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These excerpts taken from the FL 10-K filed Mar 31, 2008. Critical Accounting Policies Management’s responsibility for integrity and objectivity in the preparation and presentation of the Company’s financial statements requires diligent application of appropriate accounting policies. Generally, the Company’s accounting policies and methods are those specifically required by U.S. generally accepted accounting principles (“GAAP”). Included in the “Summary of Significant Accounting Policies” footnote in “Item 8. Consolidated Financial Statements and Supplementary Data” is a summary of the Company’s most significant accounting policies. In some cases, management is required to calculate amounts based on estimates for matters that are inherently uncertain. The Company believes the following to be the most critical of those accounting policies that necessitate subjective judgments. Merchandise Inventories Merchandise inventories for the Company’s Athletic Stores are valued at the lower of cost or market using the retail inventory method. The retail inventory method (“RIM”) is commonly used by retail companies to value inventories at cost and calculate gross margins due to its practicality. Under the retail method, cost is determined by applying a cost-to-retail percentage across groupings of similar items, known as departments. The cost-to-retail percentage is applied to ending inventory at its current owned retail valuation to determine the cost of ending inventory on a department basis. The RIM is a system of averages that requires management’s estimates and assumptions regarding markups, markdowns and shrink, among others, and as such, could result in distortions of inventory amounts. Significant judgment is required for these estimates and assumptions, as well as to differentiate between promotional and other markdowns that may be required to correctly reflect merchandise inventories at the lower of cost or market. The Company provides reserves based on current selling prices when the inventory has not been marked down to market. The failure to take permanent markdowns on a timely basis may result in an overstatement of cost under the retail inventory method. The decision to take permanent markdowns includes many factors, including the current environment, inventory levels and the age of the item. Management believes this method and its related assumptions, which have been consistently applied, to be reasonable. Vendor Reimbursements In the normal course of business, the Company receives allowances from its vendors for markdowns taken. Vendor allowances are recognized as a reduction in cost of sales in the period in which the markdowns are taken. The effect of vendor allowances negatively effected gross margin in 2007, as a percentage of sales, of 60 basis points as compared with 2006. The Company also has volume-related agreements with certain vendors, under which it receives rebates based on fixed percentages of cost purchases. These volume-related rebates are recorded in cost of sales when the product is sold and they contributed 10 basis points to the 2007 gross margin rate. The Company receives support from some of its vendors in the form of reimbursements for cooperative advertising and catalog costs for the launch and promotion of certain products. The reimbursements are agreed upon with vendors for specific advertising campaigns and catalogs. Cooperative income, to the extent that it reimburses specific, incremental and identifiable costs incurred to date, is recorded in SG&A in the same period as the associated expenses are incurred. Reimbursements received that are in excess of specific, incremental and identifiable costs incurred to date are recognized as a reduction to the cost of merchandise and are reflected in cost of sales as the merchandise is sold. Cooperative reimbursements amounted to approximately 33 percent of total advertising costs in 2007 and approximately 11 percent of catalog costs in 2007. Impairment of Long-Lived Assets In accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS No. 144”), the Company recognizes an impairment loss when circumstances indicate that the carrying value of long-lived tangible and intangible assets with finite lives may not be recoverable. Management’s policy in determining whether an impairment indicator exists, a triggering event, comprises measurable operating performance criteria at the division level as well as qualitative measures. If an analysis is necessitated by the occurrence of a triggering event, the Company uses assumptions, which are predominately identified from the Company’s three-year strategic plans, in determining the impairment amount. The calculation of fair value of long-lived assets is based on estimated expected discounted 19 future cash flows by store, which is generally measured by discounting the expected future cash flows at the Company’s weighted-average cost of capital. Management believes its policy is reasonable and is consistently applied. Future expected cash flows are based upon estimates that, if not achieved, may result in significantly different results. During 2007, the Company recorded non-cash impairment charges totaling $124 million primarily to write-down long-lived assets such as store fixtures and leasehold improvements for the Company’s U.S. store operations pursuant to SFAS No. 144. The Company is required to perform an impairment review of its goodwill at least annually. The Company has chosen to perform this review at the beginning of each fiscal year, and it is done in a two-step