring and asset impairment charges
relating to the consolidation of the logistics network and creation of a Shared
Service Center. Excluding these charges, operating profit would have been $149.5
million. Also contributing to the decrease were the additional costs incurred in
1997 for functional areas required to support a stand-alone public company,
offset in part by tighter controls over administrative expenses at Footaction
and Meldisco.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities totaled $126.5 million, $145.4 million
and $206.6 million for 1998, 1997 and 1996, respectively, and continued to serve
as the Company's primary source of liquidity. During the three years ended
January 2, 1999, cash generated from operations exceeded cash requirements for
capital additions and dividends to Melville Corporation and Kmart. Additionally,
the Company has a credit agreement that provides for a $300 million unsecured
revolving credit facility (the "Credit Facility") to meet its operating and
discretionary spending requirements.
The Company's Credit Facility contains various operating covenants which,
among other things, impose certain limitations on the Company's ability to incur
liens, incur indebtedness, merge, consolidate or declare and make dividend
payments. Under the Credit Facility, the Company is required to comply with
financial covenants relating to ratios of debt and fixed charge coverage. The
Credit Facility may be prepaid or retired by the Company without penalty prior
to the maturity date of September 18, 2000. The Credit Facility can be utilized
for direct borrowings and the issuance of letters of credit.
Footstar, Inc. and Subsidary Companies 11
<PAGE>
Fiscal Year Ended
-------------------------------------
($ in millions) 1998 1997 1996
- -------------------------------------------------------------------------------
Cash flows provided by
Operating activities(1) $ 126.5 $ 145.4 $ 206.6
Working capital 161.9 285.1 259.4
Current ratio 1.60x 2.17x 1.80x
Capital expenditures 58.6 59.1 68.3
- -------------------------------------------------------------------------------
(1) Cash flows from operating activities are stated before cash outlays for
minority interest of $36.3 million, $35.9 million and $63.8 million for
the fiscal years ended 1998, 1997 and 1996, respectively. The cash flow
amounts include after-tax interest income of approximately $17.7 million
for the fiscal year ended 1996, related to intercompany balances with
Melville which were eliminated subsequent to the spin-off.
As of January 2, 1999, there were no loans outstanding under the Credit
Facility.
Despite a difficult year, the Company's financial position remains strong.
At the end of the year, the Company had $49.1 million in cash and cash
equivalents and it was debt free, in spite of spending $134.5 million in its
share buyback programs during the 1998 fiscal year. The decline in working
capital and the reduced current ratio were primarily due to lower levels of cash
and cash equivalents as a result of the share repurchases.
The Company's businesses are seasonal in nature. Peak selling periods
coincide with Christmas, the Easter holiday and the back-to-school season.
Working capital requirements vary with seasonal business volume and inventory
buildups occurring prior to peak selling periods. The Company expects that its
current cash, together with cash generated from operations and the Credit
Facility, will be adequate to fund its operating expenses, working capital
needs, capital expenditures and projected growth for the foreseeable future. The
Company currently maintains significant borrowing capacity to take advantage of
growth and investment opportunities.
At the end of 1998 accounts receivable balances increased over 1997 levels
due to a calendar shift and stronger sales during the week after Christmas.
Ending inventories were slightly lower than in 1997. The increase in current
liabilities in 1998 versus 1997 was due primarily to increases in accounts
payable reflecting fresh inventory receipts and better working capital
management.
The Company spent $58.6 million in capital expenditures in 1998 and $59.1
million in 1997, relating primarily to opening, remodeling, relocating or
expanding Footaction stores, and the continuing investment in strategic
management information systems.
For fiscal year 1999 the Company expects capital expenditures to be
approximately $30 million, due primarily to the slower store growth at
Footaction. Footaction plans to open or convert 20 to 30 stores in 1999. In
addition, the Company plans to continue to invest in management information
systems in 1999.
YEAR 2000 UPDATE
General
The Year 2000 issue is the result of computer programs being written using two
digits rather than four to define the applicable year. The Company's computer
equipment and software and devices with embedded technology that are
time-sensitive may recognize a date using "00" as the year 1900 rather than the
year 2000. This could result in a system failure or miscalculations causing
disruptions of operations, including, among other things, a temporary inability
to process transactions, send invoices or engage in similar normal business
activities. The Company has undertaken various initiatives intended to ensure
that its computer equipment and software will function properly with respect to
dates in the Year 2000 and thereafter. For this purpose, the term "computer
equipment and software" includes systems that are commonly thought of as
information technology ("IT") systems, including hardware, accounting, data
processing and telephone/PBX systems, cash registers, hand-held terminals,
scanning equipment and other miscellaneous systems, as well as systems that are
not commonly thought of as IT systems, such as alarm systems, fax machines,
elevators, sprinkler systems, material handling equipment and heating,
ventilating and air-conditioning systems. Both IT and non-IT systems may contain
embedded technology, which complicates the Company's Year 2000 identification,
assessment, remediation and testing efforts.
Project
Overall, the Company's Year 2000 Project ("Project") is proceeding on schedule
toward its goal of remediating the Year 2000 issue as it applies to the Company
without a material business impact. The Project is divided into three major
sections - Infrastructure and Facilities, Applications Software, and third-party
suppliers, trading partners and vendors ("Third Parties"). Virtually all of the
compliance was performed or is expected to be performed by Company associates.
The general phases common to all sections are inventory, prioritization and
assessment; remediation and replacement; testing; and contingency planning.
As of January 2, 1999, the inventory, prioritization and assessment phase
of each section of the Project had been substantially completed for all material
items. The remediation and replacement phase of each section of the Project has
also been substantially completed for all material items. Material items are
those believed by the Company to have a significant risk involving the safety of
individuals, or that may cause damage to property or affect business operations
and/or revenues. The testing phase of the Project is being performed by the
Company in 1999. None of the Company's other IT projects have been delayed due
to the Project.
12 Footstar, Inc. and Subsidary Companies
<PAGE>
The Applications Software section includes both the conversion of
applications software that is not Year 2000 compliant and, where available from
the supplier, the replacement of such software. The Company utilizes
commercially available packaged software to support the majority of its
application needs. A large majority of such packages have been represented by
the respective vendors as Year 2000 compliant. Initial testing has to date
confirmed this. Remaining business software programs not addressed by such
commercially available packaged software have been inventoried, prioritized and
assessed for Year 2000 compliance. Remediation of such software programs, where
required, is completed and is currently undergoing integration testing. Such
integration testing is scheduled to be completed by approximately the end of the
second quarter of 1999. Contingency planning for this section, as necessary, is
ongoing.
The Infrastructure and Facilities section consists of major computer
equipment and software other than Applications Software and facilities operated
by the Company. The majority of computer equipment and software other than
Applications Software has been recently remediated by utilizing hardware and
software represented as Year 2000 compliant by the respective vendors. Initial
testing has to date confirmed this. The remainder of the major Infrastructure
has been inventoried, prioritized and assessed, and remediation efforts are
ongoing and currently scheduled for completion by approximately the end of
second quarter 1999. The testing phase is ongoing as computer equipment and
software other than Applications Software is remediated, upgraded or replaced.
All material Infrastructure and Facility activities are expected to be completed
by approximately the end of the second quarter of 1999. This section also
includes non-IT systems that are used in the operation of facilities operated by
the Company. Integration testing to confirm Year 2000 compliance is scheduled to
be completed by approximately the end of the second quarter of 1999. Contingency
planning for this section, if necessary, is scheduled to begin in the second
quarter 1999.
The Third Parties section includes the process of identifying and
prioritizing major suppliers, trading partners and vendors and communicating
with them about their plans and progress in addressing the Year 2000 problem.
Correspondence regarding the Year 2000 issue has been sent to all material
suppliers, trading partners and vendors. The Company has been told by such
material suppliers, trading partners and vendors that they expect to be Year
2000 compliant prior to the creation of material issues. The Company has
conducted certain follow-up inquiries of such major suppliers, trading partners
and vendors. Based on the results of such follow-up, the Company is scheduled to
develop contingency plans during the first and second quarters of 1999. If
necessary, the Company intends to implement contingency plans during the second
and third quarters of 1999.
Costs
The total cost associated with required steps to become Year 2000 compliant is
not expected to be material to the Company's financial position. The estimated
total cost of the Year 2000 Project is approximately $1.0 million excluding
payroll costs of the Company's internal personnel. The total amount expended on
the Project through January 2, 1999 was $0.6 million, all of which was expensed.
The future cost of completing the Year 2000 Project is estimated to be
approximately $0.4 million excluding any costs for contingency plans and any
costs if third parties experience Year 2000 problems. Funds for the Project are
provided from existing operating budgets.
Risks
Although the Company anticipates minimal business disruption will occur as a
result of the Year 2000 issue, the Year 2000 issue is unique and the failure to
correct a material Year 2000 issue could result in an interruption in, or a
failure of, certain normal business activities or operations, such as loss of
communication links with store locations, loss of electric power, inability to
process transactions and send purchase orders, inability to interact with
providers of banking and other services and disruption of the supply of product
and distribution channel (including, but not limited to ports, transportation
vendors and U.S. Customs). Such failures could materially and adversely affect
the Company's results of operations, liquidity and financial condition. In
addition, the Company's Kmart relationship is significant to the Company and the
failure of Kmart to be Year 2000 compliant could have a material adverse effect
on the Company. Due to the general uncertainty inherent in the Year 2000
problem, resulting in part from the uncertainty of the Year 2000 readiness of
Third Parties, the Company is unable to determine at this time whether the
consequences of Year 2000 failures will have a material impact on the Company's
results of operations, liquidity or financial condition. The Year 2000 Project
is expected to significantly reduce the Company's level of uncertainty about the
Year 2000 problem and, in particular, about the Year 2000 compliance and
readiness of its material Third Parties. The Company believes that, with the
implementation of new business systems and completion of the Project as
scheduled, the possibility of significant interruptions of normal operations
should be reduced.
