FOOT LOCKER, INC. - Annual Report: 2018 (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, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.



If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards pursuant to Section 13(a) 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 23, 2018: 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. As of February 3, 2018, the Company operated 3,310 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. 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 Nike, Jordan, adidas, and Puma) are owned by Foot Locker, Inc. or its subsidiaries.



Employees



The Company and its consolidated subsidiaries had 15,141 full-time and 34,068 part-time employees as of February 3, 2018. 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.”



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.

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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, the ability to attract and retain qualified personnel, and our ability to successfully implement technological initiatives. 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, 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 experience, 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 an increasing proportion of our merchandise via the Internet, a significantly faster 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, especially at the premium end of the price spectrum, 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.



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.



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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, we have negotiated volume discounts, cooperative advertising, and markdown allowances with our suppliers, as well as the ability to cancel orders and return excess or unneeded merchandise. We cannot be certain that such terms with our suppliers will continue in the future.



We purchased approximately 93 percent of our merchandise in 2017 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 67 percent of all merchandise purchased in 2017 was purchased from one supplier — Nike, Inc. (“Nike”). Each of our operating divisions is highly dependent on Nike: they individually purchased 44 to 73 percent of their merchandise from Nike during the year. 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, as well as high-traffic urban retail areas and high streets. We cannot be certain that desirable 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 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 could negatively affect our ability to obtain and retain store locations. Additionally, further landlord consolidation may negatively affect our ability to negotiate favorable lease terms.



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.



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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 2017 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. Except for our business in the United Kingdom (the “U.K”),  our international subsidiaries conduct most of their business in their local currency. Inventory purchases for our U.K. business 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.



Significant developments stemming from the U.K.’s decision to withdraw from the European Union could have a material adverse effect on the Company.



The U.K. has voted in favor of leaving the European Union (“E.U.”), and such withdrawal (commonly referred to as “Brexit”) is scheduled to take effect over the next two years. This decision has created political and economic uncertainty, particularly in the U.K. and the E.U., and this uncertainty may last for several years. The pending withdrawal and its possible future consequences have caused and may continue to cause significant volatility in global financial markets, including in global currency and debt markets. This volatility could cause a slowdown in economic activity in the U.K., Europe or globally, which could adversely affect the Company's operating results and growth prospects.  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 effects 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.



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, 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. Other than insignificant amounts used for standby letters of credit, we do not have any borrowings under our credit facility.





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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 February 3, 2018, our cash and cash equivalents totaled $849 million. The majority of our investments were short-term deposits in highly-rated banking institutions. As of February 3, 2018, $669 million of our cash and cash equivalents were held in foreign jurisdictions, almost half of which was held in U.S. dollars. 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 February 3, 2018, 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 $639 million at February 3, 2018. 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 affect 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 February 3, 2018, we had $160 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.



Changes in tax laws and interpretations may affect our earnings negatively.



On December 22, 2017, the Tax Cuts and Jobs Act (H.R. 1) (the “Tax Act”) was signed into law. The Tax Act includes a number of changes in existing tax law affecting businesses including, among other things, a reduction in the U.S. corporate income tax rate from 35 percent to 21 percent, disallowance of certain deductions that had previously been allowed, limitations on interest deductions, alteration of the expensing of capital expenditures, adoption of a territorial tax system, assessment of a repatriation tax or “toll-charge” on undistributed earnings and profits of U.S.-owned foreign corporations, and introduction of certain anti-base erosion provisions.

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In the fourth quarter of 2017, we recognized a provisional net tax expense of $99 million associated with the Tax Act; however, the ultimate effect on our financial condition and results of operations in 2018 and future years remains uncertain and may differ materially from our expectations due to the issuance of technical guidance regarding elements of the Tax Act and changes in interpretations and assumptions we have made with respect to the Tax Act. In addition, it is unclear how these U.S. federal income tax changes will affect state and local taxation, which often uses federal taxable income as a starting point for computing state and local tax liabilities. As such, there may be material adverse effects resulting from the Tax Act that we have not yet identified.



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 effect 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.



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.

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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, cybersecurity risks, 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 those associated with credit card fraud, the need to keep pace with rapid technological change, 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.



Privacy and data security concerns and regulation could result in additional costs and liabilities.