approach. The initial step requires that the carrying value of each reporting unit be compared with its estimated fair value. The second step — to evaluate goodwill of a reporting unit for impairment — is only required if the carrying value of that reporting unit exceeds its estimated fair value. The fair value of each of the Company’s reporting units exceeded its carrying value as of the beginning of the year. The Company used a combination of a discounted cash flow approach and market-based approach to determine the fair value of a reporting unit. The latter requires judgment and uses one or more methods to compare the reporting unit with similar businesses, business ownership interests or securities that have been sold. During the third and fourth quarters of 2007, the Company performed reviews of its U.S. Athletic stores’ goodwill, as a result of the SFAS No. 144 recoverability analysis. These analyses did not result in an impairment charge. Share-Based Compensation The Company estimates the fair value of options granted using the Black-Scholes option pricing model. The Company estimates the expected term of options granted using its historical exercise and post-vesting employment termination patterns, which the Company believes are representative of future behavior. Changing the expected term by one year changes the fair value by 10 to 15 percent depending if the change was an increase or decrease to the expected term. The Company estimates the expected volatility of its common stock at the grant date using a weighted-average of the Company’s historical volatility and implied volatility from traded options on the Company’s common stock. A 50 basis point change in volatility would have a 1 percent change to the fair value. The risk-free interest rate assumption is determined using the Federal Reserve nominal rates for U.S. Treasury zero-coupon bonds with maturities similar to those of the expected term of the award being valued. The expected dividend yield is derived from the Company’s historical experience. A 50 basis point change to the dividend yield would change the fair value by approximately 5 percent. The Company records stock-based compensation expense only for those awards expected to vest using an estimated forfeiture rate based on its historical pre-vesting forfeiture data, which it believes are representative of future behavior, and periodically will revise those estimates in subsequent periods if actual forfeitures differ from those estimates. The Black-Scholes option valuation model requires the use of subjective assumptions. Changes in these assumptions can materially affect the fair value of the options. The Company may elect to use different assumptions under the Black-Scholes option pricing model in the future if there is a difference between the assumptions used in determining stock-based compensation cost and the actual factors that become known over time. Pension and Postretirement Liabilities The Company determines its obligations for pension and postretirement liabilities based upon assumptions related to discount rates, expected long-term rates of return on invested plan assets, salary increases, age, and mortality among others. Management reviews all assumptions annually with its independent actuaries, taking into consideration existing and future economic conditions and the Company’s intentions with regard to the plans. Management believes that its estimates for 2007, as disclosed in “Item 8. Consolidated Financial Statements and Supplementary Data,” to be reasonable. Long-Term Rate of Return Assumption - The expected long-term rate of return on invested pension plan assets is a component of pension expense. The rate is based on the plans’ weighted-average target asset allocation, as well as historical and future expected performance of those assets. The target asset allocation is selected to obtain an investment return that is sufficient to cover the expected benefit payments and to reduce future contributions by the Company. The Company’s common stock represented approximately 1 percent of the total pension plans’ assets at February 2, 2008. 20 The weighted-average long-term rate of return used to determine 2007 pension expense was 8.85 percent. A decrease of 50 basis points in the weighted-average expected long-term rate of return would have increased 2007 pension expense by approximately $3 million. The actual return on plan assets in a given year may differ from the expected long-term rate of return and the resulting gain or loss is deferred and amortized into the plans’ expense over time. Discount Rate - An assumed discount rate is used to measure the present value of future cash flow obligations of the plans and the interest cost component of pension expense and postretirement income. The discount rate selected to measure the present value of the Company’s U.S. benefit obligations as of February 2, 2008 was derived using a cash flow matching method whereby the Company compares the plans’ projected payment obligations by year with the corresponding yield on the Citibank Pension Discount Curve. The cash flows are then discounted to their present value and an overall discount rate is determined. The discount rate selected to measure the present value of the Company’s Canadian benefit obligations as of February 2, 2008 was developed by using the plan’s bond portfolio indices which match the benefit obligations. A decrease of 50 basis points in the weighted-average discount rate would have increased the accumulated benefit obligation as of February 2, 2008 of the pension plans by approximately $27 