Readers are cautioned that forward-looking statements contained in the
Year 2000 Update should be read in conjunction with the Company's disclosures
under the heading "Forward Looking Statements" beginning on page 9.
Footstar, Inc. and Subsidary Companies 13
<PAGE>
MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL REPORTING
The integrity and objectivity of the financial statements and related financial
information in this report are the responsibility of the management of the
Company. The financial statements have been prepared in conformity with
generally accepted accounting principles and include, when necessary, the best
estimates and judgments of management.
The Company maintains a system of internal accounting controls designed to
provide reasonable assurance, at appropriate cost, that assets are safeguarded,
transactions are executed in accordance with management's authorization, and the
accounting records provide a reliable basis for the preparation of the financial
statements. The system of internal accounting controls is continually reviewed
by management and improved and modified as necessary in response to changing
business conditions and recommendations of the Company's internal auditors and
independent auditors.
The Audit Committee of the Board of Directors, consisting solely of
outside directors, meets periodically with management, internal auditors and the
independent auditors to review matters relating to the Company's financial
reporting, the adequacy of internal accounting controls and the scope and
results of audit work. The internal auditors and independent auditors have free
access to the Audit Committee.
KPMG LLP, certified public accountants, were engaged to audit the
consolidated financial statements of the Company. Their Independent Auditors'
Report, which is based on an audit made in accordance with generally accepted
auditing standards, expresses an opinion as to the fair presentation of these
financial statements.
/s/ J. M. Robinson
- --------------------------------
J. M. Robinson
Chairman of the Board and Chief Executive Officer
/s/ Carlos E. Alberini
- --------------------------------
Carlos E. Alberini
Senior Vice President and Chief Financial Officer
February 8, 1999
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders of Footstar, Inc.:
We have audited the accompanying consolidated balance sheets of Footstar,
Inc. and Subsidiary Companies as of January 2, 1999 and January 3, 1998, and the
related consolidated statements of operations, shareholders' equity,
comprehensive income and cash flows for each of the years in the three-year
period ended January 2, 1999. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects the financial position of Footstar,
Inc. and Subsidiary Companies as of January 2, 1999 and January 3, 1998, and the
results of its operations and its cash flows for each of the years in the
three-year period ended January 2, 1999 in conformity with generally accepted
accounting principles.
/s/ KPMG LLP
- --------------------------------
KPMG LLP
Short Hills, New Jersey
February 8, 1999
14 Footstar, Inc. and Subsidary Companies
<PAGE>
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Fiscal Years Ended
--------------------------------
(dollars in millions, Jan. 2, Jan. 3, Dec. 28,
except per share amounts) 1999 1998 1996
- --------------------------------------------------------------------------------
Net sales $1,829.1 $1,794.9 $1,672.3
Cost of sales 1,278.0 1,240.8 1,144.7
- --------------------------------------------------------------------------------
Gross profit 551.1 554.1 527.6
Store operating, selling, general
and administrative expenses 386.3 371.1 355.5
Depreciation and amortization 33.5 33.5 24.8
Restructuring and asset impairment
charges 26.7 15.7 --
- --------------------------------------------------------------------------------
Operating profit 104.6 133.8 147.3
Interest (expense) income, net (0.6) 2.1 14.4
- --------------------------------------------------------------------------------
Income from continuing operations
before income taxes and minority
interests 104.0 135.9 161.7
Provision for income taxes 32.4 41.3 54.6
- --------------------------------------------------------------------------------
Income from continuing operations
before minority interests 71.6 94.6 107.1
Minority interests in net income 38.1 36.0 36.0
- --------------------------------------------------------------------------------
Income from continuing operations
before discontinued operations 33.5 58.6 71.1
Earnings from discontinued operations,
net of income taxes of $1.1 -- -- 0.8
Income (loss) on disposal of
discontinued operations, net of
income taxes (benefit) of $12.6
and $(31.4) -- 21.4 (53.6)
- --------------------------------------------------------------------------------
Net income $ 33.5 $ 80.0 $ 18.3
- --------------------------------------------------------------------------------
Average common shares outstanding
Basic 25.2 29.3
- --------------------------------------------------------------------------------
Diluted 25.4 29.4
- --------------------------------------------------------------------------------
Earnings per share
Basic:
Income from continuing operations $ 1.33 $ 2.00
Income from discontinued operations -- 0.73
- --------------------------------------------------------------------------------
Net income $ 1.33 $ 2.73
- --------------------------------------------------------------------------------
Diluted:
Income from continuing operations $ 1.32 $ 1.99
Income from discontinued operations -- 0.73
- --------------------------------------------------------------------------------
Net income $ 1.32 $ 2.72
- --------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
- --------------------------------------------------------------------------------
Footstar, Inc. and Subsidiary Companies 15
<PAGE>
CONSOLIDATED BALANCE SHEETS
Jan. 2, Jan. 3,
(dollars in millions, except per share amounts) 1999 1998
- --------------------------------------------------------------------------------
Assets
Current assets:
Cash and cash equivalents $ 49.1 $ 152.2
Accounts receivable, net 52.0 43.9
Inventories 280.2 284.5
Prepaid expenses and other current assets 49.4 48.4
- --------------------------------------------------------------------------------
Total current assets 430.7 529.0
Property and equipment, net 217.3 201.9
Goodwill, net of accumulated amortization of
$6.4 and $5.5, respectively 26.6 27.5
Deferred charges and other noncurrent assets 10.8 12.6
- --------------------------------------------------------------------------------
Total assets $ 685.4 $ 771.0
================================================================================
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable $ 112.3 $ 95.4
Accrued expenses 143.8 126.6
Income taxes payable 12.7 21.9
- --------------------------------------------------------------------------------
Total current liabilities 268.8 243.9
Other long-term liabilities 45.5 59.5
Minority interests in subsidiaries 67.8 65.1
- --------------------------------------------------------------------------------
Total liabilities $ 382.1 $ 368.5
================================================================================
Shareholders' equity:
Common stock $.01 par value: 100,000,000 shares
authorized, 30,591,575 and 30,558,107 shares issued 0.3 0.3
Additional paid-in capital 335.5 333.6
Accumulated other comprehensive income (0.2) (0.4)
Treasury stock: 7,068,825 and 2,685,900 shares,
at cost, respectively (200.8) (66.3)
Unearned compensation (5.4) (5.1)
Retained earnings 173.9 140.4
- --------------------------------------------------------------------------------
Total shareholders' equity 303.3 402.5
- --------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 685.4 $ 771.0
================================================================================
See accompanying notes to consolidated financial statements.
- --------------------------------------------------------------------------------
16 Footstar, Inc. and Subsidiary Companies
<PAGE>
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
AND COMPREHENSIVE INCOME
<TABLE>
<CAPTION>
Accumulated
Other
Common Stock Treasury Stock Additional Compre-
(dollars in millions, -------------- --------------- Paid-in Unearned Retained hensive Divisional
except per share amounts) Shares Amount Stock Amount Capital Compensation Earnings Income Equity Total
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance as of December 31, 1995 -- $ -- -- $ -- $-- $-- $-- $-- $ 1,013.8 $ --
- -----------------------------------------------------------------------------------------------------------------------------------
Changes in shareholders'
equity for the period
ended October 12, 1996:
Comprehensive income:
Net loss -- -- -- -- -- -- -- -- (4.2) --
Foreign currency
translation adjustment,
net of tax -- -- -- -- -- -- -- -- (2.0) --
------
Total comprehensive
income (6.2)
Melville Capital
Withdrawal -- -- -- -- -- -- -- -- (646.2) --
Distribution of
Footstar, Inc.
common stock by
Melville 30,533,883 0.3 -- -- 323.6 -- 37.9 (0.4) (361.4) --
- ------------------------------------------------------------------------------------------------------------------------------------
Balance as of
October 12, 1996 30,533,883 $0.3 -- $ -- $323.6 $ -- $ 37.9 $(0.4) $ -- $ 361.4
- ------------------------------------------------------------------------------------------------------------------------------------
Comprehensive income:
Net income -- -- -- -- -- -- 22.5 -- -- 22.5
Common stock incentive plans -- -- -- -- 6.4 (6.1) -- -- -- 0.3
- ------------------------------------------------------------------------------------------------------------------------------------
Balance as of
December 28, 1996 30,533,883 $0.3 -- $ -- $330.0 $(6.1) $ 60.4 $(0.4) $ -- $ 384.2
- ------------------------------------------------------------------------------------------------------------------------------------
Comprehensive income:
Net income -- -- -- -- -- -- 80.0 -- -- 80.0
Common stock
incentive plans 24,224 -- -- -- 3.6 1.0 -- -- -- 4.6
Purchase of Treasury shares -- -- (2,685,900) (66.3) -- -- -- -- -- (66.3)
- ------------------------------------------------------------------------------------------------------------------------------------
Balance as of
January 3, 1998 30,558,107 $0.3 (2,685,900) $(66.3) $333.6 $(5.1) $140.4 $(0.4) $ -- $ 402.5
- ------------------------------------------------------------------------------------------------------------------------------------
Comprehensive income:
Net income -- -- -- -- -- -- 33.5 -- $ -- 33.5
Foreign currency
translation
adjustment,
net of tax -- -- -- -- -- -- -- 0.2 -- 0.2
-------
Total comprehensive
income 33.7
Common stock incentive
plans 33,468 -- -- -- 1.9 (0.3) -- -- -- 1.6
Purchase of Treasury
shares -- -- (4,382,925) (134.5) -- -- -- -- -- (134.5)
- ------------------------------------------------------------------------------------------------------------------------------------
Balance as of
January 2, 1999 30,591,575 $0.3 (7,068,825) $(200.8) $335.5 $(5.4) $173.9 $(0.2) $ -- $ 303.3
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes to consolidated financial statements.
