Edgar Filing: FOOT LOCKER INC

New York

13-3513936

(State or other jurisdiction of

(I.R.S. Employer Identification No.)

incorporation or organization)

112 West 34^th Street, New York, New York

(Address of principal executive offices)

(Zip Code)

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

Annual Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934

For the fiscal year ended January 29, 2005

Commission file number 1-10299

FOOT LOCKER, INC.

(Exact name of Registrant as specified in its charter)

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

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

Title of each class				Name of each exchange on which registered
Common Stock, par value $0.01				New York Stock Exchange

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

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 [X] 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. [X]

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes [X] No [ ]

See pages 59 through 63 for Index of Exhibits.

Number of shares of Common Stock outstanding at March 18, 2005:					156,355,058
The aggregate market value of voting stock held by non-affiliates of the Registrant computed by reference to the closing price as of the last business day of the Registrant’s most recently completed second fiscal quarter, July 31, 2004, was approximately:				$	2,600,112,397	*

For purposes of this calculation only (a) all directors plus one executive officer and owners of five percent or more of the Registrant are deemed to be affiliates of the Registrant and (b) shares deemed to be “held” by such persons at July 31, 2004 include only outstanding shares of the Registrant’s voting stock with respect to which such persons had, on such date, voting or investment power.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant’s definitive Proxy Statement (the “Proxy Statement”) to be filed in connection with the 2005 Annual Meeting of Shareholders: Parts III and IV.

TABLE OF CONTENTS

PART I

Item 1	Business	1
Item 2	Properties	2
Item 3	Legal Proceedings	2
Item 4	Submission of Matters to a Vote of Security Holders	2

PART II

Item 5	Market for the Company’s Common Equity and Related Stockholder Matters and Issuer Purchases of Equity Securities	3
Item 6	Selected Financial Data	3
Item 7	Management’s Discussion and Analysis of Financial Condition and Results of Operations	3
Item 7A	Quantitative and Qualitative Disclosures about Market Risk	17
Item 8	Consolidated Financial Statements and Supplementary Data	18
Item 9	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	56
Item 9A	Controls and Procedures	56

PART III

Item 10	Directors and Executive Officers of the Company	56
Item 11	Executive Compensation	57
Item 12	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	57
Item 13	Certain Relationships and Related Transactions	57
Item 14	Principal Accountant Fees and Services	57

PART IV

Item 15	Exhibits and Financial Statement Schedules	57

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 athletic footwear and apparel, operating as of January 29, 2005, 3,967 primarily mall-based stores in the United States, Canada, Europe and Asia Pacific, which includes Australia and New Zealand. Foot Locker, Inc. and its subsidiaries hereafter are referred to as the “Registrant” or “Company.” 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 Securities and Exchange Commission, 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 112 West 34^th Street, New York, NY 10120. The Company intends to disclose promptly amendments to the Code of Business Conduct and Waivers of the Code for directors and executive officers on the corporate governance section of the Company’s corporate website.

The Certification of the Chief Executive Officer required by Section 303A.12(a) of The New York Stock Exchange Listing Standards relating to the Company’s compliance with The New York Stock Exchange Corporate Governance Listing Standards was submitted to The New York Stock Exchange on June 15, 2004.

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” footnote in “Item 8. Consolidated Financial Statements and Supplementary Data.”

The service marks and trademarks appearing on this page and elsewhere in this report (except for ESPN, NFL, NBA, Nike, Amazon.com, Burger King, Popeye’s, The San Francisco Music Box Company and USOC) are owned by Foot Locker, Inc. or its subsidiaries.

Employees

The Company and its consolidated subsidiaries had 16,562 full-time and 27,547 part-time employees at January 29, 2005. The Company considers employee relations to be satisfactory.

Competition

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

Merchandise Purchases

The 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” footnote in “Item 8. Consolidated Financial Statements and Supplementary Data.”

Item 2.

Properties

The properties of the Company and its consolidated subsidiaries consist of land, leased and owned stores and administrative and distribution facilities. Total selling area for the Athletic Stores segment at the end of 2004 was approximately 8.89 million square feet. These properties are primarily located in the United States, Canada, various European countries, Australia and New Zealand.

The Company currently operates three distribution centers, of which one is owned and two are leased, occupying an aggregate of 2.12 million square feet. Two of the three distribution centers are located in the United States and one is in Europe. The Company also has two additional distribution centers that are leased and partly sublet, occupying approximately 0.26 million square feet.

Item 3.

Legal Proceedings

Legal proceedings pending against the Company or its consolidated subsidiaries consist of ordinary, routine litigation, including administrative proceedings, incident to the businesses of the Company, as well as litigation incident to the sale and disposition of businesses that have occurred in the past several years. Management does not believe that the outcome of such proceedings will have a material effect on the Company’s consolidated financial position, liquidity, or results of operations.

Item 4.

Submission of Matters to a Vote of Security Holders

There were no matters submitted to a vote of security holders during the fourth quarter of the year ended January 29, 2005.

