FOOT LOCKER, INC. - Annual Report: 2017 (Form 10-K)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



  FORM 10-K 







Registrant’s telephone number, including area code: (212) 720-3700

   Securities registered pursuant to Section 12(b) of the Act:



Securities registered pursuant to Section 12(g) of the Act: None



Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes☒No  ☐ 



Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No☒



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 ☒   No ☐

 

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ 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 definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☒



Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.



Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No☒







DOCUMENTS INCORPORATED BY REFERENCE



Portions of the Registrant’s definitive Proxy Statement (the “Proxy Statement”) to be filed in connection with the Annual Meeting of Shareholders to be held on May 17, 2017: Parts III and IV.

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FOOT LOCKER, INC.

TABLE OF CONTENTS









 

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PART I



Item 1. Business



General



Foot Locker, Inc., incorporated under the laws of the State of New York in 1989, is a leading global retailer of athletically inspired shoes and apparel, operating 3,363 primarily mall-based stores, as well as stores in high-traffic urban retail areas and high streets, in the United States, Canada, Europe, Australia, and New Zealand as of January 28, 2017. Foot Locker, Inc. and its subsidiaries hereafter are referred to as the “Registrant,” “Company,” “we,” “our,” or “us.” Information regarding the business is contained under the “Business Overview” section in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”



The Company maintains a website on the Internet at www.footlocker-inc.com. The Company’s filings with the U.S. Securities and Exchange Commission (the “SEC”), including its annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports are available free of charge through this website as soon as reasonably practicable after they are filed with or furnished to the SEC by clicking on the “SEC Filings” link. The Corporate Governance section of the Company’s corporate website contains the Company’s Corporate Governance Guidelines, Committee Charters, and the Company’s Code of Business Conduct for directors, officers and employees, including the Chief Executive Officer, Chief Financial Officer, and Chief Accounting Officer. Copies of these documents may also be obtained free of charge upon written request to the Company’s Corporate Secretary at 330 West 34th Street, New York, N.Y. 10001.



Information Regarding Business Segments and Geographic Areas



The financial information concerning business segments, divisions, and geographic areas is contained under the “Business Overview” and “Segment Information” sections in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Information regarding sales, operating results, and identifiable assets of the Company by business segment and by geographic area is contained under the Segment Information note in “Item 8. Consolidated Financial Statements and Supplementary Data.”

The service marks, trade names, and trademarks appearing in this report (except for adidas and Nike) are owned by Foot Locker, Inc. or its subsidiaries.



Employees



The Company and its consolidated subsidiaries had 15,761 full-time and 34,407 part-time employees at January 28, 2017. The Company considers employee relations to be satisfactory.



Competition



Financial information concerning competition is contained under the “Business Risk” section in the Financial Instruments and Risk Management note in “Item 8. Consolidated Financial Statements and Supplementary Data.”



Merchandise Purchases



Financial information concerning merchandise purchases is contained under the “Liquidity” section in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and under the “Business Risk” section in the Financial Instruments and Risk Management note in “Item 8. Consolidated Financial Statements and Supplementary Data.”

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Item 1A. Risk Factors



The statements contained in this Annual Report on Form 10-K (“Annual Report”) that are not historical facts, including, but not limited to, statements regarding our expected financial position, business and financing plans found in “Item 1. Business” and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations,” constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995.



Please also see “Disclosure Regarding Forward-Looking Statements.” Our actual results may differ materially due to the risks and uncertainties discussed in this Annual Report, including those discussed below. Additional risks and uncertainties that we do not presently know about or that we currently consider to be insignificant may also affect our business operations and financial performance.



Our inability to implement our long-range strategic plan may adversely affect our future results.



Our ability to successfully implement and execute our long-range plan is dependent on many factors. Our strategies may require significant capital investment and management attention. Additionally, any new initiative is subject to certain risks including customer acceptance of our products and renovated store designs, competition, product differentiation, and the ability to attract and retain qualified personnel. If we cannot successfully execute our strategic growth initiatives or if the long-range plan does not adequately address the challenges or opportunities we face, our financial condition and results of operations may be adversely affected. Additionally, failure to meet shareholder expectations, particularly with respect to sales, operating margins, and earnings per share, would likely result in volatility in the market value of our stock.



The retail athletic footwear and apparel business is highly competitive.



Our athletic footwear and apparel operations compete primarily with athletic footwear specialty stores, sporting goods stores, department stores, discount stores, traditional shoe stores, mass merchandisers, and Internet retailers, many of which are units of national or regional chains that have significant financial and marketing resources. The principal competitive factors in our markets are selection of merchandise, customer service, reputation, store location, advertising, and price. We cannot assure that we will continue to be able to compete successfully against existing or future competitors. Our expansion into markets served by our competitors, and entry of new competitors or expansion of existing competitors into our markets, could have a material adverse effect on our business, financial condition, and results of operations.



Although we sell merchandise via the Internet, a significant shift in customer buying patterns to purchasing athletic footwear, athletic apparel, and sporting goods via the Internet could have a material adverse effect on our business results. In addition, all of our significant suppliers operate retail stores and distribute products directly through the Internet and others may follow. Should this continue to occur, and if our customers decide to purchase directly from our suppliers, it could have a material adverse effect on our business, financial condition, and results of operations.



The industry in which we operate is dependent upon fashion trends, customer preferences, product innovations, and other fashion-related factors.



The athletic footwear and apparel industry is subject to changing fashion trends and customer preferences. In addition, retailers in the athletic industry rely on their suppliers to maintain innovation in the products they develop. We cannot guarantee that our merchandise selection will accurately reflect customer preferences when it is offered for sale or that we will be able to identify and respond quickly to fashion changes, particularly given the long lead times for ordering much of our merchandise from suppliers. A substantial portion of our highest margin sales are to young males (ages 12–25), many of whom we believe purchase athletic footwear and athletic apparel as a fashion statement and are frequent purchasers. Our failure to anticipate, identify or react appropriately in a timely manner to changes in fashion trends that would make athletic footwear or athletic apparel less attractive to our customers could have a material adverse effect on our business, financial condition, and results of operations.

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If we do not successfully manage our inventory levels, our operating results will be adversely affected.



We must maintain sufficient inventory levels to operate our business successfully. However, we also must guard against accumulating excess inventory. For example, we order most of our athletic footwear four to six months prior to delivery to our stores. If we fail to anticipate accurately either the market for the merchandise in our stores or our customers’ purchasing habits, we may be forced to rely on markdowns or promotional sales to dispose of excess or slow moving inventory, which could have a material adverse effect on our business, financial condition, and results of operations.



A change in the relationship with any of our key suppliers or the unavailability of key products at competitive prices could affect our financial health.



Our business is dependent to a significant degree upon our ability to obtain exclusive product and the ability to purchase brand-name merchandise at competitive prices from a limited number of suppliers. In addition, our suppliers provide volume discounts, cooperative advertising, and markdown allowances, as well as the ability to negotiate cancellations and returns of excess or unneeded merchandise. We cannot be certain that such terms with our suppliers will continue in the future.



We purchased approximately 91 percent of our merchandise in 2016 from our top five suppliers and we expect to continue to obtain a significant percentage of our athletic product from these suppliers in future periods. Approximately 68 percent of all merchandise purchased in 2016 was purchased from one supplier — Nike, Inc. (“Nike”). Each of our operating divisions is highly dependent on Nike: they individually purchased 48 to 76 percent of their merchandise from Nike. Merchandise that is high profile and in high demand is allocated by our suppliers based upon their internal criteria. Although we have generally been able to purchase sufficient quantities of this merchandise in the past, we cannot be certain that our suppliers will continue to allocate sufficient amounts of such merchandise to us in the future. Our inability to obtain merchandise in a timely manner from major suppliers as a result of business decisions by our suppliers or any disruption in the supply chain could have a material adverse effect on our business, financial condition, and results of operations. Because of the high proportion of purchases from Nike, any adverse development in Nike’s reputation, financial condition or results of operations or the inability of Nike to develop and manufacture products that appeal to our target customers could also have an adverse effect on our business, financial condition, and results of operations. We cannot be certain that we will be able to acquire merchandise at competitive prices or on competitive terms in the future. These risks could have a material adverse effect on our business, financial condition, and results of operations.



We are affected by mall traffic and our ability to secure suitable store locations.



Many of our stores, especially in North America, are located primarily in enclosed regional and neighborhood malls. Our sales are affected, in part, by the volume of mall traffic. Mall traffic may be adversely affected by, among other factors, economic downturns, the closing or continued decline of anchor department stores and/or specialty stores, and a decline in the popularity of mall shopping among our target customers. Further, any terrorist act, natural disaster, public health or safety concern that decreases the level of mall traffic, or that affects our ability to open and operate stores in such locations, could have a material adverse effect on our business.



To take advantage of customer traffic and the shopping preferences of our customers, we need to maintain or acquire stores in desirable locations such as in regional and neighborhood malls anchored by major department stores,  as well as high-traffic urban retail areas and high streets. We cannot be certain that desirable mall locations will continue to be available at favorable rates. Some traditional enclosed malls are experiencing significantly lower levels of customer traffic, driven by economic conditions as well as the closure of certain mall anchor tenants.



Several large landlords dominate the ownership of prime malls, particularly in the United States, Canada, and Australia, and because of our dependence upon these landlords for a substantial number of our locations, any significant erosion of their financial condition or our relationships with these landlords would negatively affect our ability to obtain and retain store locations. Additionally, further landlord consolidation may negatively affect our ability to negotiate favorable lease terms.

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We may experience fluctuations in, and cyclicality of, our comparable-store sales results.