million and the effect on the postretirement plan would not be significant. Such a decrease would not have significantly changed 2007 pension expense or postretirement income. There is limited risk to the Company for increases in health care costs related to the postretirement plan as, beginning in 2001, new retirees have assumed the full expected costs and then-existing retirees and future retirees have assumed all increases in such costs. The Company expects to record postretirement income of approximately $8 million and pension expense of approximately $5 million in 2008. Income Taxes In accordance with GAAP, deferred tax assets are recognized for tax credit and net operating loss carryforwards, reduced by a valuation allowance, which is established when it is more likely than not that some portion or all of the deferred tax assets will not be realized. Management is required to estimate taxable income for future years by taxing jurisdiction and to use its judgment to determine whether or not to record a valuation allowance for part or all of a deferred tax asset. A one percent change in the Company’s overall statutory tax rate for 2007 would have resulted in a $8 million change in the carrying value of the net deferred tax asset and a corresponding charge or credit to income tax expense depending on whether such tax rate change was a decrease or increase. The Company has operations in multiple taxing jurisdictions and is subject to audit in these jurisdictions. Tax audits by their nature are often complex and can require several years to resolve. Accruals of tax contingencies require management to make estimates and judgments with respect to the ultimate outcome of tax audits. Actual results could vary from these estimates. The Company expects its 2008 effective tax rate to be approximately 35.5 percent. The actual rate will primarily depend upon the percentage of the Company’s income earned in the United States as compared with international operations. Discontinued, Repositioning and Restructuring Reserves The Company exited four business segments as part of its discontinuation and restructuring programs. The final discontinued segment and disposition of the restructured businesses were completed in 2001. In order to identify and calculate the associated costs to exit these businesses, management made assumptions regarding estimates of future liabilities for operating leases and other contractual agreements, the net realizable value of assets held for sale or disposal and the fair value of non-cash consideration received. The Company has settled the majority of these liabilities and the remaining activity relates to the disposition of the residual lease liabilities. As a result of achieving divestiture accounting in the fourth quarter of 2002, the Northern Group note was recorded at its fair value. The Company is required to review the collectibility of the note based upon various criteria such as the credit-worthiness of the issuer or a delay in payment of the principal or interest. Future adjustments, if any, to the carrying value of the note will be recorded pursuant to SEC Staff Accounting Bulletin Topic 5:Z:5, “Accounting 21 and Disclosure Regarding Discontinued Operations,” which requires changes in the carrying value of assets received as consideration from the disposal of a discontinued operation to be classified within continuing operations. The purchaser has made all payments required under the terms of the note; however, the business has sustained unexpected operating losses during the past fiscal year. The Company has evaluated the projected performance of the business and will continue to monitor its results during the coming year. At February 2, 2008, CAD$15.5 million remains outstanding on the note, the fair value of which is US$14 million. The remaining discontinued reserve balances at February 2, 2008 totaled $23 million of which $14 million is expected to be utilized within the next twelve months. The remaining repositioning and restructuring reserves totaled $2 million at February 2, 2008. Critical Accounting Management’s responsibility for integrity and objectivity in the Merchandise Merchandise inventories for the Company’s Athletic Stores are valued at Vendor In The Impairment of Long-Lived In 19 | ||||||||||
future cash flows by store, which During 2007, the Company recorded non-cash impairment charges totaling The The During the third and fourth quarters of 2007, the Company performed Share-Based The The Pension and Postretirement The Long-Term Rate of Return Assumption - The expected long-term rate of 20 | ||||||||||
The Discount Rate - An assumed discount rate is used to measure the present A There is limited risk to the Company for increases in health care costs The Income In The The Discontinued, Repositioning The As a 21 | ||||||||||