Executive Officers of the Company

Information with respect to Executive Officers of the Company, as of March 28, 2005, is set forth below:

Chairman of the Board, President and Chief Executive Officer				Matthew D. Serra
Executive Vice President and Chief Financial Officer				Bruce L. Hartman
President and Chief Executive Officer, Foot Locker, Inc. — U.S.A.				Richard T. Mina
Senior Vice President, General Counsel and Secretary				Gary M. Bahler
Senior Vice President — Real Estate				Jeffrey L. Berk
Senior Vice President — Chief Information Officer				Marc D. Katz
Senior Vice President — Strategic Planning				Lauren B. Peters
Senior Vice President — Human Resources				Laurie J. Petrucci
Vice President — Investor Relations and Treasurer				Peter D. Brown
Vice President and Chief Accounting Officer				Robert W. McHugh

Matthew D. Serra, age 60, has served as Chairman of the Board since February 1, 2004, President since April 12, 2000 and Chief Executive Officer since March 4, 2001. Mr. Serra served as Chief Operating Officer from February 2000 to March 3, 2001 and as President and Chief Executive Officer of Foot Locker Worldwide from September 1998 to February 2000.

Bruce L. Hartman, age 51, has served as Executive Vice President since April 18, 2002 and Chief Financial Officer since February 27, 1999. He served as Senior Vice President from February 1999 to April 2002.

Richard T. Mina, age 48, has served as President and Chief Executive Officer of Foot Locker, Inc.- U.S.A. since February 2, 2003. He served as President and Chief Executive Officer of Champs Sports, an operating division of the Company, from April 1999 to February 1, 2003.

Gary M. Bahler, age 53, has served as Senior Vice President since August 1998, General Counsel since February 1993 and Secretary since February 1990.

Jeffrey L. Berk, age 49, has served as Senior Vice President — Real Estate since February 2000.

Marc D. Katz, age 40, has served as Senior Vice President — Chief Information Officer since May 12, 2003. Mr. Katz served as Vice President and Chief Information Officer from July 2002 to May 11, 2003. During the period of 1999 to 2002, he served in the following capacities at the Financial Services Center of Foot Locker Corporate Services: Vice President and Controller from July 2001 to April 2002 and Controller from December 1999 to July 2001.

Lauren B. Peters, age 43, has served as Senior Vice President — Strategic Planning since April 18, 2002. Ms. Peters served as Vice President — Planning from January 2000 to April 17, 2002.

Laurie J. Petrucci, age 46, has served as Senior Vice President — Human Resources since May 2001. Ms. Petrucci served as Senior Vice President — Human Resources of Foot Locker Worldwide from March 2000 to April 2001. She served as Vice President of Organizational Development and Training of Foot Locker Worldwide from February 1999 to March 2000.

Peter D. Brown, age 50, has served as Vice President — Investor Relations and Treasurer since October 2001. Mr. Brown served as Vice President — Investor Relations and Corporate Development from April 2001 to October 2001 and as Assistant Treasurer — Investor Relations and Corporate Development from August 2000 to April 2001. He served as Vice President and Chief Financial Officer of Lady Foot Locker from October 1999 to August 2000.

Robert W. McHugh, age 46, has served as Vice President and Chief Accounting Officer since January 2000.

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

PART II

Item 5.

Market for the Company’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Information regarding the Company’s market for stock exchange listings, common equity, quarterly high and low prices and dividend policy are contained in the “Shareholder Information and Market Prices” footnote under “Item 8. Consolidated Financial Statements and Supplementary Data.”

This table provides information with respect to purchases by the Company of shares of its Common Stock during the fourth quarter of 2004:

		Average Price Paid per Share⁽¹⁾
Oct. 31, 2004 through Nov. 27, 2004	—	$	—	—	$50,000,000
Nov. 28, 2004 through Jan. 1, 2005	6,670		26.28	—	50,000,000
Jan. 2, 2005 through Jan. 29, 2005	—		—	—	50,000,000
Total	6,670	$	26.28	—

(1)

These columns reflect shares purchased through option exercises by stock swaps.

(2)

On November 20, 2002, the Company announced that the Board of Directors authorized the purchase of up to $50 million of the Company’s Common Stock; no purchases have been made under this program. This authorization will terminate on February 3, 2006.

Item 6.

Selected Financial Data

Selected financial data is included as the “Five Year Summary of Selected Financial Data” footnote in “Item 8. Consolidated Financial Statements and Supplementary Data.”

Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Business Overview

Foot Locker, Inc., through its subsidiaries, operates in two reportable segments — Athletic Stores and Direct-to-Customers. The Athletic Stores segment is one of the largest athletic footwear and apparel retailers in the world, whose formats include Foot Locker, Lady Foot Locker, Kids Foot Locker, Champs Sports and Footaction (beginning May 2004). The Direct-to-Customers segment reflects Footlocker.com, Inc., which sells, through its affiliates, including Eastbay, Inc., to customers through catalogs and Internet websites.

The Foot Locker brand is one of the most widely recognized names in the market segments in which the Company operates, epitomizing high quality for the active lifestyle customer. This brand equity has aided the Company’s ability to successfully develop and increase its portfolio of complementary retail store formats, specifically, Lady Foot Locker and Kids Foot Locker, as well as Footlocker.com, Inc., its direct-to-customers business. Through various marketing channels,

including television campaigns and sponsorships of various sporting events, Foot Locker, Inc. reinforces its image with a consistent message: namely, that it is the destination store for athletic apparel and footwear with a wide selection of merchandise in a full-service environment.