Our comparable-store sales have fluctuated significantly in the past, on both an annual and a quarterly basis, and we expect them to continue to fluctuate in the future. A variety of factors affect our comparable-store sales results, including, among others, fashion trends, product innovation, promotional events, the highly competitive retail sales environment, economic conditions, timing of income tax refunds, changes in our merchandise mix, calendar shifts of holiday periods, supply chain disruptions, and weather conditions. Many of our products represent discretionary purchases. Accordingly, customer demand for these products could decline in an economic downturn or if our customers develop other priorities for their discretionary spending. These risks could have a material adverse effect on our business, financial condition, and results of operations.



Economic or political conditions in other countries, including fluctuations in foreign currency exchange rates and tax rates may adversely affect our operations.



A significant portion of our sales and operating income for 2016 was attributable to our operations in Europe, Canada, Australia, and New Zealand. As a result, our business is subject to the risks associated with doing business outside of the United States such as local customer product preferences, political unrest, disruptions or delays in shipments, changes in economic conditions in countries in which we operate, foreign currency fluctuations, real estate costs, and labor and employment practices in non-U.S. jurisdictions that may differ significantly from those that prevail in the United States. In addition, because our suppliers manufacture a substantial amount of our products in foreign countries, our ability to obtain sufficient quantities of merchandise on favorable terms may be affected by governmental regulations, trade restrictions, labor, and other conditions in the countries from which our suppliers obtain their product.



Fluctuations in the value of the euro and the British Pound may affect the value of our European earnings when translated into U.S. dollars. Similarly our earnings in Canada, Australia, and New Zealand may be affected by the value of currencies when translated into U.S. dollars. Our international subsidiaries conduct most of their business in their local currency, other than in the U.K., whose inventory purchases are denominated in euros, which could result in foreign currency transaction gains or losses. 



Our products are subject to import and excise duties and/or sales or value-added taxes in many jurisdictions. Fluctuations in tax rates and duties and changes in tax legislation or regulation could have a material adverse effect on our results of operations and financial condition.



The United Kingdom electorate voted to exit the European Union in a referendum, which could adversely affect our business, results of operations and financial condition.



On June 23, 2016, the United Kingdom (the “U.K.”) held a referendum in which voters approved an exit from the European Union (“E.U.”), commonly referred to as “Brexit.” The referendum is non-binding; however, it is expected to be passed into law, after which negotiations will commence to determine the future terms of the U.K.’s relationship with the E.U. The effect on our business from Brexit will depend, in part, on the outcome of tariff, trade, regulatory, and other negotiations. Volatility in currency exchange rates resulting from Brexit is expected to continue in the short term as the U.K. negotiates its exit from the E.U. In addition, Brexit could lead to legal uncertainty and potentially divergent national laws and regulations as the U.K. determines which E.U. laws to replace or replicate, and those laws and regulations may be cumbersome, difficult or costly in terms of compliance. Any of these effects of Brexit, among others, could adversely affect our business, results of operations and financial condition. 



Macroeconomic developments may adversely affect our business.  



Our performance is subject to global economic conditions and the related impact on consumer spending levels. Continued uncertainty about global economic conditions poses a risk as consumers and businesses may postpone spending in response to tighter credit, unemployment, negative financial news, and/or declines in income or asset values, which could have a material negative effect on demand for our products.



As a retailer that is dependent upon consumer discretionary spending, our results of operations are sensitive to changes in macroeconomic conditions. Our customers may have less money for discretionary purchases as a result of job losses, foreclosures, bankruptcies, increased fuel and energy costs, higher interest rates, higher taxes, reduced access to credit, and lower home values. These and other economic factors could adversely affect demand for our products, which could adversely affect our financial condition and operating results.



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Instability in the financial markets may adversely affect our business.



Instability in the global financial markets could reduce availability of credit to our business. Although we currently have a revolving credit agreement in place until May 19, 2021 and, other than amounts used for standby letters of credit, we do not have any borrowings under it, tightening of credit markets could make it more difficult for us to access funds, refinance our existing indebtedness, enter into agreements for new indebtedness, or obtain funding through the issuance of the Company’s securities. 



We rely on a few key suppliers for a majority of our merchandise purchases (including a significant portion from one key supplier). The inability of these key suppliers to access liquidity, or the insolvency of key suppliers, could lead to their failure to deliver merchandise to us. Our inability to obtain merchandise in a timely manner from major suppliers could have a material adverse effect on our business, financial condition, and results of operations.



Material changes in the market value of the securities we hold may adversely affect our results of operations and financial condition.



At January 28, 2017, our cash and cash equivalents totaled $1,046 million. The majority of our investments were short-term deposits in highly-rated banking institutions. As of January 28, 2017, $730 million of our cash and cash equivalents were held in foreign jurisdictions. We regularly monitor our counterparty credit risk and mitigate our exposure by making short-term investments only in highly-rated institutions and by limiting the amount we invest in any one institution. We continually monitor the creditworthiness of our counterparties. At January 28, 2017, all of the investments were in investment grade institutions. Despite an investment grade rating, it is possible that the value or liquidity of our investments may decline due to any number of factors, including general market conditions and bank-specific credit issues.



Our U.S. pension plan trust holds assets totaling $589 million at January 28, 2017. The fair values of these assets held in the trust are compared to the plan’s projected benefit obligation to determine the pension funding liability. We attempt to mitigate funding risk through asset diversification, and we regularly monitor investment risk of our portfolio through quarterly investment portfolio reviews and periodic asset and liability studies. Despite these measures, it is possible that the value of our portfolio may decline in the future due to any number of factors, including general market conditions and credit issues. Such declines could have an impact on the funded status of our pension plan and future funding requirements.



If our long-lived assets, goodwill or other intangible assets become impaired, we may need to record significant non-cash impairment charges.



We review our long-lived assets, goodwill and other intangible assets when events indicate that the carrying value of such assets may be impaired. Goodwill and other indefinite lived intangible assets are reviewed for impairment if impairment indicators arise and, at a minimum, annually. As of January 28, 2017, we had $155 million of goodwill; this asset is not amortized but is subject to an impairment test, which consists of either a qualitative assessment on a reporting unit level, or a two-step impairment test, if necessary. The determination of impairment charges is significantly affected by estimates of future operating cash flows and estimates of fair value. Our estimates of future operating cash flows are identified from our long-range strategic plans, which are based upon our experience, knowledge, and expectations; however, these estimates can be affected by factors such as our future operating results, future store profitability, and future economic conditions, all of which can be difficult to predict accurately. Any significant deterioration in macroeconomic conditions could affect the fair value of our long-lived assets, goodwill, and other intangible assets and could result in future impairment charges, which would adversely affect our results of operations.



Our financial results may be adversely affected by tax rates or exposure to additional tax liabilities.



We are a U.S.-based multinational company subject to tax in multiple U.S. and foreign tax jurisdictions. Our provision for income taxes is based on a jurisdictional mix of earnings, statutory rates, and enacted tax rules, including transfer pricing. Significant judgment is required in determining our provision for income taxes and in evaluating our tax positions on a worldwide basis. Our effective tax rate could be adversely affected by a number of factors, including shifts in the mix of pretax results by tax jurisdiction, changes in tax laws or related interpretations in the jurisdictions in which we operate, and tax assessments and related interest and penalties resulting from income tax audits.



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A substantial portion of our cash and investments is invested outside of the United States.  In accordance with U.S. GAAP, we have not provided for U.S. federal and state income taxes or foreign withholding taxes that may result from potential future remittances of undistributed earnings of foreign subsidiaries because we plan to permanently reinvest our foreign earnings. Our effective tax rate could be adversely affected if our plans change and all or a portion of our foreign earnings were no longer considered to be permanently reinvested.



Changes in tax laws could materially affect our financial position and results of operations



The current administration and Congress have made public statements regarding their plans to make substantial changes in the taxation of U.S. companies and their foreign operations, including the possible implementation of a border adjustment tax; tariffs or increases in custom duties on products manufactured outside of and imported into the U.S.; taxation of unremitted foreign earnings; corporate tax rate reductions; and the renegotiation of U.S. trade agreements. Due to economic and political conditions, tax rates and policies in the U.S. or internationally may be subject to significant change. Moreover, there has been an increase in attention to the tax practices of multinational companies, including the issuance of a series of action items by the Organization for Economic Cooperation and Development with respect to base erosion and profit shifting. This attention has, and is likely to continue to result in legislative changes that could adversely affect our tax rate. Any changes in the taxation of our business activities may impact our worldwide effective tax rate, our financial position, and results of operations.



The effects of natural disasters, terrorism, acts of war, and public health issues may adversely affect our business.



Natural disasters, including earthquakes, hurricanes, floods, and tornadoes may affect store and distribution center operations. In addition, acts of terrorism, acts of war, and military action both in the United States and abroad can have a significant effect on economic conditions and may negatively affect our ability to purchase merchandise from suppliers for sale to our customers. Public health issues, such as flu or other pandemics, whether occurring in the United States or abroad, could disrupt our operations and result in a significant part of our workforce being unable to operate or maintain our infrastructure or perform other tasks necessary to conduct our business. Additionally, public health issues may disrupt, or have an adverse effect on, our suppliers’ operations, our operations, our customers, or customer demand. Our ability to mitigate the adverse impact of these events depends, in part, upon the effectiveness of our disaster preparedness and response planning as well as business continuity planning. However, we cannot be certain that our plans will be adequate or implemented properly in the event of an actual disaster. We may be required to suspend operations in some or all of our locations, which could have a material adverse effect on our business, financial condition, and results of operations. Any significant declines in public safety or uncertainties regarding future economic prospects that affect customer spending habits could have a material adverse effect on customer purchases of our products.



Manufacturer compliance with our social compliance program requirements.



We require our independent manufacturers to comply with our policies and procedures, which cover many areas including labor, health and safety, and environmental standards. We monitor compliance with our policies and procedures using internal resources, as well as third-party monitoring firms. Although we monitor their compliance with these policies and procedures, we do not control the manufacturers or their practices. Any failure of our independent manufacturers to comply with our policies and procedures or local laws in the country of manufacture could disrupt the shipment of merchandise to us, force us to locate alternate manufacturing sources, reduce demand for our merchandise, or damage our reputation.