The protection of customer, employee, and Company data is critical. The regulatory environment surrounding information security and privacy is demanding, with the frequent imposition of new and changing requirements. In addition, customers have a high expectation that we will adequately protect their personal information. Any actual or perceived misappropriation or breach involving this data could attract negative media attention, cause harm to our reputation or result in liability (including but not limited to fines, penalties or lawsuits), any of which could have a material adverse effect on our business, operational results, financial position and cash flows. Additionally, the E.U. adopted a comprehensive General Data Privacy Regulation (the “GDPR”), which will become fully effective in May 2018. The GDPR requires companies to satisfy new requirements regarding the handling of personal and sensitive data, including its use, protection and the ability of persons whose data is stored to correct or delete such data about themselves. Failure to comply with GDPR requirements could result in penalties of up to 4 percent of worldwide revenue. The GDPR and other similar laws and regulations, as well as any associated inquiries or investigations or any other government actions, may be costly to comply with, result in negative publicity, increase our operating costs, require significant management time and attention, and subject us to remedies that may harm our business, including fines or demands or orders that we modify or cease existing business practices.



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, and 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.



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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.



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. At this time, there is uncertainty concerning whether the ACA will be repealed or what requirements will be included in a new law, if enacted.  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 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 affect 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, 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 2017 were approximately 13.30 and 7.71 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 for our leased distribution center in Germany expires during 2019 and the Company is currently negotiating a lease extension for this facility.



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 29, 2018, including business experience for the last five years.



Richard A. Johnson, age 60, has served as Chairman of the Board since May 2016 and President and Chief Executive Officer since December 2014. Mr. Johnson previously served as Executive Vice President and Chief Operating Officer from May 2012 through November 2014. He served as Executive Vice President and Group President from July 2011 to May 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 55, has served as Executive Vice President and Chief Executive Officer-North America since February 2016. He previously served as Executive Vice President and Chief Executive Officer Foot Locker North America from December 2014 through February 2016 and President and Chief Executive Officer of Foot Locker U.S., Lady Foot Locker, Kids Foot Locker, and Footaction from July 2011 to November 2014. 



Lewis P. Kimble, age 59,  has served as Executive Vice President and Chief Executive Officer-International since February 2016. Mr. Kimble previously served as President and Chief Executive Officer of Foot Locker Europe from February 2010 to February 2016.



Lauren B. Peters, age 56, has served as Executive Vice President and Chief Financial Officer since July 2011.



Pawan Verma, age 41, has served as Executive Vice President, Chief Information and Customer Connectivity Officer since October 2017 and as Senior Vice President and Chief Information Officer from August 2015 to September 2017. From February 2013 to July 2015, Mr. Verma served in various technology leadership roles at Target Corporation ranging from enterprise architecture, e-commerce, mobile and digital, with his most recent role at Target as Vice President - Digital Technology and API Platforms.



Paulette R. Alviti, age 47, 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., with her most recent role as Senior Vice President and Chief Human Resources Asia, Middle East, Africa.



Giovanna Cipriano, age 48, has served as Senior Vice President and Chief Accounting Officer since May 2009.



Sheilagh M. Clarke, age 58, has served as Senior Vice President, General Counsel and Secretary since June 2014. She previously served as Vice President, Associate General Counsel and Assistant Secretary from May 2007 to May 2014.



W. Scott Martin, age 50, has served as Senior Vice President - Strategy and Store Development since October 2017 and as Senior Vice President — Real Estate from June 2016 to September 2017. 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).



John A. Maurer, age 58, has served as Vice President, Treasurer since September 2006.  In addition to this role, he also served as the Vice President of Investors Relations from February 2011 through March 2018.



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 February 3, 2018, the Company had 13,244 shareholders of record owning 119,829,023 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 2017, the Company declared a dividend of $0.31 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 20, 2018, the Board of Directors declared a quarterly dividend of $0.345 per share to be paid on May 4, 2018. This dividend represents an 11 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.



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



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 U.S. Securities and Exchange Commission. 



These forward-looking statements are based largely on our expectations and judgments and are subject to a number of risks and uncertainties, many of which are unforeseeable and beyond our control. 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.



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 e-commerce 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, part of our 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 premium athletically-inspired shoes and apparel with a wide selection of merchandise in a full-service environment.



Store Profile









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Athletic Stores



We operated 3,310 stores in the Athletic Stores segment as of the end of 2017. The following is a brief description of the Athletic Stores segment’s operating businesses:



Foot Locker — Foot Locker is a leading global youth culture brand that connects the sneaker obsessed consumer with the most innovative and culturally relevant sneakers and apparel. Across all of our consumer touchpoints (stores, websites, mobile apps, social media), Foot Locker enables consumers to fulfill their desire to be part of sneaker and youth culture. We curate special product assortments and marketing content that supports our premium position – from leading global brands such as Nike, Jordan, adidas, and Puma, as well as new and emerging brands in the athletic and lifestyle space. We connect emotionally with our consumers through a combination of global brand events and highly targeted and personalized experiences in local markets. Foot Locker’s 1,755 stores are located in 24 countries including 910 in the United States, Puerto Rico, U.S. Virgin Islands, and Guam, 111 in Canada, 636 in Europe, and a combined 98 in Australia and New Zealand. Our domestic stores have an average of 2,700 selling square feet and our international stores have an average of 1,600 selling square feet.