Athletic Stores

The Company operates 3,967 stores in the Athletic Stores segment. The following is a brief description of the Athletic Stores segment’s operating businesses:

Foot Locker — Foot Locker is a leading athletic footwear and apparel retailer. Its stores offer the latest in athletic-inspired performance products, manufactured primarily by the leading athletic brands. Foot Locker offers products for a wide variety of activities including running, basketball, hiking, tennis, aerobics, fitness, baseball, football and soccer. Its 2,135 stores are located in 18 countries including 1,428 in the United States, Puerto Rico, the United States Virgin Islands and Guam, 130 in Canada, 485 in Europe and a combined 92 in Australia and New Zealand. The domestic stores have an average of 2,400 selling square feet and the international stores have an average of 1,500 selling square feet.

Champs Sports — Champs Sports is one of the largest mall-based specialty athletic footwear and apparel retailers in the United States. Its product categories include athletic footwear, apparel and accessories, and a focused assortment of equipment. This combination allows Champs Sports to differentiate itself from other mall-based stores by presenting complete product assortments in a select number of sporting activities. Its 570 stores are located throughout the United States and Canada. The Champs Sports stores have an average of 3,800 selling square feet.

Footaction — Footaction is a national athletic footwear and apparel retailer that offers street-inspired fashion styles. The primary customers are young urban males with the secondary customers being young urban women with diverse fashion needs. Its 349 stores are located throughout the United States and Puerto Rico and focus on marquee allocated footwear and branded apparel. The Footaction stores have an average of 3,000 selling square feet.

Lady Foot Locker — Lady Foot Locker is a leading U.S. retailer of athletic footwear, apparel and accessories for women. Its stores carry all major athletic footwear and apparel brands, as well as casual wear and an assortment of proprietary merchandise designed for a variety of activities, including running, basketball, walking and fitness. Its 567 stores are located in the United States and Puerto Rico and have an average of 1,200 selling square feet.

Kids Foot Locker — Kids Foot Locker is a national children’s athletic retailer that offers the largest selection of brand-name athletic footwear, apparel and accessories for infants, boys and girls, primarily on an exclusive basis. Its stores feature an entertaining environment geared to both parents and children. Its 346 stores are located in the United States and Puerto Rico and have an average of 1,400 selling square feet.

Store Profile


Foot Locker	2,088	11	84	48	2,135
Champs Sports	581	—	5	16	570
Footaction	—	349	4	4	349
Lady Foot Locker	584	—	2	19	567
Kids Foot Locker	357	—	1	12	346

Total Athletic Stores	3,610	360	96	99	3,967

Direct-to-Customers

Footlocker.com — Footlocker.com, Inc., sells, through its affiliates, directly to customers through catalogs and its Internet websites. Eastbay, Inc., one of its affiliates, is one of the largest direct marketers of athletic footwear, apparel, equipment and team licensed private-label merchandise in the United States and provides the Company’s seven full-service e-commerce sites access to an integrated fulfillment and distribution system. The Company has an agreement with the National Football League (NFL) as its official catalog and e-commerce retailer, which includes managing the NFL catalog and e-commerce businesses. Footlocker.com designs, merchandises and fulfills the NFL’s official catalog (NFL Shop) and the e-commerce site linked to www.NFLshop.com. The Company has a strategic alliance to offer footwear and apparel on

the Amazon.com website and the Foot Locker brands are featured in the Amazon.com specialty stores for apparel and accessories and sporting goods. The Company also has an arrangement with the NBA and Amazon.com whereby Footlocker.com provides the fulfillment services for NBA licensed products sold over the Internet at NBAstore.com and the NBA store on Amazon.com. In addition, the Company has a marketing agreement with the U.S. Olympic Committee (USOC) providing the Company with the exclusive rights to sell USOC licensed products through catalogs and via a new e-commerce site. During the fourth quarter of 2004, the Company entered into an agreement with ESPN for ESPN Shop — an ESPN-branded direct mail catalog and e-commerce site linked to www.ESPNshop.com, where fans can purchase athletic footwear, apparel and equipment which will be managed by Footlocker.com. Both the catalog and the e-commerce site feature a variety of ESPN-branded and non-ESPN-branded athletically inspired merchandise.

Executive Summary

The Company reported income from continuing operations for the year ended January 29, 2005 of $255 million, or $1.64 per diluted share, an increase of 22 percent as compared with 2003. Net income for the year ended January 29, 2005 increased to $293 million, or $1.88 per diluted share, and includes $0.24 per diluted share from discontinued operations. Earnings per share of $0.24 or $38 million in discontinued operations reflects the resolution of U.S. income tax examinations of $37 million, as well as income of $1 million related to a refund of custom duties related to certain of the businesses that comprised the Specialty Footwear segment.

Sales

All references to comparable-store sales for a given period relate to sales of stores that are open at the period-end and that have been open for more than one year and exclude the effect of foreign currency fluctuations. Accordingly, stores opened and closed during the period are not included. Sales from the Direct-to-Customer segment are included in the calculation of comparable-store sales for all periods presented. All references to comparable-store sales for 2004 exclude the acquisition of the 349 Footaction stores and the 11 stores purchased in the Republic of Ireland. Sales from acquired businesses that include the purchase of inventory will be included in the computation of comparable-store sales after 15 months of operations. Accordingly, Footaction sales will be included in the computation of comparable-store sales beginning in August 2005.

The following table summarizes sales by segment:

	2004		2003		2002
	(in millions)
Athletic Stores	$	4,989	$	4,413	$	4,160
Direct-to-Customers		366		366		349
	$	5,355	$	4,779	$	4,509

Sales of $5,355 million in 2004 increased by 12.1 percent from sales of $4,779 million in 2003. Excluding the effect of foreign currency fluctuations, sales increased by 9.8 percent as compared with 2003, primarily as a result of the Company’s acquisition of 349 Footaction stores in May 2004 and the acquisition of 11 stores in the Republic of Ireland in late October 2004, which accounted for $332 million and $5 million in sales, respectively, for 2004. Comparable-store sales increased by 0.9 percent. The remaining increase is a result of the Company’s continuation of the new store-opening program.