- --------------------------------------------------------------------------------
Footstar, Inc. and Subsidiary Companies 17
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
Jan. 2, Jan. 3, Dec. 28,
(dollars in millions) 1999 1998 1996
- -------------------------------------------------------------------------------
Cash flows from operating activities:
Net income $ 33.5 $ 80.0 $ 18.3
Adjustments to reconcile net income to
net cash provided by operating
activities:
(Gain) loss on disposal of discontinued
operations -- (34.0) 85.0
Restructuring and asset impairment
charges 34.4 15.7 --
Minority interests in net income 38.1 36.0 36.0
Depreciation and amortization 33.5 33.5 29.8
Loss on disposal of fixed assets 4.6 3.9 2.3
Deferred income taxes (2.3) 18.9 (12.2)
Stock incentive plans 2.2 1.9 --
Changes in operating assets and
liabilities:
(Decrease) increase in accounts
receivable, net (8.1) 33.7 (9.2)
(Increase) decrease in inventories (3.4) (2.6) 16.2
Decrease (increase) in prepaid expenses,
deferred charges and other assets 1.1 (3.5) 0.2
Decrease (increase) in accounts payable
and accrued expenses 13.9 (30.6) 14.8
(Decrease) increase in federal income
taxes payable and other liabilities (21.0) (7.5) 25.4
- -------------------------------------------------------------------------------
Net cash provided by operating
activities 126.5 145.4 206.6
- -------------------------------------------------------------------------------
Cash flows from (used in) investing
activities:
Additions to property and equipment (58.6) (59.1) (68.3)
Proceeds from the sale or disposal of
property and equipment -- -- 3.4
- -------------------------------------------------------------------------------
Net cash used in investing activities (58.6) (59.1) (64.9)
- -------------------------------------------------------------------------------
Cash flows from (used in) financing
activities:
Payments on stock incentive plans (0.8) -- --
Dividends paid to minority interests (36.3) (35.9) (63.8)
Proceeds of common stock from minority
interest 0.8 -- --
Treasury stock acquired (134.5) (66.3) --
Decrease in due from parent and other
divisions -- -- 710.8
Melville capital withdrawal -- -- (646.2)
Other (0.2) 3.5 (4.2)
- -------------------------------------------------------------------------------
Net cash used in financing activities (171.0) (98.7) (3.4)
- -------------------------------------------------------------------------------
Net (decrease) increase in cash and
cash equivalents (103.1) (12.4) 138.3
Cash and cash equivalents beginning
of year 152.2 164.6 26.3
- -------------------------------------------------------------------------------
Cash and cash equivalents end of year $ 49.1 $ 152.2 $ 164.6
================================================================================
See accompanying notes to consolidated financial statements.
- -------------------------------------------------------------------------------
18 Footstar, Inc. and Subsidiary Companies
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Tabular dollars in millions, except per share amounts)
THE COMPANY
Footstar, Inc. (the "Company") became an independent company after the Board of
Directors of Melville Corporation ("Melville") approved the spin-off of its
footwear operations. These businesses were comprised of Meldisco, a leading
operator of leased footwear departments nationwide and abroad; Footaction, a
mall-based branded athletic footwear and apparel chain; and Thom McAn, which has
been reported as discontinued operations. The spin-off was completed with the
distribution (the "Distribution") on October 12, 1996, to Melville shareholders
of record on October 2, 1996, of all the shares of the Company. The Distribution
was made on the basis of .2879 shares of the Company's common stock for every
one share of Melville Corporation common stock. A total of 30,533,883 shares of
the Company's common stock was issued and began trading on the New York Stock
Exchange on a when-issued basis on September 25, 1996.
The following transactions were recorded through shareholders' equity at
historical cost on the date of the Distribution:
Pre- Capital Post-
Distribution Withdrawal Distribution
- --------------------------------------------------------------------------------
Melville equity investment $1,007.6
Transfer of retained earnings
to Melville $(896.8)
Transfer of equity to Melville (110.8)
Shareholders' equity:
Common stock 0.3 $ 0.3
Contributed capital
from elimination of
intercompany debt 253.8
Contributed capital from
Melville's equity investment 69.8 323.6
Retained earnings 37.9 37.9
Cumulative translation adjustment (0.4) (0.4)
- --------------------------------------------------------------------------------
Total equity $1,007.6 $(646.2) $361.4
================================================================================
Melville Corporation allocated various costs to its subsidiaries based on
the Company's share of costs paid by Melville for consolidated programs. Such
allocations may not be reflective of the costs which would be incurred if the
Company operated on a stand-alone basis or which will be incurred in the future.
Management believes that the basis for allocations was reasonable. A summary of
the amounts allocated to the Company for the fiscal year ended December 28, 1996
was as follows:
1996
- --------------------------------------------------------------------------------
Cost of Employee Stock Ownership Plan $2.6
Administrative costs 1.5
- --------------------------------------------------------------------------------
$4.1
- --------------------------------------------------------------------------------
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements of the Company include the accounts of all
subsidiary companies. The minority interests represent the 49 percent
participation of Kmart Corporation ("Kmart") in the ownership of substantially
all retail subsidiaries of Meldisco formed or to be formed from July 1967 until
July 1, 2012 for the purpose of operating leased shoe departments in Kmart
stores. Interdivisional balances and transactions between the entities have been
eliminated. The accompanying financial statements include the consolidated
results of operations, assets and liabilities of the Company for the 52-week
year ended January 2, 1999 and the 53-week year ended January 3, 1998 and the 11
weeks ended December 28, 1996 and the combined historical results of operation,
assets and liabilities of the Company while a part of Melville Corporation for
the 41 weeks ended October 12, 1996. For simplicity of presentation, these
financial statements are referred to as consolidated financial statements
herein.
Accounting Changes
The Board of Directors of the Company approved on December 5, 1996 a change to a
fiscal year ending on the Saturday closest to December 31 from a calendar year.
Fiscal 1998 ended on January 2, 1999, fiscal 1997 ended on January 3, 1998, a
53-week year-end, and fiscal 1996 ended on December 28, 1996.
Basis of Presentation
The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amount of expenses during the reporting period.
Actual results could differ from those estimates.
Cash and Cash Equivalents
Cash equivalents consist of highly liquid instruments with maturities of three
months or less and are stated at cost that approximates their fair market value.
The Company's cash management program utilizes zero balance accounts.
Accordingly, all book overdraft balances have been reclassified to current
liabilities.
Inventories
Inventories are finished goods, consisting of merchandise purchased from
domestic and foreign vendors and are carried at the lower of cost or market
value, determined by the retail inventory method on a first-in, first-out (FIFO)
basis.
Footstar, Inc. and Subsidiary Companies 19
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Property and Equipment
Property and equipment are stated at cost. Depreciation and amortization of
property and equipment are computed on a straight-line basis, generally over the
estimated useful lives of the assets or, when applicable, the life of the lease,
whichever is shorter. Capitalized software costs are amortized on a
straight-line basis over their estimated useful lives. Maintenance and repairs
are charged directly to expense as incurred. Major renewals or replacements are
capitalized after making the necessary adjustment on the asset and accumulated
depreciation accounts of the items renewed or replaced.
Impairment of Long-Lived Assets
The Company accounts for long-lived assets in accordance with the provisions of
SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of." This Statement requires that long-lived
assets and certain identifiable intangibles be reviewed for impairment whenever
events or changes in circumstances indicate that the carrying amount of an asset
may not be recoverable. Recoverability of assets to be held and used is measured
by a comparison of the carrying amount of an asset to future net cash flows
expected to be generated by the asset. If such assets are considered to be
impaired, the impairment to be recognized is measured by comparing projected
individual store cash flows over the lease term to the asset carrying values.
Deferred Charges
Deferred charges are amortized on a straight-line basis, generally over the
remaining life of the charge.
Goodwill
The excess of acquisition costs over the fair value of net assets acquired is
amortized on a straight-line basis over 40 years. The Company assesses the
recoverability of this intangible asset by determining whether the amortization
of the goodwill balance over its remaining life can be recovered through
undiscounted future operating cash flows of the acquired operation. The
assessment of the recoverability of goodwill will be impacted if estimated
future operating cash flows are not achieved.
Store Opening and Closing Costs
New store opening costs are charged to expense as incurred. In the event a store
is closed before its lease has expired, the total lease obligation, less
sublease rental income, is provided for in the year of closing.
Advertising Costs
The Company charges production costs of advertising to expense the first time
the advertising takes place. Advertising costs, as a component of store
operating, selling, general and administrative expenses, were $40.6 million in
1998, $39.6 million in 1997 and $39.0 million in 1996.
Income Taxes
In 1996, the Company and Melville entered into a Tax Disaffiliation Agreement.
Under the Agreement, the Company is generally responsible for any of its tax
with respect to periods prior to the spin-off, determined as if on a separate
company basis. For periods subsequent to October 12, 1996, the Company files its
own federal and state tax returns.
Deferred tax assets and liabilities are recognized for future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases and operating loss and tax credit carry forwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled.
Foreign Currency Translation
The Company translates foreign currency financial statements by translating
balance sheet accounts at the exchange rate as of the balance sheet date and
income statement accounts at the average rate for the year. Adjustments
resulting from the translation of financial statements are reflected as a
component of comprehensive income. Translation gains and losses were
insignificant in all periods.
Postretirement Benefits
The Company provides a defined benefit health care plan for substantially all
retirees who meet certain eligibility requirements. The annual cost of
postretirement benefits is funded as it arises and the cost is recognized over
an employee's term of service to the Company.
Stock-Based Compensation Plans
As permitted under Statement of Financial Accounting Standard No. 123,
"Accounting for Stock-Based Compensation" ("SFAS No. 123"), the Company has
elected not to adopt the fair value-based method of accounting for its
stock-based compensation plans, but continues to apply the provisions of APB
Opinion No. 25.