Complications in our distribution centers and other factors affecting the distribution of merchandise may affect our business.



We operate multiple distribution centers worldwide to support our businesses. In addition to the distribution centers that we operate, we have third-party arrangements to support our operations in the United States, Canada, Australia, and New Zealand. If complications arise with any facility or if any facility is severely damaged or destroyed, our other distribution centers may be unable to support the resulting additional distribution demands. We also may be affected by disruptions in the global transportation network such as port strikes, weather conditions, work stoppages or other labor unrest. These factors may adversely affect our ability to deliver inventory on a timely basis. We depend upon third-party carriers for shipment of merchandise;   any interruption in service by these carriers for any reason could cause disruptions in our business, a loss of sales and profits, and other material adverse effects.



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We are subject to technology risks including failures, security breaches, and cybersecurity risks which could harm our business, damage our reputation, and increase our costs in an effort to protect against such risks.



Information technology is a critically important part of our business operations. We depend on information systems to process transactions, make operational decisions, manage inventory, operate our websites, purchase, sell and ship goods on a timely basis, and maintain cost-efficient operations. There is a risk that we could experience a business interruption, theft of information, or reputational damage as a result of a cyber-attack, such as an infiltration of a data center or data leakage of confidential information, either internally or at our third-party providers. We may experience operational problems with our information systems as a result of system failures, system implementation issues, viruses, malicious hackers, sabotage, or other causes.



Our business involves the storage and transmission of customers’ personal information, including consumer preferences and certain credit card information. In an effort to enhance the security of our customers’ credit card information, during 2015 we implemented an encryption and tokenization platform for most domestic credit card transactions, whereby no credit card data is stored in our internal systems, and we plan to expand this platform to the entire company. We invest in security technology to protect the data stored by us, including our data and business processes, against the risk of data security breaches and cyber-attacks. Our data security management program includes enforcement of standard data protection policies such as Payment Card Industry compliance. Additionally, we certify our major technology suppliers and any outsourced services through accepted security certification measures. We maintain and routinely test backup systems and disaster recovery, along with external network security penetration testing by an independent third party as part of our business continuity preparedness.



While we believe that our security technology and processes follow leading practices in the prevention of security breaches and the mitigation of cybersecurity risks, given the ever-increasing abilities of those intent on breaching cybersecurity measures and given the necessity of our reliance on the security procedures of third-party vendors, the total security effort at any point in time may not be completely effective. Any such security breaches and cyber incidents could adversely affect our business. Failure of our systems, including failures due to cyber-attacks that would prevent the ability of systems to function as intended, could cause transaction errors, loss of customers and sales, and negative consequences to us, our employees, and those with whom we do business. Any security breach involving the misappropriation, loss, or other unauthorized disclosure of confidential information by us could also severely damage our reputation, expose us to the risks of litigation and liability, increase operating costs associated with remediation, and harm our business. While we carry insurance that would mitigate the losses, such insurance may be insufficient to compensate us for potentially significant losses.



Risks associated with digital operations.



Our digital operations are subject to numerous risks, including risks related to the failure of the computer systems that operate our websites and mobile sites and their related support systems, computer viruses, telecommunications failures, denial of service attacks, and similar disruptions. Also, we will require additional capital in the future to sustain or grow our digital commerce. Business risks related to digital commerce include risks associated with the need to keep pace with rapid technological change, Internet cybersecurity risks, risks of system failure or inadequacy, governmental regulation, and legal uncertainties with respect to Internet regulatory compliance. If any of these risks materialize, it could have a material adverse effect on our business.



The technology enablement of omni-channel in our business is complex and involves the development of a new digital platform and a new order management system in order to enhance the complete customer experience.



We continue to invest in initiatives designed to deliver a high-quality, coordinated shopping experience online, in-stores, and on mobile devices, which requires substantial investment in technology, information systems, employee training,  as well as significant management time and resources. Our omni-channel retailing efforts include the integration and implementation of new technology, software and processes to be able to fulfill orders from any point within our system of stores and distribution centers, which is extremely complex and may not meet customer expectations for timely and accurate deliveries. These efforts involve substantial risk, including risk of implementation delays, cost overruns, technology interruptions, supply and distribution delays, and other issues that can affect the successful implementation and operation of our omni-channel initiatives. If our omni-channel initiatives are not successful, or we do not realize the return on our omni-channel investments that we anticipate, our financial performance and future growth could be materially adversely affected.

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Our reliance on key management.



Future performance will depend upon our ability to attract, retain, and motivate our executive and senior management teams. Our executive and senior management teams have substantial experience and expertise in our business and have made significant contributions to our success. Our future performance depends to a significant extent both upon the continued services of our current executive and senior management teams, as well as our ability to attract, hire, motivate, and retain additional qualified management in the future. While we feel that we have adequate succession planning and executive development programs, competition for key executives in the retail industry is intense, and our operations could be adversely affected if we cannot retain and attract qualified executives.



Risks associated with attracting and retaining store and field associates.



Our success depends, in part, upon our ability to attract, develop, and retain a sufficient number of qualified store and field associates. The turnover rate in the retail industry is generally high. If we are unable to attract and retain quality associates, our ability to meet our growth goals or to sustain expected levels of profitability may be compromised. Our ability to meet our labor needs while controlling costs is subject to external factors such as unemployment levels, prevailing wage rates, minimum wage legislation, overtime regulations, and changing demographics.



Changes in employment laws or regulation could harm our performance.



Various foreign and domestic labor laws govern our relationship with our employees and affect our operating costs. These laws include minimum wage requirements, overtime and sick pay, paid time off, work scheduling, healthcare reform and the Patient Protection and Affordable Care Act (“ACA”), unemployment tax rates, workers’ compensation rates, European works council requirements, and union organization. A number of factors could adversely affect our operating results, including additional government-imposed increases in minimum wages, overtime and sick pay, paid leaves of absence and mandated health benefits, and changing regulations from the National Labor Relations Board or other agencies. Additionally, recent changes in the leadership of the U.S. government could lead to repeal of, or changes, in some or all of the ACA; complying with any new legislation and/or reversing changes implemented under the ACA could be time-intensive and expensive, and may affect our business.



Legislative or regulatory initiatives related to global warming/climate change concerns may negatively affect our business.



There has been an increasing focus and significant debate on global climate change, including increased attention from regulatory agencies and legislative bodies. This increased focus may lead to new initiatives directed at regulating an as-yet unspecified array of environmental matters. Legislative, regulatory, or other efforts in the United States to combat climate change could result in future increases in taxes or in the cost of transportation and utilities, which could decrease our operating profits and could necessitate future additional investments in facilities and equipment. We are currently unable to predict the potential effects that any such future environmental initiatives may have on our business.



We may be adversely affected by regulatory and litigation developments.



We are exposed to the risk that federal or state legislation may negatively impact our operations. Changes in federal or state wage requirements, employee rights, health care, social welfare or entitlement programs, such as health insurance, paid leave programs, or other changes in workplace regulation could increase our cost of doing business or otherwise adversely affect our operations. Additionally, we are regularly involved in various litigation matters, including class actions and patent infringement claims, which arise in the ordinary course of our business. Litigation or regulatory developments could adversely affect our business operations and financial performance.



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We operate in many different jurisdictions and we could be adversely affected by violations of the U.S. Foreign Corrupt Practices Act and similar worldwide anti-corruption laws.



The U.S. Foreign Corrupt Practices Act (“FCPA”) and similar worldwide anti-corruption laws, including the U.K. Bribery Act of 2010, which is broader in scope than the FCPA, generally prohibit companies and their intermediaries from making improper payments to government officials for the purpose of obtaining or retaining business.



Our internal policies mandate compliance with these anti-corruption laws. Despite our training and compliance programs, we cannot be assured that our internal control policies and procedures will always protect us from reckless or criminal acts committed by our employees or agents. Our continued expansion outside the United States, including in developing countries, could increase the risk of FCPA violations in the future. Violations of these laws, or allegations of such violations, could result in a material adverse effect on our results of operations or financial condition.



Failure to fully comply with Section 404 of the Sarbanes-Oxley Act of 2002 could negatively affect our business, market confidence in our reported financial information, and the price of our common stock.



We continue to document, test, and monitor our internal controls over financial reporting in order to satisfy all of the requirements of Section 404 of the Sarbanes-Oxley Act of 2002; however, we cannot be assured that our disclosure controls and procedures and our internal controls over financial reporting will prove to be completely adequate in the future. Failure to fully comply with Section 404 of the Sarbanes-Oxley Act of 2002 could negatively affect our business, market confidence in our reported financial information, and the price of our common stock.



Item 1B. Unresolved Staff Comments



None.



Item 2. Properties



The properties of the Company and its consolidated subsidiaries consist of land, leased stores, administrative facilities, and distribution centers. Gross square footage and total selling area for the Athletic Stores segment at the end of 2016 were approximately 13.12 and 7.63 million square feet, respectively. These properties, which are primarily leased, are located in the United States and its territories, Canada, various European countries, Australia, and New Zealand.



We currently operate five distribution centers, of which two are owned and three are leased, occupying an aggregate of 2.9 million square feet. Three distribution centers are located in the United States, one in Germany, and one in the Netherlands. The location in Germany serves as the central warehouse distribution center for the Runners Point and Sidestep stores and their direct-to-customer business. We also own a cross-dock and manufacturing facility, and operate a leased warehouse in the United States, both of which support our Team Edition apparel business. The lease on our Wisconsin distribution center expires in April 2018. Additionally, our leased distribution centers in Germany and the Netherlands expire during 2019.



We believe that all leases of properties that are material to our operations may be renewed, or that alternative properties are available, on terms not materially less favorable to us than existing leases.



Item 3. Legal Proceedings



Information regarding the Company’s legal proceedings is contained in the Legal Proceedings note under “Item 8. Consolidated Financial Statements and Supplementary Data.”