Sales of $4,779 million in 2003 increased by 6.0 percent from sales of $4,509 million in 2002. Excluding the effect of foreign currency fluctuations, sales increased by 2.2 percent as compared with 2002, primarily as a result of the Company’s continuation of the new store-opening program. Comparable-store sales decreased by 0.5 percent.

Gross Margin

Gross margin as a percentage of sales was 30.5 percent in 2004, decreasing by 50 basis points from 31.0 percent in 2003. Of the 50 basis points decrease in 2004, approximately 60 basis points is the result of the Footaction chain, offset, in part, by a decrease in the cost of merchandise. The effect of vendor allowances on gross margin, as a percentage of sales, as compared with the corresponding prior year period was not significant.

Gross margin as a percentage of sales was 31.0 percent in 2003, an increase of 110 basis points in 2003 from 29.9 percent in 2002. This change primarily reflected a decrease in the cost of merchandise, as a percentage of sales. Increased vendor allowances improved gross margin, as a percentage of sales, by 28 basis points, year over year.

Division Profit

The Company evaluates performance based on several factors, the primary financial measure of which is division profit. Division profit reflects income from continuing operations before income taxes, corporate expense, non-operating income and net interest expense. The following table reconciles division profit by segment to income from continuing operations before income taxes.

	2004			2003				2002
	(in millions)
Athletic Stores	$	420		$	363		$279
Direct-to-Customers		45			53		40
Division profit		465			416		319
Restructuring (charges) income ⁽¹⁾		(2	)		(1	)	2
Total division profit		463			415		321
Corporate expense		(74	)		(73	)		(52	)
Total operating profit		389			342		269
Non-operating income ⁽²⁾		—			—		3
Interest expense, net		(15	)		(18	)	(26)
Income from continuing operations before income taxes	$	374		$	324		$ 246

(1)

As more fully described in the notes to the consolidated financial statements, restructuring charges of $2 million and $1 million in 2004 and 2003, respectively, were recorded related to the dispositions of non-core businesses. Restructuring income of $2 million in 2002 reflects revisions to estimates used in the disposition of non-core businesses and the accelerated store-closing program.

(2)

2002 includes $2 million gain related to the condemnation of a part-owned and part-leased property for which the Company received proceeds of $6 million and real estate gains from the sale of corporate properties of $1 million during 2002.

Segment Information

Athletic Stores

	2004			2003
	(in millions)
Sales	$	4,989		$	4,413		$4,160

Division profit
Stores	$	420		$	363		$279
Restructuring income		—			—		1

Total division profit	$	420		$	363		$ 280

Sales as a percentage of consolidated total		93	%		92	%	92%
Number of stores at year end		3,967			3,610		3,625
Selling square footage (in millions)		8.89			7.92		8.04
Gross square footage (in millions)		14.78			13.14		13.22

2004 compared with 2003

Athletic Stores sales of $4,989 million increased 13.1 percent in 2004, as compared with $4,413 million in 2003. Excluding the effect of foreign currency fluctuations, primarily related to the euro, sales from athletic store formats increased 10.6 percent in 2004. This increase was primarily driven by incremental sales related to the acquisition of the 349 Footaction stores in May 2004 totaling $332 million and the sales of the 11 stores acquired in the Republic of Ireland amounting to $5 million. The balance of the increase primarily reflects new store growth. Total Athletic Stores comparable-store sales increased by 1.0 percent in 2004.

The Company benefited from continued exclusive offerings from its primary suppliers, gaining access to greater amounts of marquee products, and a developing trend towards higher priced technical footwear.

Division profit from Athletic Stores increased by 15.7 percent to $420 million in 2004 from $363 million in 2003. Division profit, as a percentage of sales, increased to 8.4 percent in 2004 from 8.2 percent in 2003. The increase in 2004 was primarily driven by the overall improvement in the selling, general and administrative (“SG&A”) rate as a result of better expense control. SG&A, as a percentage of sales, declined to 18.8 percent in 2004, as compared with 19.1 percent in the prior year. Operating performance improved in all of the formats that comprised the Athletic Stores segment. European operations improved as compared with the prior year, despite a more promotional environment. Additionally, Champs Sports and Lady Foot Locker improved considerably during 2004. Lady Foot Locker benefited from its modified merchandise assortment. For the year ended January 29, 2005, the Footaction format negatively affected division profit by 80 basis points. This was primarily the result of a lower gross margin rate as compared with the Athletic Stores segment largely related to higher occupancy costs as compared with the Athletic Stores segment as a whole.

2003 compared with 2002

Athletic Stores sales of $4,413 million increased 6.1 percent in 2003, as compared with $4,160 million in 2002. Excluding the effect of foreign currency fluctuations, primarily related to the euro, sales from athletic store formats increased 1.9 percent in 2003, driven by the Company’s new store opening program, particularly in Foot Locker Europe and Foot Locker Australia. Foot Locker Europe and Foot Locker Australia also continued to generate solid comparable-store sales increases. Total Athletic Stores comparable-store sales decreased by 0.9 percent in 2003.