and Disclosure Regarding The This excerpt taken from the FL 10-K filed Apr 2, 2007. Critical Accounting Policies Management’s responsibility for integrity and objectivity in the preparation and presentation of the Company’s financial statements requires diligent application of appropriate accounting policies. Generally, the Company’s accounting policies and methods are those specifically required by U.S. generally accepted accounting principles (“GAAP”). Included in the “Summary of Significant Accounting Policies” footnote in “Item 8. Consolidated Financial 17 Statements and Supplementary Data” is a summary of the Company’s most significant accounting policies. In some cases, management is required to calculate amounts based on estimates for matters that are inherently uncertain. The Company believes the following to be the most critical of those accounting policies that necessitate subjective judgments. Merchandise Inventories Merchandise inventories for the Company’s Athletic Stores are valued at the lower of cost or market using the retail inventory method. The retail inventory method (“RIM”) is commonly used by retail companies to value inventories at cost and calculate gross margins due to its practicality. Under the retail method, cost is determined by applying a cost-to-retail percentage across groupings of similar items, known as departments. The cost-to-retail percentage is applied to ending inventory at its current owned retail valuation to determine the cost of ending inventory on a department basis. The RIM is a system of averages that requires management’s estimates and assumptions regarding markups, markdowns and shrink, among others, and as such, could result in distortions of inventory amounts. Significant judgment is required for these estimates and assumptions, as well as to differentiate between promotional and other markdowns that may be required to correctly reflect merchandise inventories at the lower of cost or market. The Company provides reserves based on current selling prices when the inventory has not been marked down to market. The failure to take permanent markdowns on a timely basis may result in an overstatement of cost under the retail inventory method. The decision to take permanent markdowns includes many factors, including the current environment, inventory levels and the age of the item. Management believes this method and its related assumptions, which have been consistently applied, to be reasonable. Vendor Reimbursements In the normal course of business, the Company receives allowances from its vendors for markdowns taken. Vendor allowances are recognized as a reduction in cost of sales in the period in which the markdowns are taken. The effect of vendor allowances was an improvement in gross margin in 2006, as a percentage of sales, of 20 basis points as compared with 2005. The Company also has volume-related agreements with certain vendors, under which it receives rebates based on fixed percentages of cost purchases. These volume-related rebates are recorded in cost of sales when the product is sold and they contributed 10 basis points to the 2006 gross margin rate. The Company receives support from some of its vendors in the form of reimbursements for cooperative advertising and catalog costs for the launch and promotion of certain products. The reimbursements are agreed upon with vendors for specific advertising campaigns and catalogs. Cooperative income, to the extent that it reimburses specific, incremental and identifiable costs incurred to date, is recorded in SG&A in the same period as the associated expenses are incurred. Reimbursements received that are in excess of specific, incremental and identifiable costs incurred to date are recognized as a reduction to the cost of merchandise and are reflected in cost of sales as the merchandise is sold. Cooperative reimbursements amounted to approximately 27 percent of total advertising costs in 2006 and approximately 9 percent of catalog costs in 2006. Impairment of Long-Lived Assets In accordance with SFAS No. 144, the Company recognizes an impairment loss when circumstances indicate that the carrying value of long-lived tangible and intangible assets with finite lives may not be recoverable. Management’s policy in determining whether an impairment indicator exists, a triggering event, comprises measurable operating performance criteria as well as qualitative measures. If an analysis is necessitated by the occurrence of a triggering event, the Company uses assumptions, which are predominately identified from the Company’s three-year strategic plans, in determining the impairment amount. The calculation of fair value of long-lived assets is based on estimated expected discounted future cash flows by store, which is generally measured by discounting the expected future cash flows at the Company’s weighted-average cost of capital. Management believes its policy is reasonable and is consistently applied. Future expected cash flows are based upon estimates that, if not achieved, may result in significantly different results. The Company is required to perform an impairment review of its goodwill at least annually. The Company has chosen to perform this review at the beginning of each fiscal year, and it is done in a two-step approach. The initial step requires that the carrying value of each reporting unit be compared with its estimated fair value. The second step — to evaluate goodwill of a reporting unit for impairment — is only required if the carrying value of that reporting unit 18 exceeds its estimated fair value. The fair value of each of the Company’s reporting units exceeded its carrying value as of the beginning of the year. The Company used a combination of a discounted cash flow approach and market-based approach to determine the fair value of a reporting unit. The latter requires judgment and uses one or more methods to compare the reporting unit with similar businesses, business ownership interests or securities that have been sold. During 2006, the Company recorded an impairment charge of $17 million ($12 million after-tax) to write-down long-lived assets such as store fixtures and leasehold improvements in 69 stores in the European operations to their estimated fair value. Share-Based Compensation The Company estimates the fair value of options granted using the Black-Scholes option pricing