Item 4. Mine Safety Disclosures



Not applicable.



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Item 4A.  Executive Officers of the Registrant



The following table provides information with respect to all persons serving as executive officers as of March 23, 2017, including business experience for the last five years.





Richard A. Johnson, age 59, has served as Chairman of the Board since May 18, 2016 and President and Chief Executive Officer since December 1, 2014. Mr. Johnson previously served as Executive Vice President and Chief Operating Officer from May 16, 2012 through November 30, 2014. He served as Executive Vice President and Group President from July 2011 to May 15, 2012; President and Chief Executive Officer of Foot Locker U.S., Lady Foot Locker, Kids Foot Locker, and Footaction from January 2010 to July 2011; President and Chief Executive Officer of Foot Locker Europe from August 2007 to January 2010; and President and Chief Executive Officer of Footlocker.com/Eastbay from April 2003 to August 2007.



Stephen D. Jacobs, age 54, has served as Executive Vice President and Chief Executive Officer-North America since February 29, 2016. Mr. Jacobs has been with the Company for 18 years in positions of increasing responsibility. He previously served as Executive Vice President and Chief Executive Officer Foot Locker North America from December 1, 2014 through February 28, 2016. He served as President and Chief Executive Officer of Foot Locker U.S., Lady Foot Locker, Kids Foot Locker, and Footaction from July 2011 to November 2014 and President and Chief Executive Officer of Champs Sports from January 2009 to June 2011. 



Lewis P. Kimble, age 58, has served as Executive Vice President and Chief Executive Officer-International since February 29, 2016. Mr. Kimble previously served as President and Chief Executive Officer of Foot Locker Europe from February 1, 2010 to February 28, 2016. Prior to that role Mr. Kimble led our business in Australia and New Zealand as Managing Director of Foot Locker Asia Pacific. Over his 40 years with the Company, Mr. Kimble has also held Vice President positions across multiple functions within the United States and Europe.



Lauren B. Peters, age 55, has served as Executive Vice President and Chief Financial Officer since July 2011.



Paulette R. Alviti, age 46, has served as Senior Vice President and Chief Human Resources Officer since June 2013. From March 2010 to May 2013, Ms. Alviti served in various roles at PepsiCo, Inc.: SVP and Chief Human Resources Officer Asia, Middle East, Africa (February to May 2013); SVP Global Talent Acquisition and Deployment (July 2012 to February 2013); and SVP — Human Resources (March 2010 to July 2012).



Giovanna Cipriano, age 47, has served as Senior Vice President and Chief Accounting Officer since May 2009.



Sheilagh M. Clarke, age 57, has served as Senior Vice President, General Counsel and Secretary since June 1, 2014. She previously served as Vice President, Associate General Counsel and Assistant Secretary from May 2007 to May 2014.



W. Scott Martin, age 49, has served as Senior Vice President — Real Estate since June 13, 2016. Mr. Martin previously served as Vice President, Store Development – Asia Pacific with Gap Inc. from June 2014 to June 2016. Prior to that role, he served in various roles at Starbucks Coffee Company: Director, Strategy Development, China, Asia Pacific and Emerging Brands (July 2013 to July 2014); Director, Global Store Development (June 2007 to July 2013).



Pawan Verma, age 40, has served as Senior Vice President and Chief Information Officer since August 10, 2015. From February 2013 to July 2015, Mr. Verma served in various technology leadership roles at Target Corporation ranging from enterprise architecture, ecommerce, mobile and digital, with his most recent role at Target as Vice President-Digital Technology and API Platforms. From March 2011 to January 2013, he served as Sr. Director, eCommerce, Digital and Mobile of Convergys Corporation.



John A. Maurer, age 57, has served as Vice President, Treasurer and Investor Relations since February 2011.



There are no family relationships among the executive officers or directors of the Company.

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PART II





Foot Locker, Inc. common stock (ticker symbol “FL”) is listed on The New York Stock Exchange as well as on the Börse Stuttgart stock exchange in Germany. As of January 28, 2017, the Company had 13,717 shareholders of record owning 131,495,621 common shares.



The following table provides the intra-day high and low sales prices for the Company’s common stock for the periods indicated below:





During each of the quarters of 2016, the Company declared a dividend of $0.275 per share. The Board of Directors reviews the dividend policy and rate, taking into consideration the overall financial and strategic outlook for our earnings, liquidity, and cash flow. On February 14, 2017, the Board of Directors declared a quarterly dividend of $0.31 per share to be paid on April 28, 2017. This dividend represents a 13 percent increase over the previous quarterly per share amount.



The following table is a summary of our fourth quarter share repurchases:







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Performance Graph



The graph below compares the cumulative five-year total return to shareholders (common stock price appreciation plus dividends, on a reinvested basis) on Foot Locker, Inc.’s common stock relative to the total returns of the S&P 500 Specialty Retailing Index and the S&P 500 Index. During 2016 Foot Locker, Inc. was chosen for inclusion in the S&P 500 Index. As a result, we have updated our peer group to reflect this change. For comparative purposes, we have also included our previous year peers, the S&P 400 Retailing Index and the Russell Midcap Index, in the performance graph below.



The following Performance Graph and related information shall not be deemed “soliciting material” or deemed to be filed with the SEC, nor shall such information be incorporated by reference into any future filing under the Securities Act of 1933 or Securities Exchange Act of 1934, each as amended, except to the extent that we specifically incorporate it by reference into such filing.











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Item 6. Selected Financial Data



FIVE-YEAR SUMMARY OF SELECTED FINANCIAL DATA



The selected financial data below should be read in conjunction with the Consolidated Financial Statements and the Notes thereto and other information contained elsewhere in this report.









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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations



Business Overview



Foot Locker, Inc., through its subsidiaries, operates in two reportable segments — Athletic Stores and Direct-to-Customers. The Athletic Stores segment is one of the largest athletic footwear and apparel retailers in the world, with formats that include Foot Locker, Kids Foot Locker, Lady Foot Locker, Champs Sports, Footaction, Runners Point, Sidestep, and SIX:02. The Direct-to-Customers segment includes Footlocker.com, Inc. and other affiliates, including Eastbay, Inc., and our international ecommerce businesses, which sell to customers through their Internet and mobile sites and catalogs.



The Foot Locker brand is one of the most widely recognized names in the markets in which we operate, epitomizing premium quality for the active lifestyle customer. This brand equity has aided our ability to successfully develop and increase our portfolio of complementary retail store formats, such as Lady Foot Locker and Kids Foot Locker, as well as Footlocker.com, its direct-to-customer business. Through various marketing channels and experiences, including social, digital, broadcast, and print media,  as well as various sports sponsorships and events, we reinforce our image with a consistent message — namely, that we are the destination for athletically inspired shoes and apparel with a wide selection of merchandise in a full-service environment.



Store Profile





Athletic Stores



We operated 3,363 stores in the Athletic Stores segment as of the end of 2016. The following is a brief description of the Athletic Stores segment’s operating businesses and their respective taglines:



Foot Locker — “Approved” — Foot Locker is a leading global athletic footwear and apparel retailer, which caters to the sneaker aficionado — If it’s at Foot Locker, it’s Approved.  These stores offer the latest in athletically-inspired footwear and apparel, manufactured primarily by the leading athletic brands. Foot Locker provides the best selection of premium and limited products that supports the global sneaker culture. Additionally, we operate 217 House of Hoops shops,  which sell premier basketball-inspired footwear and apparel from Nike and Jordan; 15 Puma Labs, selling Puma’s most creative and limited footwear and apparel styles, and 1 adidas Foundation, offering the freshest assortment of both adidas performance and Originals product. Foot Locker’s 1,784 stores are located in 23 countries including 948 in the United States, Puerto Rico, U.S. Virgin Islands, and Guam, 119 in Canada, 622 in Europe, and a combined 95 in Australia and New Zealand. Our domestic stores have an average of 2,600 selling square feet and our international stores have an average of 1,600 selling square feet.





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Kids Foot Locker — “Go Big” — Kids Foot Locker offers the largest selection of brand-name athletic footwear, apparel and accessories for young children. Its stores feature an environment geared to appeal to both parents and children. Of its 411 stores, 370 are located in the United States, Puerto Rico, and the U.S. Virgin Islands, 29 in Europe, and 12 in Canada. These stores have an average of 1,700 selling square feet.



Lady Foot Locker —“Leading Sneaker Culture for Her” — Lady Foot Locker is a U.S. retailer of athletic footwear, apparel, and accessories dedicated to sneaker-obsessed young women. Our stores provide premium sneakers and apparel, carefully selected to reflect the latest styles. Lady Foot Locker operates 124 stores that are located in the United States and Puerto Rico. These stores have an average of 1,300 selling square feet. 



Champs Sports — “We Know Game” — Champs Sports is one of the largest mall-based specialty athletic footwear and apparel retailers in North America. With a focus on the lifestyle expression of sport, Champs Sports’ product categories include athletic footwear and apparel, and sport-lifestyle inspired accessories. This assortment allows Champs Sports to offer the best head-to-toe fashion stories representing the most powerful athletic brands, sports teams, and athletes in North America. Of its 545 stores, 516 are located throughout the United States, Puerto Rico, and the U.S. Virgin Islands and 29 in Canada. The Champs Sports stores have an average of 3,500 selling square feet.



Footaction — “Own It” — Footaction is a national athletic footwear and apparel retailer that offers the freshest, best edited selection of athletic lifestyle brands and looks. This banner is uniquely positioned at the intersection of sport and style. The primary customer is a style-obsessed, confident, influential young male who is always dressed to impress. Its 261 stores are located throughout the United States and Puerto Rico and focus on authentic, premium product. The Footaction stores have an average of 3,000 selling square feet.