Footwear sales in the U.S. were led by the classic category. Consumer demand for “retro” fashioned athletic footwear was also a primary driver of sales throughout 2003. The Company also benefited from exclusive offerings from its primary suppliers, such as the Nike 20 pack line in the latter part of 2003. Sales of private label and licensed product also contributed to the increase in sales, as consumer interest began to show improvement with the strengthening of the economy.

Comparable-store sales at Kids Foot Locker continuously improved since its realignment under the Foot Locker U.S. management team in 2002. Kids Foot Locker’s sales significantly improved during the fourth quarter of 2003, nearly reaching double-digit comparable-store sales increases. Lady Foot Locker sales remained essentially unchanged in 2003 versus the prior year as this business continued to modify its merchandising mix to better suit its target customers. The Company closed a number of underperforming stores, focused on remodeling and relocating numerous stores, and changed its merchandise assortment.

Division profit from Athletic Stores increased by 30.1 percent to $363 million in 2003 from $279 million in 2002. Division profit as a percentage of sales increased to 8.2 percent in 2003 from 6.7 percent in 2002. The increase in 2003 was primarily driven by the overall improvement in the gross margin rate as a result of better merchandise purchasing as well as increased vendor allowances that contributed 30 basis points to the overall improvement. Additionally, during 2002 the Company recorded $7 million of impairment charges for the Kids Foot Locker and Lady Foot Locker formats. Operating performance improved in the U.S. Foot Locker, Kids Foot Locker and international formats as compared with the prior year. Champs Sports and Lady Foot Locker remained relatively flat as compared with 2002. However, for the second half of 2003 the operating results of the Lady Foot Locker format improved considerably, compared with the corresponding prior year period.

Direct-to-Customers

	2004			2003			2002
	(in millions)
Sales	$	366		$	366		$	349
Division profit	$	45		$	53		$	40
Sales as a percentage of consolidated total		7	%		8	%		8	%

2004 compared with 2003

Direct-to-Customers sales were $366 million in both 2004 and 2003. The growth of the Internet business continued to drive sales in 2004. Internet sales increased by 11.0 percent to $212 million from $191 million in 2003. Catalog sales decreased by 12.0 percent to $154 million in 2004 from $175 million in 2003. Management believes that the decrease in catalog sales which was substantially offset by the increase in Internet sales resulted as customers continue to browse and select products through its catalogs, then make their purchases via the Internet. The Company continues to implement new initiatives to increase this business, including new marketing arrangements and strategic alliances with well-known third parties. During the fourth quarter of 2004, a new agreement was reached with ESPN whereby the Company manages the ESPN Shop — an ESPN-branded direct mail catalog and e-commerce destination where fans can purchase athletic footwear, apparel and equipment.

The Direct-to-Customers business generated division profit of $45 million in 2004, as compared with $53 million in 2003. The decrease in division profit is a result of expanded catalog circulation expenses in 2004. Division profit, as a percentage of sales, decreased to 12.3 percent from 14.5 percent, however, the Direct-to-Customer business remains more profitable than the Company’s Athletic Stores segment.

2003 compared with 2002

Direct-to-Customers sales increased 4.9 percent in 2003 to $366 million as compared with $349 million in 2002, driven by the growth of the Internet business. Internet sales increased by 32.6 percent to $191 million from $144 million in 2002. Catalog sales declined by 14.6 percent to $175 million in 2003 from $205 million in 2002. During 2003, the Company extended its agreement with the NFL, entered into new alliance agreements with the NBA and the USOC and expanded its services through on-line specialty stores with Amazon.com. These agreements generally provide for the Company to merchandise, fulfill and manage the websites of these strategic partners.

The Direct-to-Customers business generated division profit of $53 million in 2003, as compared with $40 million in 2002. The increase in division profit was primarily due to increased sales. Division profit, as a percentage of sales, increased to 14.5 percent in 2003 from 11.5 percent in 2002.

Corporate Expense

Corporate expense consists of unallocated general and administrative expenses related to the Company’s corporate headquarters, centrally managed departments, unallocated insurance and benefit programs, certain foreign exchange transaction gains and losses, certain depreciation and amortization expenses and other items.

The increase in corporate expense of $1 million in 2004 comprised several items, and primarily included decreased incentive bonuses of $9 million, offset by increased expenses related to integration costs of $5 million, restricted stock expense from additional grants of $4 million and costs of $3 million related to the Company’s expanded loyalty program. Integration costs represent incremental costs directly related to the acquisitions, primarily expenses to re-merchandise the Footaction stores during the first three months of operations. Depreciation and amortization included in corporate expense, amounted to $23 million in 2004, $25 million in 2003 and $26 million in 2002. The increase in corporate expense in 2003 as compared with 2002 was primarily related to increased compensation costs for incentive bonuses and increased restricted stock expense from additional grants.

Costs and Expenses

Selling, General and Administrative Expenses

SG&A increased by $101 million to $1,088 million in 2004, or by 10.2 percent, as compared with 2003. Excluding the effect of foreign currency fluctuations, primarily related to the euro, SG&A increased by $82 million, of which the acquired businesses contributed $68 million. Increased payroll and related costs primarily comprised the balance of the increase. SG&A as a percentage of sales decreased to 20.3 percent compared with 20.7 percent in 2003. Pension expense declined by $2 million primarily as a result of the positive market performance experienced in the prior year. Additionally, postretirement income decreased by $2 million in 2004 as compared with 2003 as the amortization of the unrecognized gains, which are amortized over the average remaining life expectancy, continues to decrease over time.