model. The Company estimates the expected term of options granted using its historical exercise and post-vesting employment termination patterns, which the Company believes are representative of future behavior. Changing the expected term by one year changes the fair value by 10 to 15 percent depending if the change was an increase or decrease to the expected term. The Company estimates the expected volatility of its common stock at the grant date using a weighted-average of the Company’s historical volatility and implied volatility from traded options on the Company’s common stock. A 50 basis point change in volatility would have a 1 percent change to the fair value. The risk-free interest rate assumption is determined using the Federal Reserve nominal rates for U.S. Treasury zero-coupon bonds with maturities similar to those of the expected term of the award being valued. The expected dividend yield is derived from the Company’s historical experience. A 50 basis point change to the dividend yield would change the fair value by approximately 5 percent. The Company records stock-based compensation expense only for those awards expected to vest using an estimated forfeiture rate based on its historical pre-vesting forfeiture data, which it believes are representative of future behavior, and periodically will revise those estimates in subsequent periods if actual forfeitures differ from those estimates. The Black-Scholes option valuation model requires the use of subjective assumptions. Changes in these assumptions can materially affect the fair value of the options. The Company may elect to use different assumptions under the Black-Scholes option pricing model in the future if there is a difference between the assumptions used in determining stock-based compensation cost and the actual factors that become known over time. The guidance in SFAS No. 123(R) is relatively new and best practices are not well established. The application of these principles may be subject to further interpretation and refinement over time. There are significant differences among valuation models and there is a possibility that the Company will adopt different valuation models and assumptions in the future. This may result in both a lack of comparability with other companies that use different models, methods, and assumptions, and in a lack of consistency in future periods. Pension and Postretirement Liabilities The Company determines its obligations for pension and postretirement liabilities based upon assumptions related to discount rates, expected long-term rates of return on invested plan assets, salary increases, age, and mortality among others. Management reviews all assumptions annually with its independent actuaries, taking into consideration existing and future economic conditions and the Company’s intentions with regard to the plans. Management believes that its estimates for 2006, as disclosed in “Item 8. Consolidated Financial Statements and Supplementary Data,” to be reasonable. Long-Term Rate of Return Assumption - The expected long-term rate of return on invested plan assets is a component of pension expense and the rate is based on the plans’ weighted-average target asset allocation of 64 percent equity securities and 36 percent fixed income investments, as well as historical and future expected performance of those assets. The target asset allocation is selected to obtain an investment return that is sufficient to cover the expected benefit payments based on the timing of settlements and to reduce future contributions by the Company. The Company’s common stock represented approximately 1 percent of the total pension plans’ assets at February 3, 2007. A decrease of 50 basis points in the weighted-average expected long-term rate of return would have increased 2006 pension expense by approximately $3 million. The actual return on plan assets in a given year may differ from the expected long-term rate of return and the resulting gain or loss is deferred and amortized into the plans’ performance over time. 19 Discount Rate - An assumed discount rate is used to measure the present value of future cash flow obligations of the plans and the interest cost component of pension expense and postretirement income. The discount rate selected to measure the present value of the Company’s benefit obligations as of February 3, 2007 was derived using a cash flow matching method whereby the Company compares the plans’ projected payment obligations by year with the corresponding yield on the Citibank Pension Discount Curve. The cash flows are then discounted to their present value and an overall discount rate is determined. A decrease of 50 basis points in the weighted-average discount rate would have increased the accumulated benefit obligation as of February 3, 2007 of the pension plan by approximately $28 million and the effect on the postretirement plan would not be significant. Such a decrease would not have significantly changed 2006 pension expense or postretirement income. There is limited risk to the Company for increases in healthcare costs related to the postretirement plan as, beginning in 2001, new retirees have assumed the full expected costs and then existing retirees and future retirees have assumed all increases in such costs. The Company expects to record postretirement income of approximately $8 million and pension expense of approximately $6 million in 2007. Income Taxes In accordance with GAAP, deferred tax assets are recognized for tax credit and net operating loss carryforwards, reduced by a valuation allowance, which is established when