Runners Point — “Your Way, Our Passion” — Runners Point specializes in running footwear, apparel, and equipment for performance and lifestyle purposes. Its 122 stores are located in Germany, Austria, and Switzerland. This banner caters to local running communities providing technical products, training tips and access to local running and group events, while also serving their lifestyle running needs. Runners Point stores have an average of 1,300 selling square feet. 



Sidestep — “Sneaker Lifestyle” —  Sidestep is a predominantly athletic fashion footwear banner. Its 86 stores are located in Germany, Austria, the Netherlands, and Switzerland. Sidestep caters to a more discerning, fashion forward consumer. Sidestep stores have an average of 900 selling square feet.



SIX:02 —“It’s Your Time”  — SIX:02 is an elevated retail concept designed for the modern woman, featuring top brands in athletic-inspired style. The apparel, footwear, and accessory assortments are carefully curated to provide a unique athletic fashion point of view, fusing performance and casual style. This banner leverages top celebrity and social influencers to connect meaningfully to all aspects of a woman’s life. SIX:02 operates 30 stores in the United States and have an average of 2,000 selling square feet.



Direct-to-Customers



Our Direct-to-Customers segment is multi-branded and sells directly to customers through Internet and mobile sites and catalogs. The Direct-to-Customers segment operates the websites for eastbay.com, final-score.com, eastbayteamsales.com, and sp24.com. Additionally, this segment includes the websites, both desktop and mobile, aligned with the brand names of our store banners (footlocker.com, ladyfootlocker.com, six02.com kidsfootlocker.com, champssports.com, footaction.com, footlocker.ca, footlocker.eu, runnerspoint.com, and sidestep-shoes.com). These sites offer some of the largest online selections of athletically inspired shoes and apparel, while providing a seamless link between ecommerce and physical stores. 



Eastbay — “First Choice For Athletes”  — Eastbay is among the largest direct marketers in the United States, providing serious high school and other athletes with a complete sports solution including athletic footwear, apparel, equipment, and team licensed merchandise for a broad range of sports.



Franchise Operations



The Company has two separate ten-year agreements with third parties for the operation of Foot Locker stores located within the Middle East and the Republic of Korea. Additionally, we operate franchised stores in Germany under the Runners Point banner. A total of 74 franchised stores were operating at January 28, 2017, of which 54 were operating in the Middle East, 15 in Germany, and 5 in the Republic of Korea.

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Reconciliation of Non-GAAP Measures



In the following tables, we have presented certain financial measures and ratios identified as non-GAAP such as Earnings Before Interest and Taxes (“EBIT”), adjusted EBIT, adjusted EBIT margin, adjusted income before income taxes, adjusted net income, adjusted net income margin, adjusted diluted earnings per share, Return on Invested Capital (“ROIC”), free cash flow, and net debt capitalization. Additionally, we present certain amounts as excluding the effects of foreign currency fluctuations, which are also considered non-GAAP measures. Throughout the following discussions, where amounts are expressed as excluding the effects of foreign currency fluctuations, such changes are determined by translating all amounts in both years using the prior-year average foreign exchange rates.



We present these non-GAAP measures because we believe they assist investors in comparing our performance across reporting periods on a consistent basis by excluding items that we do not believe are indicative of our core business or which affect comparability. Presenting amounts on a constant currency basis is useful to investors because it enables them to better understand the changes in our businesses that are not related to currency movements. In addition, these non-GAAP measures are useful in assessing our progress in achieving our long-term financial objectives.



The non-GAAP financial information is provided in addition to, and not as an alternative to, our reported results prepared in accordance with GAAP. We estimate the tax effect of the non-GAAP adjustments by applying its marginal rate to each of the respective items. The income tax items represent the discrete amount.



Presented below is a reconciliation of GAAP and non-GAAP results discussed throughout this Annual Report on Form 10-K. Please see the non-GAAP reconciliations for free cash flow and net debt capitalization in the “Liquidity and Capital Resources” section.

 



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ROIC is presented below and represents a non-GAAP measure. We believe it is a meaningful measure because it quantifies how efficiently we generated operating income relative to the capital we have invested in the business. In order to calculate ROIC, we adjust our results to reflect our operating leases as if they qualified for capital lease treatment. Operating leases are the primary financing vehicle used to fund store expansion and, therefore, we believe that the presentation of these leases as if they were capital leases is appropriate. Accordingly, the asset base and net income amounts are adjusted to reflect this in the calculation of ROIC. ROIC, subject to certain adjustments, is also used as a measure in executive long-term incentive compensation.



The closest U.S. GAAP measure to ROIC is Return on Assets (“ROA”) and is also represented below. ROA increased to 17.4 percent as compared to 14.7 percent in the prior year, which partially relates to the fact that the prior year results included a $61 million after-tax litigation charge. Additionally, our overall improved performance in 2016 also increased ROA. Our ROIC decreased to 15.1 percent as compared to 15.8 percent in the prior year. This reflected an increase in our average invested capital as a result of the inclusion of our new headquarters lease and the effect of opening larger stores supporting the various shop-in-shop initiatives.





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Calculation of ROIC:







Overview of Consolidated Results



The following represents our long-term objectives and our progress towards meeting those objectives. Non-GAAP results are presented for all the periods. Please see “Reconciliation of Non-GAAP Measures” earlier in this section for further information relating to non-GAAP measures, including why we believe they are useful and how they are calculated.    



Highlights of our 2016 financial performance include:







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Highlights of our 2016 financial position:











Summary of Consolidated Statements of Operations



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Sales



All references to comparable-store sales for a given period relate to sales of stores that were open at the period-end and had been open for more than one year. The computation of comparable-store sales also includes the sales of the Direct-to-Customers segment. Stores opened or closed during the period are not included in the comparable-store base; however, stores closed temporarily for relocation or remodeling are included. Computations exclude the effect of foreign currency fluctuations.



Sales of $7,766 million in 2016 increased by 4.8 percent from sales of $7,412 million in 2015, representing a comparable-store sales increase of 4.3 percent. Excluding the effect of foreign currency fluctuations, sales increased 5.2 percent as compared with 2015. Sales of $7,412 million in 2015 increased by 3.6 percent from sales of $7,151 million in 2014, this represented a comparable-store sales increase of 8.5 percent. Excluding the effect of foreign currency fluctuations, sales increased 8.9 percent as compared with 2014.



Gross Margin



The improvement in the merchandise margin rate in 2016 reflects a lower markdown rate, primarily in our Athletic Stores segment, due to an increase in full-price selling. This improvement was partially offset by increased promotional activity within our Direct-to-Customers segment. The change in the gross margin rate also reflects an increase in the occupancy and buyers’ compensation rate compared to 2015. This pressured our gross margin rate as certain high-profile locations were closed for remodeling for all or part of the year, which increased the occupancy expense rate since these locations were not generating sales while incurring tenancy costs. 



Gross margin in 2015 improved 60 basis points to 33.8 percent as compared with 2014. The improvement was driven by both an improved merchandise margin rate and a decrease in the occupancy and buyers’ compensation rate reflecting improved sales leverage. The improvement in the merchandise margin rate primarily reflected an enhanced ability to achieve full-priced selling, as fewer markdowns were needed due to the freshness of inventory.



Selling, General and Administrative Expenses (SG&A)





SG&A increased by $57 million and 4.0 percent as compared with the prior year. The effect of foreign currency fluctuations for the current year was not significant. As a percentage of sales, the SG&A rate decreased by 10 basis points as compared with 2015, which reflected diligent expense management specifically in store wages by our Athletic Stores segment and was partially offset by increased marketing costs incurred by our Direct-to-Customers segment in order to drive traffic to its websites.



For 2015, excluding the effect of foreign currency fluctuations, SG&A increased by $72 million as compared with 2014. The increase was driven by higher variable expenses to support sales, such as store wages and banking expenses. As a percentage of sales, SG&A improved 80 basis points representing improved leverage of our fixed costs as a result of our sales increase. This improvement reflected effective expense management, specifically store wage improvements due to productivity gains reflecting the continued utilization of hiring and scheduling tools.



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Depreciation and Amortization





Depreciation and amortization increased $10 million in 2016. The effect of foreign currency fluctuations for the current year was not significant. The increases in both 2016 and 2015 reflect a rise in capital spending on store improvements, our new corporate headquarters, our digital sites and various corporate technology upgrades. In addition, the 2014 amount included $2 million of capital accrual adjustments which reduced depreciation and amortization.



Impairment and Litigation Charges



During 2016 and 2015, we recorded impairment charges totaling $6 million ($5 million after-tax or $0.03 per diluted share), and $4 million ($3 million after-tax or $0.02 per diluted share), respectively, relating to the write down of store fixtures and leasehold improvements for our Runners Point and Sidestep stores. Also during 2015, we recorded an impairment charge totaling $1 million to fully write down the value of an ecommerce trade name.



During 2015, we recorded a $100 million pension litigation charge ($61 million after-tax or $0.43 per diluted share). This charge relates to a class action in which the plaintiffs alleged that the Company failed to properly disclose the effects of the 1996 conversion of the retirement plan to a defined benefit plan with a cash balance formula. In September 2015, the court ruled in favor of the plaintiffs and issued a decision ordering that the pension plan be reformed. We are appealing the court’s decision, and the judgment has been stayed pending the outcome of the appeal. Our reasonable estimate of this liability is a range between $100 million and $200 million, with no amount within that range more probable than any other amount. Therefore, in accordance with U.S. GAAP, we recorded a pre-tax charge of $100 million.



Please see Item 8. “Consolidated Financial Statements and Supplementary Data,” Note 3, Impairment and Litigation Charges and Note 22, Legal Proceedings for further information.



Interest Expense, Net







Net interest expense decreased by $2 million in 2016 as compared with 2015, and decreased $1 million in 2015 as compared with 2014. The decrease in net interest expense for both 2016 and 2015 primarily represented increased income due to higher average interest rates on our cash investments. We did not have any short-term borrowings, other than amounts related to capital leases, for any of the periods presented.