SG&A increased by $59 million to $987 million in 2003, or by 6.4 percent, as compared with 2002. Excluding the effect of foreign currency fluctuations, primarily related to the euro, SG&A increased by 2.7 percent. The increases were for additional payroll costs of $16 million in Europe, primarily as a result of new store openings and $12 million related to compensation costs for incentive bonuses due to the Company’s performance. Additionally, pension expense increased by $8 million due to the decline in plan asset values experienced in prior years, partially offset by a $4 million increase in the recognition of postretirement income and foreign exchange gain recorded in 2002. During 2002, the Company recorded asset impairment charges of $6 million and $1 million related to the Kids Foot Locker and Lady Foot Locker formats, respectively. SG&A as a percentage of sales remained relatively flat compared with 2002.

Depreciation and Amortization

Depreciation and amortization of $154 million increased by 1.3 percent in 2004 from $152 million in 2003. Depreciation and amortization of acquired businesses amounted to $7 million for 2004. These increases were offset by declines that were a result of older assets becoming fully depreciated.

Depreciation and amortization of $152 million in 2003 remained relatively flat as compared with $153 million in 2002. Excluding the effect of foreign currency fluctuations, depreciation and amortization declined by $4 million. The decrease relates primarily to assets becoming fully depreciated for the U.S. Athletic stores, offset in part by an increase related to the European new stores.

Interest Expense, Net

	2004			2003			2002
	(in millions)
Interest expense	$	22		$	26		$	33
Interest income		(7	)		(8	)		(7	)
Interest expense, net	$	15		$	18		$	26

Weighted-average interest rate (excluding facility fees):
Short-term debt		—	%		—	%		—	%
Long-term debt		5.2	%		6.1	%		7.2	%
Total debt		5.2	%		6.1	%		7.2	%

Short-term debt outstanding during the year:
High	$	—		$	—		$	—
Weighted-average	$	—		$	—		$	—

Interest expense of $22 million declined by 15.4 percent in 2004 from $26 million in 2003. The decrease in 2004 was primarily attributable to the Company’s $150 million 5.50 percent convertible subordinated notes that were converted to equity in June 2004. Also contributing to the reduction in interest expense was the repurchase of $19 million of the 8.50 percent debentures payable in 2022 in the latter part of 2003. The Company continued to utilize interest rate swap agreements, which reduced interest expense by approximately $3 million and $4 million in 2004 and 2003, respectively. These decreases were offset, in part, by an increase resulting from the interest on the $175 million term loan that commenced in May 2004.

Interest income is generated through the investment of cash equivalents, short-term investments, the accretion of the Northern Group note to its face value and accrual of interest on the outstanding principal, as well as, interest on income tax refunds. The decrease in interest income of $1 million in 2004 was primarily related to the reduction of interest income earned on tax refunds and settlements as they were received during 2003. The Northern Group note was recorded in the fourth quarter of 2002 and interest income amounted to $2 million in both 2004 and 2003. Interest income related to cash equivalents and short-term investments was $5 million in 2004 and 2003.

Interest expense of $26 million declined in 2003 by 21.2 percent from $33 million in 2002. Interest expense related to long-term debt declined by $6 million primarily as a result of the $100 million of interest rate swaps that were outstanding during 2003. These interest rate swaps were entered into to effectively convert a portion of the 8.50 percent fixed-rate debentures, due in 2022, to a lower variable rate. The Company entered into a $50 million interest rate swap agreement in December 2002 and subsequently entered into two additional swaps during 2003, totaling $50 million, to convert $50 million of the 8.50 percent debentures to a variable rate debt which allowed the Company to lower the net amount of interest expense being paid at each interest payment date. The swaps reduced interest expense by approximately $4 million. The remaining decrease is a result of the lower debt balance as the Company repurchased $19 million of the 8.50 percent debentures in 2003 and $9 million in the latter part of 2002. Interest expense in 2003 was further reduced as a result of the repayment of the remaining $32 million of the $40 million 7.00 percent medium-term notes that matured in October 2002.

Interest income related to cash equivalents and short-term investments amounted to $5 million in both 2003 and 2002. Additional interest income on the Northern Group note in 2003 was $2 million. Interest income of $1 million and $2 million was related to tax refunds and settlements in 2003 and 2002, respectively.

Income Taxes

The effective tax rate for 2004 was 31.7 percent, as compared with 35.5 percent in the prior year. The reduction was principally related to a lower rate of tax on the Company’s foreign operations and the settlement of tax examinations.

During the second quarter of 2004 the Commonwealth of Puerto Rico concluded an examination of the Company’s branch income tax returns, including an income tax audit for the years 1994 through 1999 and a branch profit tax audit for the years 1994 through 2002. As a result, the Company reduced its income tax provision for continuing operations by $2 million. Also, during the second quarter of 2004, the IRS completed its survey of the Company’s income tax returns for the years from 1999-2001 and its examination of the 2002 year. The IRS and the Company also came to an agreement on the pre-filing review of the Company’s income tax return for 2003. As a result of these actions by the IRS, the Company reduced its income tax provision for continuing operations by $7 million and discontinued operations by $37 million. During the third quarter of 2004 the IRS completed its post-filing review of the Company’s income tax return for 2003 resulting in a $2 million reduction to the income tax provision. During the fourth quarter of 2004 the Company completed an analysis of the effect of the completion of the IRS’s examination and review of the Company’s income tax returns. This analysis resulted in a reduction to the income tax provision of $3 million.