it is more likely than not that some portion or all of the deferred tax assets will not be realized. Management is required to estimate taxable income for future years by taxing jurisdiction and to use its judgment to determine whether or not to record a valuation allowance for part or all of a deferred tax asset. A one percent change in the Company’s overall statutory tax rate for 2006 would have resulted in a $3 million change in the carrying value of the net deferred tax asset and a corresponding charge or credit to income tax expense depending on whether such tax rate change was a decrease or increase. The Company has operations in multiple taxing jurisdictions and is subject to audit in these jurisdictions. Tax audits by their nature are often complex and can require several years to resolve. Accruals of tax contingencies require management to make estimates and judgments with respect to the ultimate outcome of tax audits. Actual results could vary from these estimates. The Company expects its 2007 effective tax rate to be approximately 37.5 percent. The actual rate will primarily depend upon the percentage of the Company’s income earned in the United States as compared with international operations. Discontinued, Repositioning and Restructuring Reserves The Company exited four business segments as part of its discontinuation and restructuring programs. The final discontinued segment and disposition of the restructured businesses were completed in 2001. In order to identify and calculate the associated costs to exit these businesses, management made assumptions regarding estimates of future liabilities for operating leases and other contractual agreements, the net realizable value of assets held for sale or disposal and the fair value of non-cash consideration received. The Company has settled the majority of these liabilities and the remaining activity relates to the disposition of the residual lease liabilities. As a result of achieving divestiture accounting in the fourth quarter of 2002, the Northern Group note was recorded at its fair value. The Company is required to review the collectibility of the note based upon various criteria such as the credit-worthiness of the issuer or a delay in payment of the principal or interest. Future adjustments, if any, to the carrying value of the note will be recorded pursuant to SEC Staff Accounting Bulletin Topic 5:Z:5, “Accounting and Disclosure Regarding Discontinued Operations,” which requires changes in the carrying value of assets received as consideration from the disposal of a discontinued operation to be classified within continuing operations. The Company has evaluated the projected performance of the business and will continue to monitor its results during the coming year. At February 3, 2007, CAD$15.5 million remains outstanding on the note, the fair value of which is US$11 million. The remaining discontinued reserve balances at February 3, 2007 totaled $15 million of which $3 million is expected to be utilized within the next twelve months. The remaining repositioning and restructuring reserves totaled $4 million at February 3, 2007, whereby $1 million is expected to be utilized within the next twelve months. 20 This excerpt taken from the FL 10-K filed Mar 29, 2005. Critical Accounting Policies Management’s responsibility for integrity and
objectivity in the preparation and presentation of the Company’s financial statements requires diligent application of appropriate accounting
policies. Generally, the Company’s accounting policies and methods are those specifically required by U.S. generally accepted accounting
principles (“GAAP”). Included in the “Summary of Significant Accounting Policies” footnote in “Item 8. Consolidated Financial
Statements and Supplementary Data” is a summary of the Company’s most significant accounting policies. In some cases, management is required
to calculate amounts based on estimates for matters that are inherently uncertain. The Company believes the following to be the most critical of those
accounting policies that necessitate subjective judgments.
14 Business Combinations The Company accounts for acquisitions of other
businesses in accordance with SFAS No. 141, “Business Combinations” (“SFAS 141”). SFAS 141 requires that the Company record the net
assets of acquired businesses at fair value, and make estimates and assumptions to determine the fair value of these acquired assets and liabilities.
The Company allocates the purchase price of acquired businesses based, in part, upon internal estimates of cash flows, recoverability and independent
appraisals. Changes to the assumptions used to estimate the fair value could impact the recorded amounts of the assets acquired and the resultant
goodwill.
Merchandise Inventories Merchandise inventories for the Company’s
Athletic Stores are valued at the lower of cost or market using the retail inventory method. The retail inventory method (“RIM”) is commonly
used by retail companies to value inventories at cost and calculate gross margins by applying a cost-to-retail percentage to the retail value of
inventories. The RIM is a system of averages that requires management’s estimates and assumptions regarding markups, markdowns and shrink, among
others, and as such, could result in distortions of inventory amounts. Judgment is required to differentiate between promotional and other markdowns
that may be required to correctly reflect merchandise inventories at the lower of cost or market. Management believes this method and its related
assumptions, which have been consistently applied, to be reasonable.