Income Taxes



Our effective tax rate for 2016 was 33.9 percent, as compared with 35.4 percent in 2015. We regularly assess the adequacy of provisions for income tax contingencies in accordance with the applicable authoritative guidance on accounting for income taxes. As a result, reserves for unrecognized tax benefits may be adjusted due to new facts and developments, such as changes to interpretations of relevant tax law, assessments from taxing authorities, settlements with taxing authorities, and lapses of statutes of limitations. The effective tax rate for 2016 and 2015 includes reserve releases totaling $1 million and $4 million, respectively, due to audit settlements and lapses of statutes of limitations.

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On December 7, 2016, the U.S. Treasury issued regulations under Internal Revenue Code Section 987 (“Section 987 Regulations”) which requires us to change our method for determining the tax effects of foreign currency translation gains and losses for our foreign businesses that are operated as branches and are reported in a currency other than the currency of their parent. This change resulted in an increase to deferred tax assets and a corresponding reduction in our income tax provision in the amount of $9 million, or $0.07 per diluted share.



During the fourth quarter of 2016, we also recorded tax expense of $2 million ($0.02 per diluted share) due to a  corporate income tax rate change in France.



During the third quarter of 2016, we performed a scheduled reassessment of the value of the intellectual property (“IP”) provided to our European business by Foot Locker in the U.S. during the fourth quarter of 2012. Driven by the recent success of the Foot Locker business in Europe, the new, higher valuation resulted in catch-up deductions that reduced tax expense by $10 million, or $0.07 per diluted share.



In 2015, we recorded a pension-related litigation charge of $100 million with a related tax benefit of $39 million, or $0.43 per diluted share. This litigation charge reduced the overall effective rate because it reduced the proportion of our worldwide income taxed in the United States, where the tax rates are the highest.



Excluding the reserve releases in 2016 and 2015, the effects of the IP valuation catch-up deductions, the French rate change and the issuance of Section 987 Regulations in 2016, and the pension litigation charge in 2015, the effective tax rate for 2016 decreased slightly as compared with 2015, primarily due to the mix of income as well as the current year tax benefit related to the higher IP valuation.  



The effective tax rate for 2015 was 35.4 percent, as compared with 35.7 percent in 2014. Excluding the reserve releases in 2015 and 2014 and the effect of the pension litigation charge, the effective tax rate for 2015 was essentially unchanged as compared with 2014. 



Segment Information



We have two reportable segments, Athletic Stores and Direct-to-Customers, which are based on our method of internal reporting. We evaluate performance based on several factors, the primary financial measure of which is division results. Division profit reflects income before income taxes, pension litigation charge, corporate expense, non-operating income, and net interest expense.





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2016 compared with 2015



Excluding the effect of foreign currency fluctuations, sales from our Athletic Stores segment increased by 4.7 percent. Of the total increase, 69 percent was generated by our domestic businesses, with almost all banners contributing to the growth. Champs Sports drove the domestic performance, while internationally the increase was driven by our Foot Locker Europe operations. Partially offsetting these increases were declines from Lady Foot Locker and our Runners Point and Sidestep banners. The Lady Foot Locker sales decline primarily represented the effect of store closures. The Runners Point and Sidestep banners continued to experience sales declines during 2016 as a result of assortment and traffic challenges. We continue our focus on improving these banners by better diversifying and refining our product offerings, along with providing a more elevated in-store experience. During 2015 and currently continuing, we began broadening the assortment in the Runners Point stores beyond performance running to include more lifestyle running products, while the Sidestep stores shifted to lifestyle and casual footwear. We believe that these initiatives will position the banners for future growth.



Comparable-store sales increased by 3.6 percent as compared with 2015. Footwear sales continue to be the primary contributor to our sales growth during 2016 and reflected strong gains across men’s, children’s, and women’s footwear categories. Our children’s footwear business had a very successful year experiencing comparable-store gains across almost all of our store banners, led by sales from Champs Sports and Kids Foot Locker. During 2016, we opened 45 new Kids Foot Locker stores, 16 of which are in Europe and Canada. The addition of these stores reflects our expectation that the momentum of our children’s business will continue. Within footwear, lifestyle running was the strongest category, while our basketball business slightly declined for the year.



Our apparel sales also generated positive results during the current year. This category was led primarily by gains in branded and private-label apparel sales at Champs Sports. Foot Locker Europe’s apparel sales also increased during the current year and was driven by sales of men’s branded apparel.



Division profit, as a percentage of sales, increased 20 basis points as compared with 2015. During 2016, a $6 million impairment charge was recorded to write down the value of store fixtures and leasehold improvements for 116 Runners Point and Sidestep stores. Excluding the effect of the impairment charge, division profit, as a percentage of sales, increased 30 basis points as compared with the prior year. The division profit rate improvement reflected an improved merchandise margin rate due to a lower markdown rate coupled with diligent expense management. 



2015 compared with 2014



Excluding the effect of foreign currency fluctuations, sales from the Athletic Stores segment increased 8.6 percent. Comparable-store sales increased by 7.6 percent. Foot Locker Europe and Foot Locker Asia Pacific led the comparable-stores sales increase. Foot Locker Europe generated double digit comparable-store gains in footwear, apparel, and accessories. The increase in footwear was primarily related to sales of classic court styles, lifestyle running, and men’s basketball. Apparel sales experienced gains in both the branded and private label categories.



The strong performance internationally was partially offset by the underperformance of the Runners Point and Sidestep stores. The sales decline at our Runners Point and Sidestep stores reflected the continued segmentation process and the overreliance on a few key running styles. Our segmentation process included better defining product offerings and executing upon our multi-banner strategy in the European market. During 2015 we began the process of shifting the assortment in the Runners Point stores beyond performance running to include more lifestyle running products, while the Sidestep stores were being shifted to lifestyle and casual footwear.

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Domestically, sales increases were led by Foot Locker and Kids Foot Locker with all formats generating a comparable-store sales increase. Running and basketball were the strongest drivers of footwear sales. The Jordan brand, as well as the rise of new marquee styles contributed to the growth in the basketball category. Children’s footwear sales also performed well across all of the divisions. Sales continue to benefit from the expansion of shop-in-shop partnerships with our key vendors. We opened more than 40 shop-in-shops during 2015, including 21 House of Hoops shops in partnership with Nike.



While Lady Foot Locker/SIX:02’s overall sales declined slightly in 2015, the combined banners produced a mid-single digit comparable-store sales gain. The comparable-store gain was led by both footwear and apparel, partially offset by a decline in accessories. The overall sales decline reflected the closure of 42 Lady Foot Locker stores, partially offset by the opening of 15 SIX:02 stores during 2015.



Champs Sports generated a low-single digit comparable-store sales increase driven by gains in footwear sales partially offset by declines in apparel and accessories. The decline in apparel primarily reflected the continuation of the customer’s shift away from licensed apparel.



Division profit increased by $95 million to $872 million in 2015 as compared with 2014, which reflected higher sales and an improved gross margin rate. Variable expenses, such as store wages, were also diligently managed, resulting in an improved SG&A rate. Due to the underperformance of the Runners Point and Sidestep stores during 2015, an impairment review was performed. The review resulted in an impairment charge totaling $4 million, which was recorded to write down long-lived assets such as store fixtures and leasehold improvements for 61 stores. 





2016 compared with 2015



Comparable-sales for the Direct-to-Customers segment increased 8.8 percent as compared with the prior year. Our domestic and international store-banner websites continue to represent the majority of the overall growth in sales, which was partially offset by declines in Eastbay, Runners Point and Sidestep ecommerce businesses. The overall increase in sales was led by our footwear category. Consistent with our Athletic Stores segment, footwear sales increased in men’s, women’s, and children’s. The positive sales increase in men’s footwear was primarily driven by strong gains by the Jordan brand. The increase in women’ footwear was driven by casual styles.



Direct-to-Customers division profit, as a percent of sales, declined 100 basis points as compared with the prior year. The decline in the division profit rate reflected increased spending in marketing related costs, which was incurred in order to drive traffic to our websites. Also contributing to the decline in the division profit rate was a decline in the gross margin rate as a result of greater promotional activity by our domestic ecommerce business, especially Eastbay.  



2015 compared with 2014



Excluding the effect of foreign currency fluctuations, sales of the Direct-to-Customers segment increased 10.6 percent as compared with 2014, while comparable sales increased by 14.4 percent. The increase was primarily a result of the continued strong sales performance of our domestic store-banner websites, as well as growth in our international ecommerce business, particularly in Europe. Of the total increase, sales from our U.S. store-banner websites comprised the majority of the increase. The growth in ecommerce reflected the continued elevation of the connection between the in-store experience and the banner websites, as well as the development of features and functionality to deliver an enhanced digital experience. These increases were partially offset by the 2014 closure of the CCS direct business. The strongest category for this segment was footwear, led by basketball and casual styles. Apparel increased slightly as compared with 2014, which primarily reflected gains in the branded apparel category. 

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The Direct-to-Customers segment generated a division profit increase of $33 million in 2015 as compared with 2014, which represented a division profit margin improvement of 240 basis points. The increase was the result of strong flow-through of sales to profit, resulting from improved gross margin due to more full-price selling and effective expense management. The improvement in gross margin was due, in part, to the fact that 2014 was negatively affected by the liquidation of the CCS merchandise. Division profit in 2015 included a $1 million impairment charge to write down the value of the sp24.com ecommerce trade name, which was acquired with the Runners Point Group. sp24.com is a clearance website that has been deemphasized as we focus on full-priced selling on the websites aligned with the store banners.



Corporate Expense





Corporate expense consists of unallocated general and administrative expenses as well as depreciation and amortization related to the Company’s corporate headquarters, centrally managed departments, unallocated insurance and benefit programs, certain foreign exchange transaction gains and losses, and other items. Depreciation and amortization included in corporate expense was $14 million, $11 million, and $13 million in 2016, 2015, and 2014, respectively.