Earnings Per Share
In February 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS
No. 128"), which the Company has adopted in Fiscal 1997. SFAS No. 128 replaced
the presentation of primary earnings per share (EPS) with basic EPS. 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 net income available to common shareholders divided by the
weighted average shares outstanding after giving effect to the potential
dilution that could occur if securities or other contracts to issue common stock
were exercised or converted.
20 Footstar, Inc. and Subsidiary Companies
<PAGE>
The following reconciles shares outstanding at the beginning of the year
to average shares outstanding used to compute basic and diluted earnings per
share.
1998 1997
- --------------------------------------------------------------------------------
Shares outstanding at beginning of year 27.9 30.5
Weighted average shares repurchased (2.8) (1.2)
Contingently issuable shares 0.1 --
- --------------------------------------------------------------------------------
Average shares outstanding - basic 25.2 29.3
Dilutive effect of stock options 0.2 0.1
- --------------------------------------------------------------------------------
Average shares outstanding - diluted 25.4 29.4
================================================================================
Earnings per share information has been omitted from the accompanying
consolidated statements of operations for all fiscal years prior to 1997, since
the Company was not a separate entity with its own capital structure until
October 12, 1996. See note "Pro Forma Financial Statements" with respect to pro
forma earnings per share data.
Fair Value of Financial Instruments
SFAS No. 107, "Disclosures About Fair Value of Financial Instruments," requires
disclosure of the fair value of certain financial instruments. Cash and cash
equivalents, accounts receivable, accounts payable and accrued expenses are
reflected in the consolidated financial statements at carrying value, which
approximates fair value due to the short-term nature of these instruments.
Comprehensive Income
On January 4, 1998, the Company adopted SFAS No. 130, "Reporting Comprehensive
Income." SFAS No. 130 establishes standards for reporting and presentation of
comprehensive income and its components in a full set of financial statements.
Comprehensive income consists of net income and foreign currency translation
adjustments and is presented in the consolidated statements of stockholders'
equity and comprehensive income. The Statement requires only additional
disclosures in the notes to the consolidated financial statements; it does not
affect the Company's financial position or results of operations. Prior year
financial statements have been reclassified to conform to the requirements of
SFAS No. 130.
Reclassifications
Certain reclassifications have been made to the consolidated financial
statements of prior years to conform to the 1998 presentation.
RESTRUCTURING, ASSET IMPAIRMENT AND OTHER CHARGES
During the fourth quarter of 1998, the Company approved a restructuring plan
which included the closing of approximately 30 underperforming Footaction
stores, the reconfiguring of Footaction merchandise assortments, the refinement
of store layouts and the exiting of Meldisco's Central European business. These
charges include lease buyouts, inventory markdowns and asset impairment charges
relating to planned store closings and asset impairment charges relating to
other stores.
In connection with these actions, the Company recorded a one-time, pre-tax
charge of $34.4 million ($22.7 million after taxes) in the fourth quarter of
1998.
The significant components of the restructuring, asset impairment and
other charges, and the reserves remaining as of January 2, 1999, were as
follows:
Recorded Remaining
- --------------------------------------------------------------------------------
Lease obligations and fixed asset
write-offs for Footaction store closings $20.0 $20.0
Impaired assets, principally fixtures and
leasehold improvements 6.4 --
Store footwear and apparel
inventory markdowns 5.2 5.2
Europe inventory markdown 2.5 2.5
Lease obligations and fixed asset
write-offs for Europe closings 0.3 0.3
- --------------------------------------------------------------------------------
$34.4 $28.0
================================================================================
The inventory reduction charges, totaling $7.7 million, were recorded in
cost of sales while the remaining $26.7 million was recorded in operating
expenses under restructuring and asset impairment charges. Of the $28.0 million
reserve remaining on the balance sheet,$7.7 million is recorded as a reserve
reducing inventory and $20 million of Footaction lease obligations and fixed
asset write-offs are a component of accrued expenses.The final $0.3 million of
Europe lease obligations and fixed asset write-offs are reserved for in
long-term liabilities. The asset impairment charge was recorded as a reduction
of property and equipment. The fixed asset write-offs and asset impairments
represent principally fixtures and leasehold improvements.
In connection with the Footaction store closings, the Company established
a reserve for future lease payments anticipating sublease activity and lease
buyouts based on historical experience. Costs are being charged against the
reserve as incurred. On average, the remaining lease term for the stores to be
closed is approximately five years. Given the estimated payout term of these
reserves, they will be assessed periodically to determine their adequacy.
Footstar, Inc. and Subsidiary Companies 21
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The fixed assets written off could not readily be used at other store
locations nor was there a ready market outside the Company to determine fair
value; the assets are expected to be discarded at the time of closing. The asset
impairment charge was necessary as the projected cash flows for these stores was
not sufficient to support recorded asset values. The amount of the impairment
charge was based on the difference between the fair value of the assets, as
calculated through discounted expected cash flows, and the carrying amount of
these assets. The asset impairment charge principally related to stores with
negative contribution and cash flow. Accordingly, the asset write-off and
impairment charge recorded for these assets represented their carrying value at
the time of approval for the restructuring plan.For assets that were reduced to
zero, depreciation was discontinued. The stores are operating at a loss and
continued to do so subsequent to the recording of the asset write-off and
impairment charges. Operating results for the individual stores are being
included in operations through the closing dates of the respective stores.
The exiting of Meldisco's Central European business is anticipated to be
completed by the end of 1999 by transferring these activities to Meldisco's
Central European partner or another outside party. Net sales for this business
amounted to $11.5 million, $11.8 million and $11.0 million in 1998, 1997 and
1996, respectively, and net operating results amounted to a $1.9 million loss, a
$0.1 million loss and $0.4 million income in 1998, 1997 and 1996, respectively.
The 1998 net operating loss is before non-recurring charges of $2.8 million.
During November 1997, in support of its long-term strategy, the Company
announced plans to consolidate its logistics networks and centralize certain
accounting functions.
In connection with these actions, the Company recorded a one-time, pre-tax
charge of $15.7 million in the fourth quarter of 1997. The Dallas distribution
center was closed in the third quarter of 1998 as part of this plan.
The significant components of the restructuring and asset impairment
charges recorded in the fourth quarter of 1997, and the reserves remaining as of
January 2, 1999 and January 3, 1998, were as follows:
Recorded Remaining
- --------------------------------------------------------------------------------
January 2, January 3,
1999 1998
- --------------------------------------------------------------------------------
Fixed asset write-offs $9.0 $ -- $ --
Lease obligations and transition costs
related to warehouse and service center 4.3 4.0 4.3
Severance and other employee
benefit vesting 2.4 -- 2.4
- --------------------------------------------------------------------------------
$15.7 $4.0 $6.7
================================================================================
The remaining $4.0 million reserve is included as a component of accrued
expenses.
DISCONTINUED OPERATIONS
On June 3, 1996, Melville announced a plan to convert approximately 100 Thom
McAn stores to Footaction stores and to exit the Thom McAn business. This plan
was principally completed by the end of fiscal 1997. In connection with this
plan, the Company recorded a pre-tax charge of $85.0 million in the first
quarter of 1996. Accordingly, the results of operations for the Thom McAn
segment have been classified as discontinued operations for all periods
presented in the consolidated statements of operations.
In the fourth quarter of 1997, the Company reversed $34.0 million ($21.4
million after taxes) of the $85.0 million ($53.6 million after taxes) reserve
created as a result of the discontinuation of the Thom McAn chain in 1996.
Discontinued operations accounted for 1.5 percent and 1.8 percent of total
assets as of year-end 1998 and 1997, respectively. The balances principally
consist of a deferred tax asset.
Discontinued operations accounted for 5.8 percent and 5.0 percent of total
liabilities as of year-end 1998 and 1997, respectively. Liabilities in both
years consist principally of reserves for restructuring and employee benefits.
The following table summarizes the operating results of the discontinued
operations for the fiscal years presented:
1998 1997 1996
- --------------------------------------------------------------------------------
Net sales $ -- $ -- $187.6
Operating income (loss) $ -- $34.0 $(94.5)
================================================================================
The loss on disposal of discontinued operations for 1996 included an $85.0
million pre-tax charge relating to future operating losses during the wind-down
period, lease settlement cost, asset write-offs and severance.
The significant components of the charge and the reserve remaining as of
January 2, 1999 and January 3, 1998 were as follows:
Recorded Remaining
- --------------------------------------------------------------------------------
January 2, January 3,
1999 1998
- --------------------------------------------------------------------------------
Lease obligations, contingencies
and fixed asset write-offs for
store closings, home office
and warehouse shutdowns $61.9 $5.5 $7.7
Operating loss reserve 21.1 0.5 2.3
Severance and other
employee benefit vesting 2.0 -- 1.0
- --------------------------------------------------------------------------------
Total $85.0 $6.0 $11.0
================================================================================
The remaining discontinued operations reserve is a component of accrued
expenses.