The effective rate for 2003 was 35.5 percent, as compared with 34.2 percent in 2002. The increased tax rate was primarily due to the Company recording tax benefits of $5 million in 2003 as compared to $9 million in 2002. In addition the rate increased due to a shift in taxable income from lower to higher tax jurisdictions. During 2003, the Company recorded a $1 million tax benefit related to state tax law changes, a $2 million tax benefit related to a reduction in the valuation allowance for deferred tax assets related to a multi-state tax planning strategy, a $1 million tax benefit related to a reduction in the valuation allowance for foreign tax loss carryforwards, and a tax benefit of $1 million related to the settlement of tax examinations.

The effective rate for 2002 was 34.2 percent. The Company recorded a tax benefit during 2002 of $5 million related to a multi-state tax planning strategy, a $1 million tax benefit related to settlement of tax examinations, a $2 million benefit related to the reduction in the valuation allowance for deferred tax assets related to foreign tax credits and a $1 million benefit related to international tax planning strategies. The combined effect of these items, in addition to higher earnings in lower tax jurisdictions and the utilization of tax loss carryforwards, reduced the effective tax rate.

Liquidity and Capital Resources

Liquidity

Generally, the Company’s primary source of cash has been from operations. The Company usually finances real estate with operating leases. The principal uses of cash have been to finance inventory requirements, capital expenditures related to store openings, store remodelings and management information systems, and to fund other general working capital requirements.

Management believes operating cash flows and current credit facilities will be adequate to finance its working capital requirements, to make scheduled pension contributions for the Company’s retirement plans, to fund quarterly dividend payments, to make scheduled debt repayments, and to support the development of its short-term and long-term operating strategies. The Company expects to contribute an additional $22 million to its U.S. and Canadian qualified pension plans during fiscal 2005, of which $19 million was made on February 4, 2005. Planned capital expenditures for 2005 are $165 million, of which $143 million relates to new store openings and modernizations of existing stores and $22 million reflects the development of information systems and other support facilities. In addition, planned lease acquisition costs are $5 million and primarily relate to the Company’s operations in Europe. The Company has the ability to revise and reschedule the anticipated capital expenditure program, should the Company’s financial position require it.

Maintaining access to merchandise that the Company considers appropriate for its business may be subject to the policies and practices of its key vendors. Therefore, the Company believes that it is critical to continue to maintain satisfactory relationships with its key vendors. The Company purchased approximately 74 percent in 2004 and 73 percent in 2003 of its merchandise from its top five vendors, in each respective year, and expects to continue to obtain a significant percentage of its athletic product from these vendors in future periods. Of that amount, approximately 45 percent in 2004 and 40 percent in 2003 was purchased from one vendor — Nike, Inc. (“Nike”) — and 13 percent and 14 percent from another in 2004 and 2003, respectively.

Any materially adverse change in customer demand, fashion trends, competitive market forces or customer acceptance of the Company’s merchandise mix and retail locations, uncertainties related to the effect of competitive products and pricing, the Company’s reliance on a few key vendors for a significant portion of its merchandise purchases, risks associated with foreign global sourcing or economic conditions worldwide could affect the ability of the Company to continue to fund its needs from business operations.

Cash Flow

Operating activities from continuing operations provided cash of $289 million in 2004 as compared with $264 million in 2003. These amounts reflect income from continuing operations adjusted for non-cash items and working capital changes. The net increase is primarily related to the increase in net income as compared with the prior year, offset in part by an additional $56 million in pension contributions and increased working capital usage. Merchandise inventories increased by $120 million to support the recent acquisitions, offset by an increase in accounts payable. The change in other, net primarily reflects a prepaid income tax that represents an overpayment of tax which the Company will apply to its 2005 payments.

Operating activities from continuing operations provided cash of $264 million in 2003 as compared with $347 million in 2002. The decrease was primarily the result of a $50 million pension contribution and increased working capital, partially offset by increased income from continuing operations. Net income increased by $54 million in 2003. Working capital usage included higher net cash outflow for merchandise inventories in 2003 as compared with 2002 and the Company increased its inventory position to accommodate anticipated sales in 2004. The decrease in income taxes payable was attributable to increased payments made during 2003. The Company received a refund of tax and interest of $13 million during the fourth quarter of 2003.

Net cash used in investing activities of the Company’s continuing operations was $424 million in 2004 compared with $265 million in 2003. During 2004, the Company paid $226 million for the purchase of 349 Footaction stores from Footstar, Inc. and paid €13 million (approximately $17 million, of which $1 million remains to be paid) for the purchase of 11 stores in the Republic of Ireland. The Company’s purchase of short-term investments, net of sales, increased by $9 million in 2004 as compared with an increase of $106 million in 2003. Capital expenditures of $156 million in 2004 and $144 million in 2003 primarily related to store remodelings and new stores. Lease acquisition costs, primarily to secure and extend leases for prime locations in Europe, were $17 million and $15 million in 2004 and 2003, respectively.

Net cash used in investing activities of the Company’s continuing operations was $265 million in 2003 compared with $314 million in 2002. Capital expenditures of $144 million in 2003 and $150 million in 2002 primarily related to store remodelings and new stores. The Company’s purchase of short-term investments, net of sales, increased by $106 million in 2003 as compared with an increase of $152 million in 2002. Lease acquisition costs were $15 million and $18 million in 2003 and 2002, respectively. Proceeds from the disposal of real estate of $6 million in 2002 primarily related to the condemnation of a part-owned and part-leased property.