Corporate expense decreased by $7 million in 2016 as compared with the prior year. The annual adjustment of the allocation of corporate expense to the operating divisions reduced corporate expense by $9 million. This was partially offset by an increase of $3 million in depreciation and amortization included in corporate expense. During 2016, we also incurred $4 million of expenses related to our corporate headquarters relocation within New York City, as compared with $3 million during the prior year. The remaining change primarily reflected lower incentive compensation expense in 2016.



Corporate expense decreased by $4 million in 2015 as compared with 2014. Depreciation and amortization included in corporate expense decreased by $2 million. The annual adjustment of the allocation of corporate expense to the operating divisions reduced corporate expense by $5 million. These decreases were offset by $3 million of costs incurred in late 2015 relating to the Spring 2016 headquarters relocation.



Liquidity and Capital Resources



Liquidity



Our primary source of liquidity has been cash flow from earnings, while the principal uses of cash have been: to fund inventory and other working capital requirements; to finance capital expenditures related to store openings, store remodelings, Internet and mobile sites, information systems, and other support facilities; to make retirement plan contributions, quarterly dividend payments, and interest payments; and to fund other cash requirements to support the development of our short-term and long-term operating strategies. We generally finance real estate with operating leases. We believe our cash, cash equivalents, and future cash flow from operations will be adequate to fund these requirements.



As of January 28, 2017, we had $1,046 million of cash and cash equivalents, of which $730 million was held in foreign jurisdictions.  In accordance with U.S. GAAP, we have not provided for U.S. federal and state income taxes or foreign withholding taxes that may result from potential future remittances of undistributed earnings of foreign subsidiaries  because we plan to permanently reinvest our foreign earnings. Depending on the source, amount and timing of a repatriation, and changes in tax regulations including recent proposals regarding the taxation of unremitted earnings, some future tax may be payable. We believe that our cash invested domestically and future domestic cash flows are sufficient to satisfy domestic requirements.



The Company may also from time to time repurchase its common stock or seek to retire or purchase outstanding debt through open market purchases, privately negotiated transactions, or otherwise. Such repurchases and retirement of debt, if any, will depend on prevailing market conditions, liquidity requirements, contractual restrictions, and other factors. The amounts involved may be material.



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On February 14, 2017, the Board of Directors approved a new 3-year, $1.2 billion share repurchase program extending through January 2020, replacing the previous $1 billion program. Also on this date, the Board of Directors declared a quarterly dividend of $0.31 per share to be paid on April 28, 2017, representing a 13 percent increase over the previous quarterly per share amount.



As discussed further in the Legal Proceedings note under “Item 8. Financial Statements and Supplementary Data,” during 2015, in connection with our pension litigation, we recorded a pre-tax charge of $100 million ($61 million after-tax). In light of the uncertainties involved in this matter, there is no assurance that the ultimate resolution will not differ from the amount currently accrued by us. The $100 million charge has been classified as a long-term liability due to the uncertainty involved with the resolution of this litigation, as the appeals process can be lengthy. The pension plan is currently sufficiently funded to absorb a $100 million liability and, accordingly, we do not anticipate the need to make any additional pension contributions in the near term in connection with this matter. The timing and the amount of contributions to the pension plan are dependent on the funded status of the plan and various other factors, such as interest rates and the performance of the plan’s assets.



Any material adverse change in customer demand, fashion trends, competitive market forces, or customer acceptance of our  merchandise mix and retail locations, uncertainties related to the effect of competitive products and pricing, our reliance on a few key suppliers for a significant portion of our merchandise purchases and risks associated with global product sourcing, economic conditions worldwide, the effects of currency fluctuations, as well as other factors listed under the heading “Disclosure Regarding Forward-Looking Statements,” could affect our ability to continue to fund our needs from business operations.



Maintaining access to merchandise that we consider appropriate for our business may be subject to the policies and practices of our key suppliers. Therefore, we believe that it is critical to continue to maintain satisfactory relationships with these key suppliers. In 2016 and 2015, we purchased approximately 91 percent and 90 percent, respectively, of our merchandise from our top five suppliers and expect to continue to obtain a significant percentage of our athletic product from these suppliers in future periods. Approximately 68 percent in 2016 and 72 percent in 2015 was purchased from one supplier — Nike, Inc.



Our 2017 planned capital expenditures and lease acquisition costs are approximately $277 million. Planned capital expenditures are $272 million and planned lease acquisition costs related to our operations in Europe are $5 million. Planned capital expenditures reflect $191 million focused on elevating the customer’s in-store experience. It also includes the remodeling and expansion of over 200 existing stores, the planned opening of approximately 90 stores primarily related to Kids Foot Locker in the U.S. and Europe, as well as the continued expansion of the Foot Locker banner in Europe. Planned spending for 2017 also includes $81 million for the development of information systems, including a new ecommerce order management system, websites, and infrastructure. We have the ability to revise and reschedule much of the anticipated capital expenditure program, should our financial position require it.



Free Cash Flow (non-GAAP measure)



In addition to net cash provided by operating activities, we use free cash flow as a useful measure of performance and as an indication of our strength and our ability to generate cash. We define free cash flow as net cash provided by operating activities less capital expenditures (which is classified as an investing activity). We believe the presentation of free cash flow is relevant and useful for investors because it allows investors to evaluate the cash generated from underlying operations in a manner similar to the method used by management.



Free cash flow is not defined under U.S. GAAP. Therefore, it should not be considered a substitute for income or cash flow data prepared in accordance with U.S. GAAP, and may not be comparable to similarly titled measures used by other companies. It should not be inferred that the entire free cash flow amount is available for discretionary expenditures.



The following table presents a reconciliation of net cash flow provided by operating activities, the most directly comparable U.S. GAAP financial measure, to free cash flow.





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Operating Activities





The amount provided by operating activities reflects income adjusted for non-cash items and working capital changes. Adjustments to net income for non-cash items include non-cash impairment charges, depreciation and amortization, deferred income taxes, share-based compensation expense and related tax benefits.



The improvements in both 2016 and 2015 represented the Company’s earnings strength and working capital improvements. During 2016, we contributed $33 million to our U.S. qualified pension plan and $3 million to our Canadian qualified pension plan, as compared with $4 million contributed to the U.S. qualified pension plan in 2015. Pension contributions were $6 million in 2014. The amounts and timing of pension contributions are dependent on several factors, including asset performance. Cash paid for income taxes was $341 million, $283 million, and $251 million for 2016, 2015, and 2014, respectively. 



Investing Activities





Capital expenditures in 2016 were $266 million, an increase of $38 million as compared with the prior year. The increase was due, in part, to the build out of our new corporate headquarters and two new flagship stores in New York City. Current year capital expenditures also reflects increased spending on corporate technology projects. During 2016, we completed the remodeling or relocation of 218 existing stores and opened 96 new stores. As of the end of fiscal 2016, approximately 40 percent of our domestic Foot Locker and Champs Sports stores, approximately one third of our stores in Europe, and approximately 25 percent of the Footaction stores have been remodeled to their respective new store formats.



Capital expenditures in 2015 were $228 million, primarily related to the remodeling of 209 stores, the build-out of 111 new stores, and various corporate technology upgrades. This was an increase of $38 million as compared with 2014, as the timing of certain projects shifted to 2015.



During the third quarter of 2015, we completed an asset acquisition for $2 million involving 10 previously franchised Runners Point and Sidestep stores in Switzerland.



During 2014, we sold real estate for proceeds of $5 million and recorded a gain on sale of $4 million. In addition, maturities of short-term investments totaled $9 million in 2014.



Financing Activities





Cash used in financing activities consisted primarily of our return to shareholders initiatives, including our share repurchase program and cash dividend payments, as follows:





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During 2016, 2015, and 2014, we repurchased 6,984,643 shares, 6,693,100 shares, and 5,888,698 shares of our common stock under our share repurchase programs, respectively. Additionally, the Company declared and paid dividends representing a quarterly rate of $0.275, $0.25, and $0.22 per share in 2016, 2015, and 2014, respectively.



Offsetting the amounts above were proceeds received from the issuance of common stock and treasury stock in connection with the employee stock programs of $33 million, $69 million, and $22 million for 2016, 2015, and 2014, respectively. In connection with stock option exercises, we recorded excess tax benefits related to share-based compensation of $20 million, $35 million, and $12 million for 2016, 2015, and 2014, respectively.  In connection with the adoption of Accounting Standards Update (“ASU”) 2016-09, excess tax benefits and deficiencies will be recorded to the income statement rather than to equity as of the beginning of 2017. Additionally, with the adoption of this ASU, excess tax benefits and deficiencies will be classified as cash flows from operations.



In May 2016, we entered into a new $400 million credit agreement and in connection with this transaction we paid fees of $2 million.



The financing activity also includes payments on capital lease obligations of $1 million, $2 million, and $3 million for 2016, 2015, and 2014, respectively. These obligations were recorded in connection with the acquisition of the Runners Point Group.



Capital Structure



On May 19, 2016, we entered into a new credit agreement with our banks (“2016 Credit Agreement”) that replaced the prior credit agreement (“2011 Restated Credit Agreement”). The 2016 Credit Agreement provides for a $400 million asset-based revolving credit facility maturing on May 19, 2021. During the term of the 2016 Credit Agreement, we may also increase the commitments by up to $200 million, subject to customary conditions. Interest is determined, at our option, by the federal funds rate plus a margin of 0.125 percent to 0.375 percent, or a Eurodollar rate, determined by reference to LIBOR, plus a margin of 1.125 percent to 1.375 percent depending on availability under the 2016 Credit Agreement. In addition, we will pay a commitment fee of 0.20 percent per annum on the unused portion of the commitments.