Kids Foot Locker — Kids Foot Locker offers the largest selection of brand-name athletic footwear, apparel and accessories for children. Our stores, websites and social media channels feature products, content and experiences geared toward youth sneaker culture. Of our 436 stores, 375 are located in the United States, Puerto Rico, and the U.S. Virgin Islands, 40 in Europe, 19 in Canada, and a combined 2 in Australia and New Zealand. These stores have an average of 1,700 selling square feet.



Lady Foot Locker — 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 85 stores that are located in the United States and Puerto Rico. These stores have an average of 1,400 selling square feet. 



Champs Sports —  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 our 541 stores, 512 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 3,600 selling square feet.



Footaction — Footaction is a North American 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, with a focus on authentic, premium product. The primary consumer is a style-obsessed, confident, influential young male who is always dressed to impress. Of our 260 stores, 258 are located throughout the United States and Puerto Rico and 2 are in Canada. The Footaction stores have an average of 3,200 selling square feet.



Runners Point — Runners Point specializes in running footwear, apparel, and equipment for both performance and lifestyle purposes. This banner offers athletically inspired premium products and personalized service. Runners Point also 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. Our 118 stores are located in Germany, Austria, and Switzerland. Runners Point stores have an average of 1,300 selling square feet.    



Sidestep — Sidestep is a predominantly athletic fashion footwear banner. Our 83 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 — SIX:02 is for women who want to look and feel great both at the gym and in everyday life. This banner provides stylish casual and fitness looks for women on the go. SIX:02 is unique in the market place because of the ability to feature both footwear and apparel assortments across many brands – from traditional athletic brands, such as Nike, adidas and Puma – to new up-and-coming brands. Whether she is working out, going out or just hanging out, SIX:02 has an expansive selection of apparel, footwear, and accessories to choose from. SIX:02 operates 32 stores in the United States and have an average of 2,000 selling square feet.



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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, and eastbayteamsales.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, footlocker.au, 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 e-commerce and physical stores. 



Eastbay — 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 operates franchised Foot Locker stores located within the Middle East, as well as franchised stores in Germany under the Runners Point banner. In addition, we entered into a franchise agreement during 2017 with Fox-Wizel Ltd for franchised stores operating in Israel. Also during 2017, we terminated our franchise agreement with the third party that operated stores in the Republic of Korea. 



A total of 112 franchised stores were operating at February 3, 2018,  14 were operating in Germany and 98 were operating in the Middle East, of which 25 are in Israel.



U.S. Tax Reform



On December 22, 2017, the United States enacted tax reform legislation (“Tax Act”) that included a broad range of business tax provisions, including but not limited to a reduction in the U.S. corporate income tax rate from 35 percent to 21 percent as well as provisions that limit or eliminate various deductions or credits. The legislation also results in certain U.S. allocated expenses (e.g. interest and general administrative expenses) to be taxed and imposes a new tax on U.S. cross-border payments. Furthermore, the legislation includes a one-time transition tax on accumulated foreign earnings and profits.



In response to the enactment of the Tax Act, the SEC issued Staff Accounting Bulletin No. 118 which provides guidance to address the complexity in accounting for this new legislation. When the initial accounting for items under the new legislation is incomplete, the guidance allows us to recognize provisional amounts when reasonable estimates can be made or to continue to apply the prior tax law if a reasonable estimate cannot be made. The SEC has provided up to a one-year window for companies to finalize the accounting for the effect of this new legislation and we anticipate finalizing our accounting during 2018. While our accounting for the new U.S. tax legislation is not complete, we have made reasonable estimates for some provisions and recognized a $99 million tax liability for the mandatory deemed repatriation of foreign sourced net earnings and a change in our permanent reinvestment assertion.  The remeasurement of our deferred tax assets and liabilities was not significant. The 2017 charge for these provisions reflects our best estimate based on information currently available and our current interpretation of the Tax Act. 



