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Investment in JJB Sports

6 Months Ended

Jul. 28, 2012

Investment in JJB Sports

Investment in JJB Sports

4. Investment in JJB Sports

On April 27, 2012, the Company invested an aggregate of £20 million in JJB Sports, plc (“JJB Sports”), consisting of junior secured convertible notes (“Convertible Notes”) in the principal amount of £18.75 million and 12.5 million ordinary shares of JJB Sports for £1.25 million, for a total cash outlay of $32.0 million. The Convertible Notes are convertible for ordinary shares of JJB Sports and will, if not converted earlier, mature on April 27, 2015. The Company classified its investments in JJB Sports as available-for-sale investments, which have been recorded at fair value. The investments were recorded within long-term other assets on the unaudited Consolidated Balance Sheet.

The Convertible Notes bear a variable interest rate of LIBOR plus a 5% margin, compounded monthly. The interest rate is equal to the interest rate of JJB Sports’ senior credit facility. Interest will accrue and be paid at maturity or will be converted into ordinary shares of JJB Sports upon conversion of the Convertible Notes. Unless previously purchased and cancelled, redeemed or converted, the Convertible Notes, and all accrued interest thereon, will be redeemed by JJB Sports on the maturity date.

The Company has the right to convert the Convertible Notes, and all accrued interest, in whole or in portions of no less than £5 million, at any time after April 27, 2013, into ordinary shares of JJB Sports. The Company also has the right to require JJB Sports to convert the Convertible Notes, and all accrued interest, in whole or portions of no less than £5 million, before April 27, 2013, or JJB Sports may redeem the Convertible Notes before the maturity date, in certain limited circumstances (including, for example, if JJB Sports suffers certain insolvency-related events, disposes of all or substantially all of its assets or business, if there occurs an event of default under the Convertible Loan Note Instrument, or a general takeover offer for JJB Sports’ ordinary shares is made). JJB Sports may require the Company to convert the Convertible Notes after January 26, 2014, and all accrued interest thereon, in whole or in portions of no less than £5 million in the event JJB Sports exceeds earnings before interest, taxes, depreciation and amortization of £25 million on a trailing 12-month basis.

The principal and accrued interest of the Convertible Notes will convert into a percentage of JJB Sports’ then outstanding share capital based on a conversion price of £0.067 per ordinary share for the aggregate principal amount to be converted and a conversion price of £0.10 per ordinary share for the accrued interest on the Convertible Notes to be converted.

The Convertible Notes are secured by a second ranking security over all of the assets of JJB Sports and certain subsidiaries. The rights of the Company in respect of the security are regulated pursuant to an intercreditor agreement entered into with JJB Sports’ senior lenders.

The Company has the right, but not the obligation, to subscribe, in one or more subscriptions for at least £5 million in principal, for up to £20 million in additional Convertible Notes (the “Second Convertible Notes”). The Second Convertible Notes would be subject to the same terms as the Convertible Notes and are generally convertible at the same terms as the Convertible Notes. The Company’s right to subscribe to the Second Convertible Notes expires on January 31, 2014.

Based upon macroeconomic factors and weather conditions impacting the United Kingdom as well as the financial performance of JJB Sports, subsequent to the date we funded our investment, the Company assessed its investment in JJB Sports for impairment during the fiscal quarter ended July 28, 2012. Declines in the fair value of available-for-sale debt securities below their cost that are deemed to be other-than-temporary are reflected in earnings as realized losses to the extent the impairment is related to credit losses. The amount of credit losses represents the difference between the present value of cash flows expected to be collected on such securities and the amortized cost. Based on the Company’s assessment, which contemplated probability weighted future expected cash flows and the credit quality of the underlying collateral, the Company recorded an other-than-temporary impairment charge of $30.4 million on the Convertible Notes during the 13 weeks ended July 28, 2012 within the unaudited Consolidated Statement of Income. Additionally, with consideration given to the aforementioned assessment, the Company recorded an other-than-temporary impairment charge of $2.0 million on its available-for-sale equity securities in JJB Sports stock during the 13 weeks ended July 28, 2012 within the unaudited Consolidated Statement of Income, fully impairing the carrying value of its investment as of July 28, 2012.

The Company’s initial fair value of its investment in the Convertible Notes was determined using a binomial lattice model with Level 2 inputs, including JJB Sports’ stock price, the expected stock price volatility, the interest rate on the Convertible Notes, the risk-free interest rate based upon appropriate government yield curves and option-adjusted spreads for comparable securities. Due to the use of discounted expected future cash flows to derive the fair value of the Convertible Notes, the Company has reclassified its investment as a Level 3 investment (see Note 5) during the current fiscal quarter.