The 2016 Credit Agreement provides for a security interest in certain of our domestic store assets, including inventory assets, accounts receivable, cash deposits, and certain insurance proceeds. We are not required to comply with any financial covenants unless certain events of default have occurred and are continuing, or if availability under the 2016 Credit Agreement does not exceed the greater of $40 million and 10 percent of the Loan Cap (as defined in the 2016 Credit Agreement). There are no restrictions relating to the payment of dividends and share repurchases as long as no default or event of default has occurred and the aggregate principal amount of unused commitments under the 2016 Credit Agreement is not less than 15 percent of the lesser of the aggregate amount of the commitments and the Borrowing Base, determined as of the preceding fiscal month and on a proforma basis for the following six fiscal months.



We do not currently expect to borrow under the facility in 2017, other than amounts used to support standby letters of credit.



Credit Rating



As of March 23, 2017, our corporate credit ratings from Standard & Poor’s and Moody’s Investors Service are BB+ and Ba1, respectively. In addition, Moody’s Investors Service has rated our senior unsecured notes Ba2.



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Debt Capitalization and Equity (non-GAAP Measure)



For purposes of calculating debt to total capitalization, we include the present value of operating lease commitments in total net debt. Total net debt including the present value of operating leases is considered a non-GAAP financial measure. The present value of operating leases is discounted using various interest rates ranging from 2.5 percent to 14.5 percent, which represent our incremental borrowing rate at inception of the lease. Operating leases are the primary financing vehicle used to fund store expansion and, therefore, we believe that the inclusion of the present value of operating leases in total debt is useful to our investors, credit constituencies, and rating agencies.





Cash and cash equivalents increased by $25 million during 2016, which was the result of strong cash flow generation from operating activities. Including the present value of operating leases, net debt capitalization percent increased by 110 basis points in 2016, reflecting the effect of new leases related to flagship locations and ongoing lease renewals, partially offset by foreign exchange fluctuations.



Contractual Obligations and Commitments



The following tables represent the scheduled maturities of the Company’s contractual cash obligations and other commercial commitments at January 28, 2017:







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Off-Balance Sheet Arrangements



The majority of our contractual obligations relate to operating leases for our stores. Future scheduled lease payments under non-cancellable operating leases as of January 28, 2017 are described in the table under Contractual Obligations and Commitments on the preceding page and with additional information in the Leases note in “Item 8. Consolidated Financial Statements and Supplementary Data.”  



We do not participate in transactions that generate relationships with unconsolidated entities or financial partnerships, including variable interest entities. Also, our financial policies prohibit the use of derivatives for which there is no underlying exposure.



In connection with the sale of various businesses and assets, we may be obligated for certain lease commitments transferred to third parties and pursuant to certain normal representations, warranties, or indemnifications entered into with the purchasers of such businesses or assets. Although the maximum potential amounts for such obligations cannot be readily determined, we believe that the resolution of such contingencies will not significantly affect our consolidated financial position, liquidity, or results of operations. We also operate certain stores for which lease agreements are in the process of being negotiated with landlords. Although there is no contractual commitment to make these payments, it is likely that leases will be executed.



Critical Accounting Policies



Our responsibility for integrity and objectivity in the preparation and presentation of the financial statements requires diligent application of appropriate accounting policies. Generally, our accounting policies and methods are those specifically required by U.S. generally accepted accounting principles. Included in the Summary of Significant Accounting Policies note in “Item 8. Consolidated Financial Statements and Supplementary Data” is a summary of the most significant accounting policies. 



In some cases, we are required to calculate amounts based on estimates for matters that are inherently uncertain. We believe the following to be the most critical of those accounting policies that necessitate subjective judgments.



Merchandise Inventories and Cost of Sales



Merchandise inventories for the Athletic Stores segment are valued at the lower of cost or market using the retail inventory method (“RIM”). The 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 estimates and assumptions regarding markups, markdowns and shrink, among others, and as such, could result in distortions of inventory amounts. 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. Reserves are established 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 retail environment, inventory levels, and the age of the item. We believe this method and its related assumptions, which have been consistently applied, to be reasonable.

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Impairment of Long-Lived Tangible Assets, Goodwill and Other Intangibles







Share-Based Compensation



We estimate the fair value of options granted using the Black-Scholes option pricing model. The Black-Scholes option pricing valuation model requires the use of subjective assumptions. Changes in these assumptions, listed below, can materially affect the fair value of the options.









Share-based compensation expense is recorded for those awards expected to vest using an estimated forfeiture rate based on the Company’s historical pre-vesting forfeiture data. As of the beginning of 2017, in connection with the adoption of ASU 2016-09, we have made the accounting policy election to discontinue estimating forfeitures and will account for forfeitures as they occur using a modified retrospective approach.



Legal Contingencies



We are exposed to various legal proceedings and claims arising in the ordinary course of business. We record a liability when a loss is probable and the amount of loss can be reasonably estimated. The accrual is recorded based on the reasonably estimable loss or range of loss. When no point of loss is more likely than another, we record the lowest amount in the estimated range of loss and disclose the estimated range. In 2015, we recorded a pre-tax charge of $100 million related to the pension plan litigation.



There is significant judgment required in both the probability determination and as to whether an exposure can be reasonably estimated. We believe the accruals recorded within the consolidated financial statements properly reflect loss exposures that are both probable and reasonably estimable. Due to the inherent uncertainty involved in making these estimates, actual results could differ from those estimates.  



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Pension and Postretirement Liabilities



We review all assumptions used to determine our obligations for pension and postretirement liabilities annually with our independent actuaries, taking into consideration existing and future economic conditions and our intentions with regard to the plans. The assumptions used are:





We expect to record postretirement income of approximately $1 million and pension expense of approximately $19 million in 2017.

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Income Taxes



In accordance with U.S. 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. We are required to estimate taxable income for future years by taxing jurisdiction and to use our judgment to determine whether or not to record a valuation allowance for part or all of a deferred tax asset. Estimates of taxable income are based upon our long-range strategic plans.



A one percent change in the overall statutory tax rate for 2016 would have resulted in a change of $5 million to the carrying value of the net deferred tax asset and a corresponding charge or credit to income tax expense depending on whether the tax rate change was a decrease or an increase.



We have operations in multiple taxing jurisdictions and we are 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 us to make estimates and judgments with respect to the ultimate outcome of tax audits. Actual results could vary from these estimates.



Excluding the effect of any nonrecurring items that may occur, we expect the 2017 effective tax rate to approximate 34 percent including the change required by ASC 718 for treatment of excess tax benefits or deficiencies from share-based compensation being recorded to the income tax provision rather than to equity. The actual tax rate will vary if the level of stock option exercise activity and the stock price at the vesting or exercise date differs from our expectations. Additionally, the tax rate will also depend on the level and mix of income earned in the United States, as compared with our international operations.



Recent Accounting Pronouncements



Descriptions of the recently issued accounting principles, and the accounting principles adopted by us during the year ended January 28, 2017 are included in the Summary of Significant Accounting Policies note in “Item 8. Consolidated Financial Statements and Supplementary Data.”



Disclosure Regarding Forward-Looking Statements



This report contains forward-looking statements within the meaning of the federal securities laws. Other than statements of historical facts, all statements which address activities, events, or developments that the Company anticipates will or may occur in the future, including, but not limited to, such things as future capital expenditures, expansion, strategic plans, financial objectives, dividend payments, stock repurchases, growth of the Company’s business and operations, including future cash flows, revenues, and earnings, and other such matters, are forward-looking statements. These forward-looking statements are based on many assumptions and factors which are detailed in the Company’s filings with the Securities and Exchange Commission, including the effects of currency fluctuations, customer demand, fashion trends, competitive market forces, uncertainties related to the effect of competitive products and pricing, customer acceptance of the Company’s merchandise mix and retail locations, the Company’s reliance on a few key suppliers for a majority of its merchandise purchases (including a significant portion from one key supplier), cybersecurity breaches, pandemics and similar major health concerns, unseasonable weather, deterioration of global financial markets, economic conditions worldwide, deterioration of business and economic conditions, any changes in business, political and economic conditions due to the threat of future terrorist activities in the United States or in other parts of the world and related U.S. military action overseas, the ability of the Company to execute its business and strategic plans effectively with regard to each of its business units, and risks associated with global product sourcing, including political instability, changes in import regulations, and disruptions to transportation services and distribution.



For additional discussion on risks and uncertainties that may affect forward-looking statements, see “Risk Factors” in Part I, Item 1A. Any changes in such assumptions or factors could produce significantly different results. The Company undertakes no obligation to update forward-looking statements, whether as a result of new information, future events, or otherwise.



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Item 7A. Quantitative and Qualitative Disclosures About Market Risk



Information regarding foreign exchange risk management is included in the Financial Instruments and Risk Management note under “Item 8. Consolidated Financial Statements and Supplementary Data.”



Item 8. Consolidated Financial Statements and Supplementary Data



The following Consolidated Financial Statements of the Company are included as part of this Report:















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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



The Board of Directors and Shareholders of

Foot Locker, Inc.:

We have audited the accompanying consolidated balance sheets of Foot Locker, Inc. and subsidiaries as of January 28, 2017 and January 30, 2016, and the related consolidated statements of operations, comprehensive income, shareholders’ equity, and cash flows for each of the years in the three‑year period ended January 28, 2017. 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 the standards of the Public Company Accounting Oversight Board (United States). 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 Foot Locker, Inc. and subsidiaries as of January 28, 2017 and January 30, 2016, and the results of their operations and their cash flows for each of the years in the three‑year period ended January 28, 2017, in conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Foot Locker, Inc.’s internal control over financial reporting as of January 28, 2017, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 23, 2017 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.



/s/ KPMG LLP



New York, New York

March 23, 2017



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FOOT LOCKER, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS







See Accompanying Notes to Consolidated Financial Statements.





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FOOT LOCKER, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME 







See Accompanying Notes to Consolidated Financial Statements.



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FOOT LOCKER, INC.

CONSOLIDATED BALANCE SHEETS







See Accompanying Notes to Consolidated Financial Statements.