Foot Locker 2005 Annual Report Download - page 62

19 Financial Instruments and Risk Management
Foreign Exchange Risk Management — Derivative Holdings Designated as Hedges
The Company operates internationally and utilizes certain derivative financial instruments to mitigate its foreign
currency exposures, primarily related to third party and intercompany forecasted transactions.
For a derivative to qualify as a hedge at inception and throughout the hedged period, the Company formally
documents the nature and relationships between the hedging instruments and hedged items, as well as its risk-
management objectives, strategies for undertaking the various hedge transactions and the methods of assessing hedge
effectiveness and hedge ineffectiveness. Additionally, for hedges of forecasted transactions, the significant
characteristics and expected terms of a forecasted transaction must be specifically identified, and it must be probable
that each forecasted transaction would occur. If it were deemed probable that the forecasted transaction would not occur,
the gain or loss would be recognized in earnings immediately. No such gains or losses were recognized in earnings during
2005 or 2004. Derivative financial instruments qualifying for hedge accounting must maintain a specified level of
effectiveness between the hedging instrument and the item being hedged, both at inception and throughout the hedged
period, which management evaluates periodically.
The primary currencies to which the Company is exposed are the euro, the British Pound and the Canadian Dollar. For option
and forward foreign exchange contracts designated as cash flow hedges of the purchase of inventory, the effective portion of
gains and losses is deferred as a component of accumulated other comprehensive loss and is recognized as a component of cost
of sales when the related inventory is sold. Amounts classified to cost of sales related to such contracts were a gain of
approximately $2 million in 2005 and a loss of $1 million in 2004. The ineffective portion of gains and losses related to cash
flow hedges recorded to earnings in 2005 and 2004 was approximately $1 million in each year. When using a forward contract
as a hedging instrument, the Company excludes the time value from the assessment of effectiveness. At each year-end, the
Company had not hedged forecasted transactions for more than the next twelve months, and the Company expects all derivative-
related amounts reported in accumulated other comprehensive loss to be reclassified to earnings within twelve months.
In 2005, the Company hedged a portion of its net investment in its European subsidiaries. The Company entered into a
10-year cross currency swap, creating a euro 100 million long-term liability and a $122 million long-term asset. During the term
of this transaction, the Company will remit to and receive from its counterparty interest payments based on rates that are reset
monthly equal to one-month EURIBOR and one-month U.S. LIBOR rates, respectively. The Company has designated this hedging
instrument as a hedge of the net investment in a foreign subsidiary, and will use the spot rate method of accounting to value
changes of the hedging instrument attributable to currency rate fluctuations. As such, adjustments in the fair market value
of the hedging instrument due to changes in the spot rate will be recorded in other comprehensive income and are expected
to offset changes in the euro-denominated net investment. Amounts recorded to foreign currency translation within
accumulated other comprehensive loss will remain there until the net investment is disposed of. At January 28, 2006, the
amount recorded to foreign currency translation was not significant. In February 2006, the Company hedged a portion of its
net investment in its Canadian subsidiaries. The Company entered into a 10-year cross currency swap, creating a CAD $40 million
liability and a $35 million long-term asset. During the term of this transaction, the Company will remit to and receive from its
counterparty interest payments based on rates that are reset monthly equal to one-month CAD B.A. and one-month U.S. LIBOR
rates, respectively. The Company has designated this hedging instrument as a hedge of the net investment in a foreign
subsidiary, and will account for the hedge accordingly.
The fair value of foreign exchange derivative contracts designated as hedges was insignificant at both January 28,
2006 and January 29, 2005.
Foreign Exchange Risk Management — Derivative Holdings Designated as Non-Hedges
The Company mitigates the effect of fluctuating foreign exchange rates on the reporting of foreign currency
denominated earnings by entering into a variety of derivative instruments including option currency contracts. These
contracts are not designated as hedges and as a result, the changes in the fair value of these financial instruments are
charged to the statement of operations immediately. The Company recorded a net gain of approximately $3 million related
to foreign option currency contracts designated as non-hedges that settled in the second quarter of 2005.
The Company also enters into certain forward foreign exchange contracts to hedge intercompany foreign-currency
denominated transactions. In 2005, the Company recorded gains of approximately $3 million in selling, general and
administrative expenses to reflect the fair value of these contracts. These gains were offset by the foreign exchange losses
on the revaluation of the underlying assets or liabilities.
The fair value of foreign exchange derivative contracts designated as non-hedges was included as an addition to
accrued liabilities of $1 million at January 28, 2006 and $3 million at January 29, 2005.
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