The Tax Act includes a provision effective in 2018, to tax global intangible low-taxed income ("GILTI") of the Company’s foreign subsidiaries. Under generally accepted accounting principles (“GAAP”), we can make an accounting policy election to either treat taxes due on the GILTI inclusion as a current period expense, or factor such amounts into our measurement of deferred taxes. Due to the complexity of the new GILTI rules, we are continuing to evaluate this provision of the Tax Act and the application of GAAP and we have not yet elected an accounting policy.



As of the date of this Form 10-K, we are continuing to evaluate the accounting for this legislation. We continue to assemble and analyze all the information required to prepare and analyze these effects and await additional guidance from the U.S. Treasury Department, the IRS or other standard-setting bodies. Additionally, we continue to analyze other information. Accordingly, we may record additional provisional amounts or adjustments to provisional amounts. Any subsequent adjustments will be recorded to tax expense in the quarter when the analysis is complete. See Critical Accounting Policies within this item and Note 17,  Income Taxes in “Item 8. Consolidated Financial Statements and Supplementary Data” for further details on U.S. tax reform.

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Reconciliation of Non-GAAP Measures



In addition to reporting the Company’s financial results in accordance with GAAP, the Company reports certain financial results that differ from what is reported under GAAP. In the following tables, we have presented certain financial measures and ratios identified as non-GAAP such as sales excluding 53rd week, 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. 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 are not indicative of our core business or which affect comparability. In addition, these non-GAAP measures are useful in assessing our progress in achieving our long-term financial objectives.



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. 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.



Fiscal year 2017 represents the fifty-three weeks ended February 3, 2018. Accordingly, certain non-GAAP results have also been adjusted to exclude the effects of the 53rd week to assist in comparability. 



We estimate the tax effect of the non-GAAP adjustments by applying a marginal rate to each of the respective items. The income tax items represent the discrete amount that affected the period.



The non-GAAP financial information is provided in addition to, and not as an alternative to, our reported results prepared in accordance with GAAP. 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 decreased to 7.3 percent as compared to 17.4 percent in the prior year, with the decline primarily due to litigation and other charges recorded during 2017, as well as a provisional charge of $99 million relating to tax reform as discussed earlier in this section. 



Our ROIC decreased to 11.0 percent in 2017, as compared to 15.1 percent in the prior year. Average invested capital increased compared with the prior year and earnings declined, which resulted in the overall decrease in ROIC. Average invested capital increased as a result of the effect of opening larger stores, as well as signing certain high-profile leases with longer lease terms. The earnings decline is more fully discussed on the following pages.

 



Calculation of ROIC:









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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 2017 financial performance include:





Highlights of our financial position for the period ended February 3, 2018 include:

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Summary of Consolidated Statements of Operations



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 consolidated 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. Comparable-store sales for 2017 does not include the sales from the 53rd week.



Sales of $7,782 million in 2017 increased by 0.2 percent from sales of $7,766 million in 2016. Results from 2017 include the effect of the 53rd week, which represented sales of $95 million. Excluding the effect of foreign currency fluctuations, sales declined 0.5 percent as compared with 2016.  Comparable-store sales declined 3.1 percent during 2017 as compared with 2016. Sales of $7,766 million in 2016 increased by 4.8 percent from sales of $7,412 million in 2015, this represented 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.  



Gross Margin



Gross margin is calculated as sales minus cost of sales. Cost of sales includes: the cost of merchandise, freight, distribution costs including related depreciation expense, shipping and handling, occupancy and buyers’ compensation. Occupancy costs include rent, common area maintenance charges, real estate taxes, general maintenance, and utilities.



The gross margin rate decreased to 31.6 percent in 2017 as compared to 33.9 percent in the prior year. The decline in the merchandise margin rate in 2017 primarily reflects a higher markdown rate in both our Athletic Stores and Direct-to-Customer segments. The higher markdowns were the result of a more promotional environment and were necessary to ensure merchandise inventory remained current and in line with the sales trend. Although to a lesser degree, a decline in our shipping and handling revenue also negatively affected the merchandise margin for the Direct-to-Customer segment. The decline in the gross margin rate also reflects an increase in the occupancy and buyers’ compensation rate as compared to 2016. Rent-related costs continued to increase while our sales were relatively flat. The increase in rent-related costs was primarily driven by recently entering into leases for high-profile locations.



Gross margin in 2016 improved 10 basis points to 33.9 percent as compared with 2015. The improvement was driven by a lower markdown rate, primarily in our Athletic Stores segment, due to an increase in full-priced selling. This improvement was partially offset by increased promotional activity within our Direct-to-Customers segment. The change in the gross margin rate also reflected 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 2016, which increased the occupancy expense rate since these locations were not generating sales while incurring tenancy costs. 