Vendor Reimbursements In the normal course of business, the Company
receives allowances from its vendors for markdowns previously taken. Vendor allowances are recognized as a reduction in cost of sales in the period in
which the markdowns are taken. The effect of vendor allowances on gross margin, as a percentage of sales, as compared with the corresponding prior year
period was not significant. The Company also has volume-related agreements with certain vendors, under which it receives rebates based on fixed
percentages of cost purchases. These volume-related rebates are recorded in cost of sales when the product is sold and they contributed 20 basis points
to the 2004 gross margin rate.
The Company receives support from some of its
vendors in the form of reimbursements for cooperative advertising and catalog costs for the launch and promotion of certain products. The
reimbursements are agreed upon with vendors for specific advertising campaigns and catalogs. Cooperative income, to the extent that they reimburse
specific, incremental and identifiable costs incurred to date, are recorded in SG&A in the same period as the associated expenses are incurred.
Reimbursements received that are in excess of specific, incremental and identifiable costs incurred to date are recognized as a reduction to the cost
of merchandise and are reflected in cost of sales as the merchandise is sold. Cooperative reimbursements amounted to approximately 29 percent of total
advertising costs in 2004 and approximately 8 percent of catalog costs in 2004.
Impairment of Long-Lived Assets In accordance with SFAS No. 144, the Company
recognizes an impairment loss when circumstances indicate that the carrying value of long-lived tangible and intangible assets with finite lives may
not be recoverable. Management’s policy in determining whether an impairment indicator exists, a triggering event, comprises measurable operating
performance criteria as well as qualitative measures. If an analysis is necessitated by the occurrence of a triggering event, the Company uses
assumptions, which are predominately identified from the Company’s three-year strategic plans, in determining the impairment amount. The
calculation of fair value of long-lived assets is based on estimated expected discounted future cash flows by store, which is generally measured by
discounting the expected future cash flows at the Company’s weighted-average cost of capital. Management believes its policy is reasonable and is
consistently applied. Future expected cash flows are based upon estimates that, if not achieved, may result in significantly different results.
Long-lived tangible assets and intangible assets with finite lives primarily include property and equipment and intangible lease acquisition
costs.
The Company is required to perform an impairment
review of its goodwill, at least annually. The Company has chosen to perform this review at the beginning of each fiscal year, and it is done in a
two-step approach. The initial step requires that the carrying value of each reporting unit be compared with its estimated fair value. The second step
— to evaluate goodwill of a reporting unit for impairment — is only required if the carrying value of that reporting unit exceeds its
estimated fair value. The fair value of each of the Company’s reporting units exceeded its carrying value as of February 1, 2004. The Company used
a combination of a discounted cash flow approach and market-based approach to determine the
15 fair value of a reporting unit. The latter requires judgment and uses one or more methods to compare the reporting unit with similar businesses, business ownership interests or securities that have been sold. Pension and Postretirement Liabilities The Company determines its obligations for pension
and postretirement liabilities based upon assumptions related to discount rates, expected long-term rates of return on invested plan assets, salary
increases, age, mortality and health care cost trends, among others. Management reviews all assumptions annually with its independent actuaries, taking
into consideration existing and future economic conditions and the Company’s intentions with regard to the plans. Management believes that its
estimates for 2004, as disclosed in “Item 8. Consolidated Financial Statements and Supplementary Data,” to be reasonable. The expected
long-term rate of return on invested plan assets is a component of pension expense and the rate is based on the plans’ weighted-average target
asset allocation of 64 percent equity securities and 36 percent fixed income investments, as well as historical and future expected performance of
those assets. The target asset allocation is selected to obtain an investment return that is sufficient to cover the expected benefit payments based on
the timing of settlements and to reduce future contributions by the Company. The Company’s common stock represented approximately 2 percent of the
total pension plans’ assets at January 29, 2005. A decrease of 50 basis points in the weighted-average expected long-term rate of return would
have increased 2004 pension expense by approximately $3 million. The actual return on plan assets in a given year may differ from the expected