22 Footstar, Inc. and Subsidiary Companies
<PAGE>
ACCOUNTS RECEIVABLE
Accounts receivable consisted of the following:
1998 1997
- --------------------------------------------------------------------------------
Due from licensors, principally Kmart $ 28.4 $ 18.0
Other 24.8 27.4
- --------------------------------------------------------------------------------
53.2 45.4
Less: Allowance for doubtful accounts 1.2 1.5
- --------------------------------------------------------------------------------
Total $ 52.0 $ 43.9
================================================================================
PREPAID EXPENSES AND OTHER CURRENT ASSETS
Prepaid expenses and other current assets consisted of the following:
1998 1997
- --------------------------------------------------------------------------------
Deferred income taxes $ 37.4 $ 36.3
Other 12.0 12.1
- --------------------------------------------------------------------------------
Total $ 49.4 $ 48.4
================================================================================
PROPERTY AND EQUIPMENT
Property and equipment consisted of the following:
Useful Lives
(in years) 1998 1997
- --------------------------------------------------------------------------------
Land $8.9 $8.9
Buildings and improvements 10-40 12.1 13.2
Equipment and furniture 5-10 211.0 194.2
Leasehold improvements 10 75.3 69.1
- --------------------------------------------------------------------------------
307.3 285.4
Less accumulated depreciation
and amortization 90.0 83.5
- --------------------------------------------------------------------------------
Total $217.3 $201.9
================================================================================
ACCRUED EXPENSES
Accrued expenses consisted of the following:
1998 1997
- --------------------------------------------------------------------------------
Rent $ 28.1 $ 28.3
Taxes other than federal income taxes 14.4 11.7
Salaries and compensated absences 12.0 13.7
Reserve for loss on disposal of
discontinued operations 6.0 11.0
Capital expenditures 4.7 5.5
Restructuring reserves 24.0 2.8
Other 54.6 53.6
- --------------------------------------------------------------------------------
Total $143.8 $126.6
================================================================================
OTHER LONG-TERM LIABILITIES
Other long-term liabilities consisted of the following:
1998 1997
- --------------------------------------------------------------------------------
Employee benefit costs $40.4 $34.2
Restructuring reserves 0.3 3.9
Deferred taxes -- 1.2
Other 4.8 20.2
- --------------------------------------------------------------------------------
Total $45.5 $59.5
================================================================================
LONG-TERM DEBT
The Company maintains a $300 million unsecured revolving Credit Facility to
support general corporate borrowing requirements. As of January 2, 1999 and
January 3, 1998 there were no loans outstanding under the Credit Facility.
Interest on all borrowing is determined based upon several alternative rates
available under the Credit Facility.
The Company's Credit Facility contains various operating covenants which,
among other things, impose certain limitations on the Company's ability to incur
liens, incur indebtedness, merge, consolidate or declare and make dividend
payments. Under the Credit Facility, the Company is required to comply with
financial covenants relating to ratios of debt and fixed charge coverage. The
Credit Facility may be prepaid or retired by the Company without penalty prior
to the maturity date of September 18, 2000.
LEASES
The Company and its subsidiaries lease retail stores, warehouse and office
facilities over periods generally ranging from five to 10 years.
Net rental expense for all operating leases for each of the three years
ended January 2, 1999 was as follows:
1998 1997 1996
- --------------------------------------------------------------------------------
Minimum rentals $ 61.9 $ 47.9 $ 40.7
Contingent rentals 124.0 125.3 123.1
- --------------------------------------------------------------------------------
Total $185.9 $173.2 $163.8
================================================================================
Contingent rent expense principally represents rentals assessed under the
Master Agreement with Kmart which are principally based on sales. Accordingly,
the future minimum rental payments disclosed below exclude future rents to
Kmart.
Footstar, Inc. and Subsidiary Companies 23
<PAGE>
At January 2, 1999, the future minimum rental payments under operating
leases, excluding lease obligations for closed stores, were as follows:
Operating Leases
- --------------------------------------------------------------------------------
1999 $ 67.0
2000 64.1
2001 62.0
2002 59.6
2003 57.5
Thereafter 174.7
- --------------------------------------------------------------------------------
Total $484.9
================================================================================
INCOME TAXES
The provision for income taxes was comprised of the following:
1998 1997 1996
- --------------------------------------------------------------------------------
Federal $25.2 $32.2 $44.3
State 7.2 9.1 10.3
- --------------------------------------------------------------------------------
Total $32.4 $41.3 $54.6
================================================================================
The provision for income taxes for continuing operations includes net
deferred tax benefits of $9.4 million and $9.3 million for January 2, 1999 and
January 3, 1998, respectively, and a net deferred charge of $7.8 million for
December 28, 1996.
Reconciliations of the effective tax rates to the U.S. statutory income
tax rate were as follows:
1998 1997 1996
- --------------------------------------------------------------------------------
Effective tax rate 31.1% 30.4% 33.8%
State income taxes, net of
federal tax benefit (4.5) (4.3) (4.1)
51% owned subsidiaries excluded
from the Parent's consolidated
federal income tax return 11.7 8.6 6.1
Other (3.3) 0.3 (0.8)
- --------------------------------------------------------------------------------
Statutory federal income tax rate 35.0% 35.0% 35.0%
================================================================================
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax asset and liabilities for the fiscal years were as
follows:
1998 1997
- --------------------------------------------------------------------------------
Deferred tax assets:
Restructuring and purchase accounting reserves $12.0 $10.5
Inventories 14.9 10.9
Postretirement benefits 13.4 13.4
Employee benefits 9.9 11.6
Other 3.6 7.3
- --------------------------------------------------------------------------------
Total deferred tax assets 53.8 53.7
- --------------------------------------------------------------------------------
Deferred tax liabilities:
Property and equipment 13.6 15.4
Other 2.8 3.2
- --------------------------------------------------------------------------------
Total deferred tax liabilities 16.4 18.6
- --------------------------------------------------------------------------------
Net deferred tax assets $37.4 $35.1
================================================================================
Based on the Company's historical taxable income and projected future
taxable income over the periods in which deferred tax assets are deductible,
management believes it is more likely than not that the Company will realize the
net deferred tax assets.
STOCK INCENTIVE PLANS
As of October 12, 1996, the Company adopted the 1996 Incentive Compensation Plan
(the "Plan"). The Plan is designed to motivate and reward officers and key
employees for outstanding service, by providing awards that are linked to the
Company's performance and the creation of shareholder value. Under the Plan, a
maximum of 3,100,000 shares, plus 10 percent of the number of any shares newly
issued by the Company (excluding issuances under the Plan or any other
compensation or benefit plan of the Company), may be issued in connection with
stock options, restricted stock, deferred stock and other stock-based awards.
Under the Plan, employee stock options may not be awarded at less than
market value on the date of grant. Generally, options are exercisable in
installments of 20 percent beginning one year from date of grant and expire 10
years after the grant date, provided the optionee continues to be employed by
the Company.
24 Footstar, Inc. and Subsidiary Companies
<PAGE>
The following table provides information relating to the status of, and
changes in, employee stock options granted:
1998 1997
-------------------------------------
Employee Average Employee Average
Stock Option Stock Option
Options Price Options Price
- --------------------------------------------------------------------------------
Outstanding at
beginning of year 971,370 $24 615,450 $21
Granted 305,600 31 401,100 26
Cancelled (52,550) 25 (44,240) 22
Exercised (28,840) 22 (940) 21
- --------------------------------------------------------------------------------
Outstanding at end of year 1,195,580 $26 971,370 $24
- --------------------------------------------------------------------------------
Exercisable at end of year 344,451 115,164
================================================================================
Deferred restricted stock units were granted to certain officers and key
employees. The units vest five years from date of grant, provided the executive
continues to be employed by the Company.
The following table provides information relating to the status of, and
change in, deferred restricted stock units:
1998 1997
----------------------------------------------------
Deferred Deferred
Restricted Average Restricted Average
Stock Units Unit Price Stock Units Unit Price
- --------------------------------------------------------------------------------
Outstanding at
beginning of year 156,297 $21 171,212 $21
Granted 15,051 27 -- --
Cancelled -- -- (11,932) 21
Shares issued -- -- (2,983) 21
- --------------------------------------------------------------------------------
Outstanding at end of year 171,348 $22 156,297 $21
- --------------------------------------------------------------------------------
The Company recorded $3.6 million as unearned compensation in 1996 and has
amortized $0.7 million, $0.7 million and $0.2 million in 1998, 1997 and 1996,
respectively.
The Plan also permits the granting of deferred stock units, representing
rights to receive cash and/or common stock of the Company based upon certain
performance criteria generally over a three-year performance period.
Compensation expense related to grants under these provisions is based on
current market price of the Company's common stock at the date of grant and the
extent to which performance criteria are being met. The following table provides
information relating to the status of, and changes in, these deferred stock
units.
1998
-------------------------------
Deferred Average
Stock Units Unit Price
- --------------------------------------------------------------------------------
Outstanding at beginning of year -- $ --
Granted 27,902 29
Cancelled -- --
Shares issued -- --
- --------------------------------------------------------------------------------
Outstanding at end of year 27,902 $29
- --------------------------------------------------------------------------------
The Company recorded $2.1 million, $1.1 million and $2.9 million as
unearned compensation in 1998, 1997 and 1996, respectively, and amortized $1.1
million, $1.2 million and $0.2 million in 1998, 1997 and 1996, respectively.The
Company paid $0.8 million in cash relating to the plan in 1998.
The Plan also offers incentive opportunities based upon performance
results against pre-established earnings targets and other selected measures for
each fiscal year. Plan awards may be paid exclusively in cash or partially in
deferred stock with a matching Footstar grant. The elective deferrals and
matched amounts are deferred for a five-year period. The amount deferred will be
paid in shares.
The following table provides information relating to the status of, and
changes in, options granted:
1998 1997
- --------------------------------------------------------------------------------
Deferred Average Deferred Average
Shares Share Price Shares Share Price
- --------------------------------------------------------------------------------
Outstanding at
beginning of year 122,520 $26 -- $--
Granted 40,507 29 128,394 27
Cancelled (3,337) 28 (1,937) 26
Shares issued (6,676) 28 (3,937) 26
- --------------------------------------------------------------------------------
Outstanding at end of year 153,014 $28 122,520 $26
================================================================================
Shares available for grant under the Plan totaled 1,508,780 and 1,966,367 as of
January 2, 1999 and January 3, 1998, respectively.
Footstar, Inc. and Subsidiary Companies 25
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Effective on the Distribution, the Company adopted the 1996 non-employee
Director Stock Plan (the "Director Plan"). A total of 200,000 shares of Company
common stock are reserved and available for issuance under the Director Plan.