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Selling, General and Administrative Expenses (SG&A)



SG&A increased by $29 million and 2.0 percent in 2017, as compared with the prior year. As a percentage of sales, the SG&A rate increased by 30 basis points as compared with 2016. Excluding the effect of foreign currency fluctuations, SG&A increased by $16 million compared to the prior year. The 53rd week contributed $16 million of additional expenses, however as a percent of sales the SG&A rate remained unchanged at 19.3 percent.



The rise in the SG&A expense rate during 2017 primarily relates to the Athletic Stores segment, partially offset by a decline in the Direct-to-Customers segment’s SG&A rate. The Athletic Stores segment reflected an increase in store-related compensation costs as a result of increased minimum wage levels. Additionally, we incurred higher expenses related to wages, such as payroll taxes and benefits. These increases in the SG&A expense rate were partially offset by declines in incentive compensation and marketing related costs.



SG&A increased by $57 million in 2016 as compared with 2015. As a percentage of sales, the SG&A rate in 2016 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.



Depreciation and Amortization





Depreciation and amortization increased $15 million in 2017 as compared with 2016.  Excluding the effect of foreign currency fluctuations, depreciation and amortization increased $13 million as compared with the prior year. The increases in both 2017 and 2016 reflect a rise in capital spending on store improvements, the enhancement of our digital sites, and various other technologies and infrastructure. The increase in 2016 as compared with 2015 also reflected capital spending on our relocated corporate headquarters.



Litigation and Other Charges



Litigation and other charges recorded totaled $211 million, $6 million, and $105 million for 2017, 2016, and 2015, respectively.



Related to our pension litigation, we recorded charges totaling $178 million during 2017. We previously recorded a $100 million pension litigation charge during 2015.  These charges relate to a class action in which the plaintiffs alleged that the Company failed to properly disclose the effects of the 1996 conversion of the U.S. retirement plan to a defined benefit plan with a cash balance formula. In February 2018, the Company’s Petition for Writ of Certiorari with the U.S. Supreme Court was denied. Accordingly, the Company must reform the pension plan consistent with the trial court’s order. The Company has estimated that the cost of plan reformation is $278 million as of February 3, 2018 based upon our current understanding of the court order. This amount will increase with interest until paid, as required by the provisions of the required plan reformation. The Company is currently formulating the actions and steps necessary to reform the plan. 



During 2017, we reduced and reorganized our division and corporate staff which resulted in a charge of $13 million. The substantial majority of the charge was for severance and related costs. 



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Impairment charges recorded during 2017 totaled $20 million. The charges related to the write-down of store fixtures and leasehold improvements of our SIX:02, Runners Point, and Sidestep stores. During 2016 and 2015, we also recorded non-cash impairment charges totaling $6 million and $4 million, respectively, relating to the write down of store fixtures and leasehold improvements for our Runners Point and Sidestep stores. Also during 2015, we recorded a non-cash impairment charge totaling $1 million to fully write down the value of an e-commerce trade name.



Interest (Income) / Expense, Net



The changes during 2017 and 2016 primarily relate to the amounts earned as interest income. Interest income increased by $5 million in 2017 as compared with 2016, and increased $2 million in 2016 as compared with 2015. The increase for both periods primarily represented increased income due to higher average interest rates on our cash investments. We did not have any short-term borrowings, other than small amounts related to capital leases, for any of the periods presented.



Income Taxes



Our effective tax rate for 2017 was 50.8 percent, as compared with 33.9 percent in 2016. The increase was primarily attributable to the Tax Act. We recorded a provisional tax of $99 million for the mandatory deemed repatriation of historical foreign sourced net earnings and related items. The tax effect of the remeasurement of our deferred tax assets and liabilities was not significant. Also contributing to the increased rate was tax expense of $8 million related to the establishment of certain valuation allowances against the deferred tax assets associated with Runners Point, Sidestep, and their respective e-commerce businesses. In both 2017 and 2016 we recorded tax expense of $2 million for two separate tax rate reductions in France. Partially offsetting these increases were $9 million in excess tax benefits reflecting the change required by ASC 718 adopted during 2017.



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 both 2017 and 2016, includes reserve releases totaling $1 million due to audit settlements and lapses of statutes of limitations. 



In the fourth quarter of 2016, the U.S. Treasury issued regulations under Internal Revenue Code Section 987, which required 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.  Also during 2016, we performed a scheduled reassessment of the value of the intellectual property provided to our European business by Foot Locker in the U.S. during the fourth quarter of 2012. The new, higher valuation resulted in catch-up deductions that reduced tax expense by $10 million.