long-term rate of return and the resulting gain or loss is deferred and amortized into the plans’ performance over time. An assumed discount rate
is used to measure the present value of future cash flow obligations of the plans and the interest cost component of pension expense and postretirement
income. The discount rate is selected with reference to the Aa long-term corporate bond yield. A decrease of 50 basis points in the weighted-average
discount rate would have increased the accumulated benefit obligation as of January 29, 2005 of the pension and postretirement plans by approximately
$30 million and approximately $1 million, respectively. Such a decrease would not have significantly changed 2004 pension expense or postretirement
income. There is limited risk to the Company for increases in healthcare costs related to the postretirement plan as new retirees have assumed the full
expected costs and existing retirees have assumed all increases in such costs since the beginning of fiscal year 2001. The additional minimum liability
included in shareholders’ equity at January 29, 2005 for the pension plans represented the amount by which the accumulated benefit obligation
exceeded the fair market value of the plan assets. The Company contributed $44 million to the U.S. qualified pension plan and contributed $6 million to
the Canadian qualified pension plan in February 2004. In addition, $56 million was contributed to the U.S. qualified pension plan in September
2004.
The Company expects to record postretirement income
of approximately $11 million and pension expense of approximately $13 million in 2005. Pension expense in 2005 reflects the Company’s expected
contributions, of which $19 million was made on February 4, 2005. These contributions have reduced 2005 estimated pension expense by approximately $2
million.
Income Taxes In accordance with GAAP, deferred tax assets are
recognized for tax credit and net operating loss carryforwards, reduced by a valuation allowance, which is established when it is more likely than not
that some portion or all of the deferred tax assets will not be realized. Management is required to estimate taxable income for future years by taxing
jurisdiction and to use its judgment to determine whether or not to record a valuation allowance for part or all of a deferred tax asset. A one percent
change in the Company’s overall statutory tax rate for 2004 would have resulted in a $6 million change in the carrying value of the net deferred
tax asset and a corresponding charge or credit to income tax expense depending on whether such tax rate change was a decrease or
increase.
The Company has operations in multiple taxing
jurisdictions and is subject to audit in these jurisdictions. Tax audits by their nature are often complex and can require several years to resolve.
Accruals of tax contingencies require management to make estimates and judgments with respect to the ultimate outcome of tax audits. Actual results
could vary from these estimates.
The Company expects its 2005 effective tax rate to
be approximately 36.5 percent.
16 Discontinued, Repositioning and Restructuring Reserves The Company exited four business segments as part of
its discontinuation and restructuring programs. The final discontinued segment and disposition of the restructured businesses were completed in 2001.
In order to identify and calculate the associated costs to exit these businesses, management made assumptions regarding estimates of future liabilities
for operating leases and other contractual agreements, the net realizable value of assets held for sale or disposal and the fair value of non-cash
consideration received. The Company has settled the majority of these liabilities and the remaining activity relates to the disposition of the residual
lease liabilities.
As a result of achieving divestiture accounting in
the fourth quarter of 2002, the Northern Group note was recorded at its fair value. The Company is required to review the collectibility of the note
based upon various criteria such as the credit-worthiness of the issuer or a delay in payment of the principal or interest. Future adjustments, if any,
to the carrying value of the note will be recorded pursuant to SEC Staff Accounting Bulletin Topic 5:Z:5, “Accounting and Disclosure Regarding
Discontinued Operations,” which requires changes in the carrying value of assets received as consideration from the disposal of a discontinued
operation to be classified within continuing operations. The purchaser has made all payments required under the terms of the Note, however the business
sustained unexpected operating losses during the past fiscal year. The Company has evaluated the projected performance of the business and will
continue to monitor its results during the coming year. At January 29, 2005, $9 million remains outstanding on the Note.
The remaining discontinued reserve balances at
January 29, 2005 totaled $18 million of which $7 million is expected to be utilized within the next twelve months. The remaining repositioning and
restructuring reserves totaled $4 million at January 29, 2005, whereby $1 million is expected to be utilized within the next twelve
months.
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