Any person who becomes an eligible director receives an initial option to
purchase 2,000 shares of common stock. All options are awarded at the market
value on the date of grant. Generally, options are exercisable in installments
of 20 percent beginning one year from date of grant and expire 10 years after
grant date, provided the non-employee director is still a member of the board.
The following table provides information relating to the status of, and
changes in, options granted:
1998 1997
--------------------------------------
Average Average
Stock Option Stock Option
Options Price Options Price
- --------------------------------------------------------------------------------
Outstanding at
beginning of year 12,000 $21 10,000 $21
Granted 2,000 44 2,000 22
Cancelled -- -- -- --
Exercised -- -- -- --
- --------------------------------------------------------------------------------
Outstanding at end of year 14,000 $24 12,000 $21
- --------------------------------------------------------------------------------
Options exercisable at
end of year 4,400 2,000
- --------------------------------------------------------------------------------
The 1996 Director Plan also provides for automatic grants of 2,000 stock
units ("Stock Units") to each non-employee director on the date of each annual
meeting of the Company's shareholders. Each Stock Unit represents the right to
receive one share of Company common stock at the end of a specified period.
Fifty percent of such Stock Units vest six months and a day after the grant
date, provided the non-employee director has not ceased to serve as a director
for any reason other than death, disability, or retirement. The remaining 50
percent of such Stock Units will be paid upon the later of ceasing to be a
director or attaining age 65, provided that settlement of such Stock Units shall
be accelerated in the event of death, disability, or a change in control.
The following table provides information relating to the status of, and
changes in, stock units:
1998 1997
---------------------------------------
Stock Average Stock Average
Units Unit Price Units Unit Price
- --------------------------------------------------------------------------------
Outstanding at
beginning of year 18,000 $22 10,000 $21
Granted 12,000 44 12,000 22
Cancelled -- -- -- --
Shares issued (2,000) 44 (4,000) 22
- --------------------------------------------------------------------------------
Outstanding at end of year 28,000 $30 18,000 $22
- --------------------------------------------------------------------------------
Shares available for grant under the Director's Plan totaled 146,525 and
166,000 as of January 2, 1999 and January 3, 1998, respectively.
The Company applies Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees," and related interpretations in
accounting for its plans. Accordingly, no compensation expense has been
recognized for its stock-based compensation plans other than for restricted
stock and performance-based awards. Had compensation cost for the Company's
other stock option plans been determined based upon the fair value at the grant
date for awards under these plans been consistent with the methodology
prescribed under Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation," the Company's net income and earnings
per share would be as follows:
1998 1997
- --------------------------------------------------------------------------------
Net income:
Reported $33.5 $80.0
As adjusted for SFAS 123 30.2 78.2
- --------------------------------------------------------------------------------
Earnings per share:
Basic:
Reported 1.33 2.73
As adjusted for SFAS 123 1.20 2.67
Diluted:
Reported 1.32 2.72
As adjusted for SFAS 123 1.19 2.66
- --------------------------------------------------------------------------------
The fair value of options granted during 1998, 1997 and 1996 was $13.87,
$12.86 and $9.41, respectively. The fair value of each option granted was
estimated on the date of grant using the Black-Scholes option-pricing model with
the following assumptions:
1998 1997 1996
- --------------------------------------------------------------------------------
Expected volatility 35.0% 35.0% 30.0%
Expected life in years 6.0 6.1 6.5
Risk-free interest rate 5.5% 5.6% 6.2%
Assumed forfeiture rate 0.0% 0.0% 0.0%
- --------------------------------------------------------------------------------
During 1997 the Company adopted an Associate Stock Purchase Plan to
provide substantially all employees who have completed one year of service an
opportunity to purchase shares of its common stock through payroll deductions,
up to 10 percent of eligible compensation. Quarterly, participant account
balances are used to purchase shares of stock at 85 percent of the lower of the
fair market value of the shares at the beginning of the offering period or the
purchase date. A total of 1,600,000 shares are available for purchase under the
plan. There were 56,199 and 19,486 shares purchased under the plan in fiscal
1998 and 1997, respectively.
26 Footstar, Inc. and Subsidiary Companies
<PAGE>
TREASURY STOCK
In May 1997, the Company's Board of Directors authorized a stock
repurchase program to purchase up to 10 percent of its common stock outstanding,
or approximately 3,050,000 shares, in the open market. As of January 3, 1998,
the Company had purchased 2,685,900 shares of its stock in the open market for
an aggregate purchase amount of $66.3 million. In January 1998, the Company's
Board of Directors authorized a second stock repurchase program to purchase
approximately 3,000,000 additional shares of its common stock. In fiscal 1998,
the Company completed the first and second stock repurchase programs by
purchasing 3,364,100 shares of its stock in the open market for an aggregate
purchase amount of $112.9 million. In the third quarter of 1998, the Company's
Board of Directors authorized a third stock repurchase program to purchase up to
2,450,000 shares, in the open market. Under this program, 1,018,825 shares of
stock were purchased in the open market for an aggregate purchase amount of
$21.6 million during 1998. As of January 2, 1999, the Company repurchased a
total of 4,382,925 shares of stock for an aggregate purchase amount of $134.5
million. The treasury shares may be used for the exercise of employee stock
options or for other corporate purposes. As of January 2, 1999, an aggregate of
7,068,825 shares or 23 percent of the total common stock outstanding had been
repurchased.
401(k) PROFIT SHARING PLAN
The Company has a qualified 401(k) Profit Sharing Plan available to full-time
employees who meet the plan's eligibility requirements. This plan, which is also
a defined contribution plan, contains a profit sharing component, with
tax-deferred contributions to each employee based on certain performance
criteria, and also permits employees to make contributions up to the maximum
limits allowed by Internal Revenue Code Section 401(d). Under the 401(k)
component, the Company matches a portion of the employee's contribution under a
pre-determined formula based on the level of contribution and years of vesting
service.
Contributions to the plan by the Company for both profit sharing and
matching of employee contributions were approximately $2.8 million, $3.3 million
and $3.3 million for the years ended 1998, 1997 and 1996, respectively.
POSTRETIREMENT BENEFITS
On January 4, 1998, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 132, "Employer's Disclosure about Pension and
Other Postretirement Benefits." SFAS No. 132 revises employers' disclosures
about pension and other post retirement benefit plans. SFAS No. 132 does not
change the method of accounting for such plans.
The Company provides postretirement health benefits for retirees who meet
certain eligibility requirements. The following table represents the Company's
change in benefit obligation:
1998 1997
- --------------------------------------------------------------------------------
Change in benefit obligation
Benefit obligation at beginning of year $ 24.3 $ 23.2
Service cost 0.2 0.3
Interest cost 1.4 1.7
Amendments (4.1) --
Actuarial (gain)/loss (2.4) 0.6
Net benefits paid (1.6) (1.5)
- --------------------------------------------------------------------------------
Benefit obligation at end of year $ 17.8 $ 24.3
Unrecognized net actuarial loss 6.8 4.0
Unrecognized prior service cost 9.4 5.9
- --------------------------------------------------------------------------------
Accrued (prepaid) benefit cost $ 34.0 $ 34.2
================================================================================
1998 1997
- --------------------------------------------------------------------------------
Weighted-average assumptions
as of December 31
Discount rate 6.75% 7.00%
- --------------------------------------------------------------------------------
For measurement purposes a 7.9 percent annual rate of increase in the per
capita cost of covered health care benefits was assumed for 1998. The rate was
assumed to decrease gradually to 4.5 percent for 2006 and remain at that level
thereafter.
1998 1997
- --------------------------------------------------------------------------------
Components of net periodic benefit cost
Service cost $ 0.2 $ 0.3
Interest cost 1.4 1.7
Amortization of prior service cost (0.5) (0.6)
Recognized net actuarial gain (0.4) (0.2)
- --------------------------------------------------------------------------------
Net periodic benefit cost $ 0.7 $ 1.2
================================================================================
Assumed health care cost trend rates have a significant effect on the
amounts reported for the health care plans. A one-percentage point change in
assumed health care cost trend rates would have the following effects:
1-Percentage 1-Percentage
Point Increase Point Decrease
- --------------------------------------------------------------------------------
Effect on total of service and
interest cost components 0.2 (0.2)
Effect on postretirement benefit obligation 2.3 (1.9)
- --------------------------------------------------------------------------------
Footstar, Inc. and Subsidiary Companies 27
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MELDISCO'S RELATIONSHIP WITH KMART
For the fiscal years ended January 2, 1999, January 3, 1998 and December 28,
1996, Meldisco's Kmart operations represented 96.9 percent, 96.2 percent and
96.3 percent, respectively, of Meldisco's net sales. These operations
represented 62.3 percent, 63.6 percent and 66.6 percent, respectively, of the
Company's consolidated net sales during the same periods. The business
relationship between Meldisco and Kmart is very significant to the Company, and
the loss of Meldisco's Kmart operations would have a material adverse effect on
the Company.
The Company's arrangement with Kmart is governed by a Master Agreement
effective as of July 1, 1995 and amended as of March 25, 1996. The Master
Agreement provides the Company with the non-transferable exclusive right and
license to operate a footwear department in each applicable Kmart store. The
initial term of the Master Agreement expires July 1, 2012 and is renewable
thereafter for 15-year terms, unless terminated earlier as provided in the
Master Agreement.
SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN
The Company has an unfunded Supplemental Executive Retirement Plan ("SERP").
Expense related to the SERP was $0.9 million, $0.6 million and $0.6 million in
fiscal years 1998, 1997 and 1996, respectively.
LOANS
The weighted average interest rate on loans to Melville for the period from
January 1 to October 12, 1996 was 5.2 percent. The related interest income
earned by the Company on such loans was $13.7 million in 1996.
COMMITMENTS AND CONTINGENCIES
The Company is involved in various claims and legal actions arising in the
ordinary course of business. In the opinion of management, the ultimate
disposition of these matters will not have a material adverse effect on the
Company's combined financial position, results of operations or liquidity.