Excluding the provisional repatriation and related items, the establishment of valuation allowances, the effects of excess tax benefits, the effect of the charges recorded during 2017, the IP valuation catch-up deductions in 2016, and the effect of Section 987 Regulations on 2016, the effective tax rate for 2017 decreased as compared with 2016, primarily due to the partial year benefit of the federal income tax rate reduction as well as mix of income.  



The effective tax rate for 2016 was 33.9 percent, as compared with 35.4 percent in 2015. Excluding the reserve releases, the effects of the IP valuation catch-up deductions, the French rate change, the effect of Section 987 Regulations, 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 current year tax benefit related to the higher IP valuation.

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Segment Information



As of February 3, 2018, we had two reportable segments, Athletic Stores and Direct-to-Customers, which were 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 and reorganization charges, corporate expense, non-operating income, and net interest (income) / expense. Effective as of the beginning of fiscal year 2018, the Company will report one reportable segment based upon the change in our method of internal reporting.







2017 compared with 2016



Excluding the effect of foreign currency fluctuations, sales from our Athletic Stores segment decreased by 1.9 percent. The sales decline during 2017, excluding the effect of foreign currency fluctuations, was across almost all of our store banners. The Company experienced declines in sales of footwear and accessories, partially offset by a gain in apparel sales. 



Comparable-store sales decreased by 4.7 percent during 2017, as compared with the corresponding prior-year period.  The overall decline in comparable-store sales was primarily driven by a decrease in footwear sales. The decline in footwear sales reflected a lack of depth and variety of innovative new product at the premium end of the athletic footwear market to suit our customers’ quickly-changing style preferences. Children’s and women’s footwear sales were the major contributors to the comparable-store declines in footwear, although men’s footwear also experienced a modest comparable-store decline. Women’s court styles primarily contributed to the comparable-store decline in women’s footwear, particularly in Foot Locker, Lady Foot Locker, and Foot Locker Europe. The comparable store-sales decrease in children’s footwear mostly reflected declines in the basketball category. All of our store banners, with the exception of Foot Locker Canada, experienced declines in men’s footwear. Gains in men’s lifestyle running shoes were not enough to compensate for the comparable-store sales declines in basketball and court lifestyle footwear, again due to insufficient product depth.



The comparable-store sales increase in apparel as compared to the prior year was across almost all of our store banners, with gains experienced across all genders. The gain in men’s apparel sales was driven by strong results in branded outerwear partially offset by declines in sales of private label and licensed apparel.

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Included in our 2017 division profit was a non-cash impairment charge of $20 million related to the write-down of primarily store fixtures and leasehold improvements.  SIX:02 recorded a charge of $16 million and our Runners Point and Sidestep stores recorded a charge of $4 million.  The effect of the impairment charges decreased the division profit rate by 30 basis points.  Most of the remaining decline in the division profit rate was related to a decrease in the merchandise margin rate reflecting higher markdowns coupled with an increase in the SG&A rate. The division profit decline was most pronounced in our European business. The 53rd week did not have a significant effect on the overall division profit rate.  



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 produced the best domestic performance, while internationally the increase was driven by our Foot Locker Europe operations. Partially offsetting these increases were declines in our 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. During 2016, we continued 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 2016, 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. 



Comparable-store sales increased by 3.6 percent as compared with 2015. Footwear sales continued 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 or Canada. The addition of these stores reflected our expectation that the momentum of our children’s business would 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 2016. 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 2016 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 non-cash 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 2015. The division profit rate improvement reflected an improved merchandise margin rate due to a lower markdown rate coupled with diligent expense management. 





2017 compared with 2016



Comparable-sales for the Direct-to-Customers segment increased 6.9 percent as compared with the prior year. The comparable-sales gain primarily reflected growth in our domestic and international store-banner e-commerce businesses coupled with an increase in our Eastbay business. Internationally, we continued to expand the geographies that we serve in 2017, including most notably launching our e-commerce business in Australia.





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The footwear category, across men’s, women’s and children’s, was the main driver for the overall comparable-sales gains experienced for this segment. Combined, apparel and accessories sales increased modestly. The men’s and women’s lifestyle running category and men’s basketball styles primarily drove the increase in footwear sales.  Additionally, the children’s footwear category contributed to the overall increase.



Direct-to-Customers division profit, as a percent of sales, declined 180 basis points as compared with the prior year. Although sales increased during the year, the gross margin rate declined as a result of increased markdowns due to a more promotional sales environment, including additional free shipping offers that reduced our shipping and handling revenue and thereby deteriorated our gross margin. The gross margin rate decline was partially offset by an expense rate improvement relating to lower marketing costs and incentive compensation. 