SHAREHOLDER RIGHTS PLAN
On March 9, the Board of Directors approved the adoption of a Shareholder Rights
Plan. Under the Plan, preferred stock purchase rights will be distributed as a
dividend to shareholders at the rate of one Right for each share of common stock
outstanding. Initially, the rights are not exercisable. Upon a "trigger event,"
each Right entitles its holder (other than the holder who caused the trigger
event) to purchase at an "Exercise Price" of $100 the equivalent of that number
of shares of common stock of the Company worth twice the Exercise Price.
The Rights will be exercisable only if a person or group that is not
currently a 15 percent shareholder acquires beneficial ownership of 15 percent
or more of the Company`s common stock. The Rights will not be triggered by a
"Qualifying Offer" that provides that all shareholders will receive the same
"fair" consideration and is for all outstanding shares not owned by the offerer,
among other things. In addition, stock repurchases by the Company do not
constitute a trigger event, under any circumstances. Shareholders who currently
own more than 15 percent of the stock are "grandfathered" under the Plan as long
as they do not purchase additional shares.
The Company will be entitled to redeem the Rights at a price of $0.01 per
Right at any time prior to the earlier of the trigger or expiration of the
Rights.
SUPPLEMENTAL CASH FLOW INFORMATION
Cash payments for income taxes and interest for the three years ended January 2,
1999, January 3, 1998 and December 28, 1996 were as follows:
1998 1997 1996
- --------------------------------------------------------------------------------
Income taxes $43.6 $32.4 $7.6
Interest, (net of amounts capitalized) $3.2 $1.8 $0.4
- --------------------------------------------------------------------------------
MARKET INFORMATION
The Company's common stock is listed on the New York Stock Exchange. Information
concerning the 1998 and 1997 sales prices of the Company's common stock is set
forth in the following table:
Stock Trading Price
- --------------------------------------------------------------------------------
1998 1997
- --------------------------------------------------------------------------------
Quarter High Low High Low
- --------------------------------------------------------------------------------
First $38.00 $25.19 $31.00 $22.50
Second 48.63 37.50 29.63 18.63
Third 48.19 22.69 28.00 24.44
Fourth 29.75 19.31 31.50 26.13
- --------------------------------------------------------------------------------
As of January 2, 1999, the Company's stock closing price was $25.00. As of
year-end 1998, there were 4,085 shareholders of record.
28 Footstar, Inc. and Subsidiary Companies
<PAGE>
PRO FORMA FINANCIAL STATEMENTS - UNAUDITED
The following table represents a comparison of the Company's pro forma
consolidated condensed statements of operations to the actual results for the
year ended December 28, 1996. Pro forma results assume that the Distribution and
related transactions and events occurred as of the beginning of 1996. Pro forma
financial information is presented for informational purposes only and may not
reflect the future results of the Company or what the results would have been
had the Company been operated as a separate company.
December 28, 1996
---------------------------------
Pro Forma Adjustments Historical
- --------------------------------------------------------------------------------
Net sales $1,672.3 $ -- $ 1,672.3
Cost of sales 1,144.7 -- 1,144.7
- --------------------------------------------------------------------------------
Gross profit 527.6 527.6
Store operating, selling, general
and administrative expenses 363.1 7.6(a) 355.5
Depreciation and amortization 24.8 -- 24.8
- --------------------------------------------------------------------------------
Operating profit 139.7 (7.6) 147.3
Interest income, net 0.7 (13.7)(b) 14.4
- --------------------------------------------------------------------------------
Income from continuing operations before
income taxes and minority interests 140.4 (21.3) 161.7
Provision for income taxes 46.2 (8.4)(c) 54.6
- --------------------------------------------------------------------------------
Income from continuing operations
before minority interests 94.2 (12.9) 107.1
- --------------------------------------------------------------------------------
Minority interests in net income 36.0 -- 36.0
Income from continuing operations $ 58.2 $(12.9) $ 71.1
================================================================================
Weighted average shares outstanding (in millions) 30.5(d)
================================================================================
Earnings per share:
Basic $ 1.90
================================================================================
Diluted $ 1.90
================================================================================
The pro forma results have been derived from the historical financial
results and principally reflect the following:
(a) To record the elimination of the Melville expense allocation and the
anticipated net increase in overhead to add functional areas required to be a
stand-alone public company.
December 28, 1996
- --------------------------------------------------------------------------------
Elimination of Melville expense allocations $ (4.1)
Stand-alone overhead costs 11.7
- --------------------------------------------------------------------------------
Net increase $ 7.6
================================================================================
The Melville expense allocations consist of the following:
- --------------------------------------------------------------------------------
Cost of Employee Stock Ownership Plan $ 2.6
Corporate administrative costs 1.5
- --------------------------------------------------------------------------------
$ 4.1
================================================================================
The stand-alone overhead costs relate primarily to incremental salary and
related costs of corporate management, financing fees and other costs associated
with being a stand-alone public company.
(b) To eliminate net interest income relating to intercompany balances. The net
interest income on the intercompany account balance was calculated on a daily
basis utilizing the Treasury Repurchase Agreement rate for overnight
investments.
(c) To record the net change in the provision for income taxes to reflect the
pro forma adjustments. The effective tax rate utilized was 39 percent, which
approximates the Company's blended statutory rate.
(d) The weighted average number of common shares outstanding reflects (i) the
Distribution ratio times (ii) the number of shares of Melville common stock
outstanding as of August 31, 1996 plus shares of deferred stock and stock units
to be granted as of the Distribution pursuant to the Company's Incentive
Compensation Plan and Non-Employee Director Stock Plan.
Footstar, Inc. and Subsidiary Companies 29
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEGMENT INFORMATION
The Company is a retailer conducting business through retail stores in two
business segments: Meldisco in discount footwear and Footaction in branded
athletic footwear and apparel. Information about operations for each of these
segments is summarized as follows:
1998 1997 1996
- --------------------------------------------------------------------------------
Meldisco:
Net sales $ 1,174.8 $ 1,187.2 $ 1,156.6
Operating profit (1),(2) 105.7 105.0 102.7
Identifiable assets at year-end 330.3 342.5 405.3
Depreciation and amortization 13.8 13.5 8.7
Additions to property and equipment 11.3 7.9 28.5
Footaction:
Net sales 654.3 607.7 515.7
Operating profit (1),(2) 7.8 41.2 49.6
Identifiable assets at year-end 298.1 275.0 228.7
Depreciation and amortization 19.6 19.5 16.1
Additions to property and equipment 42.0 44.3 38.9
Corporate:
General corporate expense (1),(2) (8.9) (12.4) (5.0)
Identifiable assets at year-end 46.6 139.3 147.9
Depreciation and amortization 0.1 0.5 --
Additions to property and equipment 5.3 6.9 --
Consolidated:
Net sales 1,829.1 1,794.9 1,672.3
Operating profit (1),(2) 104.6 133.8 147.3
Interest (expense) income, net (0.6) 2.1 14.4
- -------------------------------------------------------------------------------
Earnings before income taxes
and minority interests $ 104.0 $ 135.9 $ 161.7
===============================================================================
Identifiable assets at year-end 675.0 756.8 781.9
Assets of discontinued operations 10.4 14.2 44.1
- -------------------------------------------------------------------------------
Total assets at year-end $ 685.4 $ 771.0 $ 826.0
===============================================================================
Depreciation and amortization 33.5 33.5 24.8
===============================================================================
Additions to property and equipment $ 58.6 $ 59.1 $ 67.4
Additions to property and equipment of
discontinued operations -- -- 0.9
- -------------------------------------------------------------------------------
Total additions to property and equipment $ 58.6 $ 59.1 $ 68.3
===============================================================================
Operating profit is defined as total revenues less operating expenses.
Identifiable assets include those assets directly related to each segment's
operations.
(1) 1998 includes special charges recorded in connection with the Company's
restructuring and other one-time charges. Excluding these charges, operating
profit for the fiscal year ended 1998 would have been $108.5 million for
Meldisco, $39.4 million for Footaction, ($8.9) million for Corporate and $139.0
million for the consolidated Company.
(2) 1997 includes special charges recorded in connection with the Company's
restructuring. Excluding these charges, operating profit for the fiscal year
ended 1997 would have been $105.0 million for Meldisco, $53.0 million for
Footaction, ($8.5) million for Corporate and $149.5 million for the consolidated
Company.
- --------------------------------------------------------------------------------
30 Footstar, Inc. and Subsidiary Companies
<PAGE>
SUMMARY OF QUARTERLY RESULTS (UNAUDITED)
Summary data for the years ended January 2, 1999 and January 3, 1998 is as
follows:
<TABLE>
<CAPTION>
1st Qtr 2nd Qtr 3rd Qtr 4th Qtr(1) Total
- -------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net sales
1998 $400.9 $462.6 $472.6 $493.0 $1,829.1
1997 376.9 426.0 464.0 528.0 1,794.9
- -------------------------------------------------------------------------------------------------
Gross profit
1998 $114.7 $149.7 $145.9 $140.8 $ 551.1
1997 106.4 136.6 142.1 169.0 554.1
- -------------------------------------------------------------------------------------------------
Income from continuing operations
1998 $ 5.3 $ 17.4 $ 18.4 $ (7.6) $ 33.5
1997 5.0 15.1 18.8 19.7 58.6
- -------------------------------------------------------------------------------------------------
Net income
1998 $ 5.3 $ 17.4 $ 18.4 $ (7.6) $ 33.5
1997 5.0 15.1 18.8 41.1 80.0
- -------------------------------------------------------------------------------------------------
Earnings per share (2)
1998 Basic
Continuing operations $ 0.20 $ 0.71 $ 0.75 $ (0.31) $ 1.33
Discontinued operations -- -- -- -- --
Net income 0.20 0.71 0.75 (0.31) 1.33
1998 Diluted
Continuing operations $ 0.20 $ 0.69 $ 0.74 $ (0.31) $ 1.32
Discontinued operations -- -- -- -- --
Net income 0.20 0.69 0.74 (0.31) 1.32
1997 Basic
Continuing operations $ 0.16 $ 0.50 $ 0.66 $ 0.70 $ 2.00
Discontinued operations -- -- -- 0.76 0.73
Net income 0.16 0.50 0.66 1.46 2.73
1997 Diluted
Continuing operations $ 0.16 $ 0.50 $ 0.66 $ 0.70 $ 1.99
Discontinued operations -- -- -- 0.75 0.73
Net income 0.16 0.50 0.66 1.45 2.72
- -------------------------------------------------------------------------------------------------
</TABLE>
(1) In the fourth quarter of 1998, the Company announced plans to close
approximately 30 underperforming Footaction stores, reconfigure Footaction
merchandise assortments, refine store layouts and exit Meldisco's Central
European business. In connection with these actions, the Company recorded a
pre-tax charge of $34.4 million. In November 1997, the Company announced plans
to consolidate its logistics network and centralize certain accounting
functions. In connection with these actions, the Company recorded a pre-tax
charge of $15.7 million. In December, the Company reversed a pre-tax charge of
$34.0 million of a reserve created as a result of the discontinuation of Thom
McAn in 1996.