2016 compared with 2015



Comparable-sales for the Direct-to-Customers segment increased 8.8 percent as compared with 2015. Our domestic and international store-banner websites continued to represent the majority of the overall growth in sales, which was partially offset by declines in the Eastbay, Runners Point, and Sidestep e-commerce 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’s footwear was driven by casual styles.



Direct-to-Customers division profit, as a percent of sales, declined 100 basis points as compared with 2015. 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 decrease in the gross margin rate as a result of greater promotional activity by our domestic e-commerce business, especially Eastbay.  



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 $16 million, $14 million, and $11 million in 2017,  2016, and 2015, respectively.



The allocation of corporate expense to the operating divisions is adjusted annually based upon an internal study; accordingly, the allocation increased by $4 million in 2017, thus reducing corporate expense. Excluding the corporate allocation change, corporate expense decreased by $18 million as compared to 2016. This was primarily due to a $13 million decline in incentive compensation, which reflects the Company’s underperformance relative to its plan. Share-based compensation declined by $7 million and is also primarily related to the portion of share-based compensation that is tied directly to the Company’s performance. Additionally, the decline in corporate expense also reflects a decrease of $4 million relating to the prior-year corporate headquarters relocation costs. These decreases were partially offset by a $2 million litigation charge, increased corporate support costs, such as information technology and real estate management, and increased depreciation and amortization expense.  The effect of the 53rd week on corporate expense was not significant.



Corporate expense decreased by $7 million in 2016 as compared with 2015. 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 spent during 2015. The remaining change primarily reflected lower incentive compensation expense in 2016.



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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 February 3, 2018, we had $849 million of cash and cash equivalents, of which $669 million was held in foreign jurisdictions. After accounting for the deemed repatriation tax required by the Tax Act, our offshore cash can be repatriated without significant additional U.S. income tax cost. In connection with the Tax Act, the Company recorded a $99 million tax liability for the mandatory deemed repatriation of foreign sourced net earnings and related items. The tax for the mandatory deemed repatriation is payable over an 8 year period beginning with 2017, 8 percent is payable for years 1 to 5, 15 percent in year 6, 20 percent in year 7, and 25 percent in the final year.



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. As of February 3, 2018, approximately $758 million remained available under our current $1.2 billion share repurchase program.



On February 20, 2018, the Board of Directors declared a quarterly dividend of $0.345 per share to be paid on May 4, 2018, representing an 11 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 2017, in connection with our pension litigation, we recorded pre-tax charges of $178 million. The accrued amount as of February 3, 2018 was $278 million and is classified as a long-term liability. The Company has exhausted all legal remedies and will reform the pension plan. The Company will be working with the plaintiffs’ counsel and the court on the specific steps needed to implement the trial court’s judgment. During the fourth quarter of 2017, we deposited $150 million into a qualified settlement fund, classified as restricted cash. This settlement fund will be used for future pension contributions and plaintiffs’ legal costs related to the pension plan reformation. Also, the Company expects to make a $128 million contribution to the pension plan during 2018. The timing and the amount of actual 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 liquidity 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 2017 and 2016, we purchased approximately 93 percent and 91 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 67 percent in 2017 and 68 percent in 2016 was purchased from one supplier — Nike, Inc.



Planned capital expenditures in 2018 are $229 million and lease acquisition costs related to our operations in Europe are $1 million. Capital expenditures reflect $124 million dedicated to elevating our in-store experience through continued relocation and remodels in major cities and key markets. It also includes the remodeling and expansion of over 100 existing stores, as well as the planned opening of approximately 40 stores, primarily related to the continued expansion of Foot Locker in Europe and our entry into Asia in a limited number of locations.

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Planned spending for 2018 also includes $105 million for digital and other investments, including enhancements to our mobile and web platforms, the global roll-out of our new point-of-sale software, expanding data analytics capabilities, and supply chain initiatives. 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 financial 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.





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 decline in 2017 primarily reflects the decrease in net income partially offset by working capital improvements.  



During 2017, we contributed $25 million to our U.S. qualified pension plan. We contributed $33 million to our U.S. qualified pension plan and $3 million to our Canadian qualified pension plan in 2016. During 2015, we contributed $4 million to the U.S. qualified pension plan. The amounts and timing of pension contributions are dependent on several factors, including asset performance. Cash paid for income taxes was $237 million, $341 million, and $283 million for 2017,  2016, and 2015, respectively. 



Investing Activities





Capital expenditures in 2017 were $274 million, an increase of $8 million as compared with the prior year. The increase was due to increased spending on technology projects and cash payments related to the prior year capital program.  During 2017, we completed the remodeling or relocation of 183 existing stores and opened 94 new stores. As of the end of fiscal 2017, approximately 40 percent of our Foot Locker, Champs Sports, and Footaction stores have been remodeled to their respective new store formats. Capital expenditures in 2016 were $266 million, primarily related to the remodeling or relocation of 218 existing stores, and the build-out of 96 new stores. The increase in 2016 as compared with 2015 primarily related to our corporate headquarters build out and two new flagship stores.

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The Company invested $15 million in a privately-held company during 2017, which was accounted for as a cost method investment.



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.



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:





During 2017,  2016, and 2015, we repurchased 12,413,590 shares, 6,984,643 shares, and 6,693,100 shares of our common stock under our share repurchase programs, respectively. Additionally, the Company declared and paid dividends representing a quarterly rate of $0.31, $0.275, and $0.25 per share in 2017, 2016, and 2015, respectively. During 2017, 2016 and 2015, we paid $10 million, $7 million and $9 million, respectively, to satisfy tax withholding obligations relating to the vesting of share-based equity awards. Offsetting the amounts above were proceeds received from the issuance of common stock and treasury stock in connection with the employee stock programs of $18 million, $33 million, and $69 million for 2017, 2016, and 2015, respectively.



During 2016, we paid fees of $2 million in connection with the credit agreement, see below for further details. During 2016 and 2015, we made payments relating to capital lease obligations of $1 million and $2 million, 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 credit agreement with our banks (“2016 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 are paying 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 2018, other than amounts used to support standby letters of credit.



Credit Rating



As of March 29, 2018, 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.



Including the present value of operating leases, net debt capitalization percent increased 590 basis points in 2017, primarily reflecting the effect of new high-profile leases and ongoing lease renewals coupled with foreign exchange fluctuations. Also contributing to the net capitalization increase during 2017 was a $197 million decline in our cash and cash equivalents, which primarily reflected the $150 million deposit to a qualified settlement fund in connection with the pension litigation matter.



Contractual Obligations and Commitments



The following tables represent the scheduled maturities of the Company’s contractual cash obligations and other commercial commitments at February 3, 2018:







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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 February 3, 2018 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 have not entered into any transactions with unconsolidated entities that expose the Company to material continuing risks, contingent liabilities, or any other obligation under a variable interest in an unconsolidated entity.  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 and Goodwill



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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 2017, we recorded pre-tax charges of $178 million related to the pension plan litigation. We previously recorded a pre-tax charge of $100 million related to this matter in 2015.



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.  



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:



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 2017 would have resulted in a change of $1 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.



The Tax Act significantly changes how the U.S. taxes corporations. It requires complex computations to be performed that were not previously required in U.S. tax law, significant judgments to be made in interpretation of the provisions of the law and significant estimates in calculations, and the preparation and analysis of information not previously relevant or regularly produced. The U.S. Department of the Treasury, the Internal Revenue Service, and other standard-setting bodies could interpret or issue guidance on how provisions of the law will be applied or otherwise administered that is different from our interpretation underlying our income tax accruals. As we complete our analysis of the Tax Act, collect data and prepare the necessary calculations, and interpret any additional guidance, we may make adjustments to provisional amounts that we have recorded that may materially affect our provision for income taxes in the period in which the adjustments are made.



Excluding the effect of any nonrecurring items that may occur, we expect the 2018 effective tax rate to approximate 27.5 percent. 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 February 3, 2018 are included in the Summary of Significant Accounting Policies note in “Item 8. Consolidated Financial Statements and Supplementary Data.”

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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



To the Board of Directors and Shareholders of
Foot Locker, Inc.:

Opinion on the Consolidated Financial Statements

We have audited the accompanying consolidated balance sheets of Foot Locker, Inc. and subsidiaries (the “Company”) as of February 3, 2018 and January 28, 2017, the related consolidated statements of operations, comprehensive income, stockholders’ equity, and cash flows for each of the years in the three‑year period ended February 3, 2018 and the related notes (collectively, the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of February 3, 2018 and January 28, 2017, and the results of its operations and its cash flows for each of the years in the three‑year period ended February 3, 2018, 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) (PCAOB), the Company’s internal control over financial reporting as of February 3, 2018, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission”, and our report dated March 29, 2018 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

Basis for Opinion

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 are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.



/s/ KPMG LLP



We have served as the Company’s auditor since 1995.



New York, New York

March 29, 2018 



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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.