(2) Computations for each quarter or other period are independent. Earnings per
share data would neither be restated retroactively nor adjusted currently to
obtain quarterly (or other period) amounts to equal the amount computed for the
year to date due to fluctuations in stock price and the application of the
treasury stock method for determining the dilutive effect of stock options.
Footstar, Inc. and Subsidiary Companies 31
<PAGE>
FIVE-YEAR HISTORICAL FINANCIAL SUMMARY
<TABLE>
<CAPTION>
($ in millions) 1998 1997 1996 1995 1994
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Statement of Operations Data
Net sales $1,829.1 $1,794.9 $1,672.3 $1,615.2 $1,612.8
Cost of sales 1,278.0 1,240.8 1,144.7 1,124.5 1,117.8
- ------------------------------------------------------------------------------------------------------------------------------
Gross profit 551.1 554.1 527.6 490.7 495.0
Store operating, selling, general and administrative expenses 386.3 371.1 355.5 343.0 319.6
Depreciation and amortization 33.5 33.5 24.8 20.0 18.7
Restructuring and asset impairment charges 26.7 15.7 -- 23.7 --
- ------------------------------------------------------------------------------------------------------------------------------
Operating profit(1) 104.6 133.8 147.3 104.0 156.7
Interest (expense) income, net (0.6) 2.1 14.4 21.1 15.4
Provision for income taxes 32.4 41.3 54.6 37.3 49.5
Minority interests in net income 38.1 36.0 36.0 38.4 51.9
Earnings (loss) from discontinued operations, net(2) -- 21.4 (52.8) (26.8) 6.0
Cumulative effect of changes in accounting principle, net(3) -- -- -- (3.9) --
- ------------------------------------------------------------------------------------------------------------------------------
Net income $ 33.5 $ 80.0 $ 18.3 $ 18.7 $ 76.7
==============================================================================================================================
Balance Sheet Data
Current assets:
Cash and cash equivalents $ 49.1 $ 152.2 $ 164.6 $ 26.3 $ 13.9
Due from parent and other divisions -- -- -- 710.8 727.7
Inventories 280.2 284.5 281.9 298.1 347.3
Other 101.4 92.3 137.6 94.6 101.8
- ------------------------------------------------------------------------------------------------------------------------------
Total current assets 430.7 529.0 584.1 1,129.8 1,190.7
Property and equipment, net 217.3 201.9 197.0 195.1 163.9
Other assets 37.4 40.1 44.9 63.3 37.9
- ------------------------------------------------------------------------------------------------------------------------------
Total assets 685.4 771.0 826.0 1,388.2 1,392.5
- ------------------------------------------------------------------------------------------------------------------------------
Current liabilities 268.8 243.9 324.7 219.0 168.3
Other liabilities 45.5 59.5 52.1 61.6 82.4
Minority interests in subsidiaries 67.8 65.1 65.0 93.8 108.7
- ------------------------------------------------------------------------------------------------------------------------------
Total liabilities 382.1 368.5 441.8 374.4 359.4
- ------------------------------------------------------------------------------------------------------------------------------
Divisional equity investment -- -- -- 1,013.8 1,033.1
Shareholders' equity 303.3 402.5 384.2 -- --
- ------------------------------------------------------------------------------------------------------------------------------
Total liabilities and equity $ 685.4 $ 771.0 $ 826.0 $1,388.2 $1,392.5
- ------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Amounts in 1998, 1997 and 1995 also reflect certain non-recurring special
charges. Operating profit in 1998, 1997 and 1995 excluding the effect of these
charges would have been $139.0 million, $149.5 million and $139.3 million,
respectively. See "Management's Discussion and Analysis."
(2) The Company recorded a pre-tax charge of $85.0 million in the first quarter
of 1996 for the discontinuation of Thom McAn. The Company reversed $34.0 million
of this pre-tax charge in 1997 ($21.4 million after taxes).
(3) The charge in 1995 was for the write-off, effective January 1, 1995, of
internally developed software costs that had previously been capitalized.
- --------------------------------------------------------------------------------
32 Footstar, Inc. and Subsidiary Companies
Exhibit 21.1
SUBSIDIARIES OF FOOTSTAR, INC.
The registrant is the direct parent corporation of Footstar Center, Inc.,
a California corporation which owns all of the outstanding shares of Footstar
Corporation, a Texas corporation which owns all of the outstanding shares of
Footaction Center, Inc., a New York Corporation, Meldisco H. C., Inc., a
Minnesota corporation, Melville Mexico H.C., Inc., a Minnesota corporation,
Melville Atlmex H.C., Inc., a Minnesota corporation and Melville Foreign, Inc.,
a Minnesota corporation.
Footaction Center, Inc. owns all of the outstanding shares of Rosedale
Open Country, Inc., a Minnesota corporation, which owns all of the outstanding
shares of Mall of America Fan Club, Inc. and Apache-Minnesota Thom McAn, Inc.
owns all of the outstanding shares of Pheasant Thom McAn, Inc., a New Hampshire
corporation. Mall of America Fan Club, Inc. owns all of the outstanding shares
of approximately 400 corporations which operate specialty retail stores under
the Footaction trade name located in the United States and Puerto Rico selling
brand name athletic footwear and related apparel for men, women and children.
Pheasant Thom McAn, Inc. owns all of the outstanding shares of approximately 120
corporations which operate specialty retail stores under the Footaction trade
name located in the United States, Puerto Rico and the U.S. Virgin Islands
selling brand name athletic footwear and related apparel for men, women and
children.
Meldisco H.C., Inc. owns all of the outstanding shares of Miles Shoes
Meldisco Lakewood, Colorado, Inc., a Colorado corporation which owns 51% of the
capital stock of approximately 2,170 corporations and 100% of the common stock
of approximately 1,060 corporations which were formed to operate leased footwear
departments in Kmart or Rite Aid Drug Stores (formerly PayLess Drug Stores) all
located in the United States, Puerto Rico, the U.S. Virgin Islands or Guam.
Miles Shoes Meldisco Lakewood Colorado, Inc., also owns 100% of the common stock
of Meldisco Europe, Inc., a New York corporation which is involved in the
registrant's operations in Hungary, Poland, the Czech Republic and Slovakia.
Melville Foreign, Inc., a Minnesota corporation directly or indirectly
owns all of the outstanding shares of approximately 4 foreign subsidiaries
involved in the registrant's operations in Hungary, Poland, the Czech Republic
and Slovakia.
Several of the subsidiaries referred to in this Exhibit have not yet
opened their stores for business and several no longer operate any stores. All
of the subsidiaries referred to herein are included in the consolidated
financial statements of the registrant.
The names of other subsidiaries are omitted as, considered in the
aggregate as a single subsidiary, they would not constitute a significant
subsidiary.
Exhibit 23.1
Independent Auditors' Consent
To the Board of Directors and Shareholders of Footstar, Inc.:
We consent to incorporation by reference in the registration statements (No.
33-20731 and No. 33-30011) on Form S-8 of Footstar, Inc. of our report dated
February 8, 1999, relating to the consolidated balance sheets of Footstar, Inc.
and Subsidiary Companies as of January 2, 1999 and January 3, 1998 and the
related consolidated statements of operations, shareholders' equity and
comprehensive income and cash flows for each of the years in the three-year
period ended January 2, 1999 and the related schedule, which report appears or
is incorporated by reference in the January 2, 1999 annual report on Form 10-K
of Footstar, Inc.
/s/ KPMG LLP
Short Hills, NJ
March 29, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> JAN-02-1999
<PERIOD-END> JAN-02-1999
<CASH> 49,100
<SECURITIES> 0
<RECEIVABLES> 53,000
<ALLOWANCES> 1,000
<INVENTORY> 280,200
<CURRENT-ASSETS> 430,700
<PP&E> 307,300
<DEPRECIATION> 90,000
<TOTAL-ASSETS> 685,400
<CURRENT-LIABILITIES> 268,800
<BONDS> 0
0
0
<COMMON> 300
<OTHER-SE> 303,000
<TOTAL-LIABILITY-AND-EQUITY> 685,400
<SALES> 1,829,100
<TOTAL-REVENUES> 1,829,100
<CGS> 1,278,000
<TOTAL-COSTS> 1,278,000
<OTHER-EXPENSES> 446,500
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 600
<INCOME-PRETAX> 104,000
<INCOME-TAX> 32,400
<INCOME-CONTINUING> 71,600
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 33,500
<EPS-PRIMARY> 1.33
<EPS-DILUTED> 1.32
</TABLE>