Net cash provided by financing activities of continuing operations was $167 million in 2004 as compared with net cash used of $13 million in 2003. The Company elected to finance a portion of the purchase price of the Footaction stores, and on May 19, 2004 obtained a 5-year, $175 million term loan from the bank group participating in its existing revolving credit facility. Concurrent with obtaining the term loan, the Company amended and extended the revolving credit facility to expire in 2009. Financing fees paid for both the term loan and the revolving credit facility amounted to $2 million. The Company repurchased $19 million of its 8.50 percent debentures that are due in 2022 during 2003. The Company declared and paid dividends totaling $39 million in 2004 and $21 million in 2003. During 2004 and 2003, the Company received proceeds from the issuance of common stock in connection with employee stock programs of $33 million and $27 million, respectively.

Net cash used in financing activities of continuing operations was $13 million in 2003 compared with $36 million in 2002. The Company repurchased $19 million of its 8.50 percent debentures that are due in 2022 during 2003. During 2002, the Company repaid the remaining $32 million of the $40 million 7.00 percent medium-term notes due in October 2002 and retired approximately $9 million of its 8.50 percent debentures. The Company declared and paid dividends, totaling $21 million for the year. During 2002, the Company declared and paid a dividend during the fourth quarter of $0.03 per share totaling $4 million. During 2003 and 2002, the Company received proceeds from the issuance of common stock in connection with employee stock programs of $27 million and $10 million, respectively.

Net cash provided by and used in discontinued operations includes losses from discontinued operations, changes in assets and liabilities of the discontinued segments and disposition activity related to the reserves. Net cash provided by discontinued operations was $1 million in 2004 as compared with $7 million in 2003. In 2003, net cash provided by discontinued operations was $7 million and primarily related to an income tax benefit of $21 million offset, in part, by payments against related reserves of $13 million. In 2002, discontinued operations utilized cash of $10 million which consisted of payments for the Northern Group’s operations and disposition activity related to the other discontinued segments.

Capital Structure

During 2004, the Company obtained a 5-year, $175 million term loan to finance a portion of the purchase price of the Footaction stores. Concurrent with the financing of a portion of the Footaction acquisition, the Company amended its revolving credit agreement, thereby, extending the maturity date to May 2009 from July 2006. On January 31, 2005, the Company prepaid the first principal payment of $18 million which would have been due in May 2005. The agreement includes various restrictive financial covenants with which the Company was in compliance on January 29, 2005.

Additionally in 2004, the Company notified The Bank of New York, as Trustee under the indenture, that it intended to redeem its entire $150 million outstanding 5.50 percent convertible subordinated notes. Effective June 4, 2004, all of the convertible subordinated notes were cancelled and approximately 9.5 million new shares of the Company’s common stock were issued. The Company reclassified the remaining $3 million of unamortized deferred costs related to the original issuance of the convertible debt to equity as a result of the conversion.

During 2003, the Company primarily focused on repurchasing the 8.50 percent debt, which matures in 2022 in addition to declaring and paying dividends. During the fourth quarters of each year, the Company increased the quarterly cash dividends paid. During 2003, the Company paid dividends of $0.03 per share in the first three quarters and increased the payments to $0.06 in the fourth quarter. During 2004, the Company paid cash dividends of $0.06 per share for each of the first three quarters and increased the payments to $0.075 per share in the fourth quarter, to an annualized rate of $0.30 per share.

Credit Rating

The Company’s corporate credit rating from Standard & Poor’s is BB+ and Ba1 from Moody’s Investors Service.

Debt Capitalization and Equity

For purposes of calculating debt to total capitalization, the Company includes the present value of operating lease commitments. These commitments are the primary financing vehicle used to fund store expansion. The following table sets forth the components of the Company’s capitalization, both with and without the present value of operating leases, and excludes the effect of interest rate swaps of $4 million that increased long-term debt at January 29, 2005 and $1 million that reduced long-term debt at January 31, 2004:

	2004			2003
	(in millions)
Cash, cash equivalents and short-term investments, net of debt
and capital lease obligations	$	131		$	112
Present value of operating leases		1,989			1,683
Total net debt		1,858			1,571
Shareholders’ equity		1,830			1,375
Total capitalization	$	3,688		$	2,946

Net debt capitalization percent		50.4	%		53.3	%
Net debt capitalization percent without operating leases		—	%		—	%

Excluding the present value of operating leases, the Company’s cash, cash equivalents and short-term investments, net of debt and capital lease obligations increased to $131 million at January 29, 2005 from $112 million at January 31, 2004. The Company increased debt and capital lease obligations by $25 million while increasing cash, cash equivalents and short-term investments by $44 million. This improvement was offset by an increase of $306 million in the present value of operating leases primarily related to the Footaction acquisition and additional lease renewals entered into during 2004. Including the present value of operating leases, the Company’s net debt capitalization percent improved 2.9 percentage points in 2004. Total capitalization increased by $742 million in 2004, which was primarily attributable to an increase in shareholders’ equity. The increase in shareholders’ equity relates to net income of $293 million in 2004, an increase of $147 million resulting from the conversion of $150 million subordinated notes to equity, net of unamortized deferred issuance costs, $49 million related to employee stock plans, and an increase of $19 million in the foreign exchange currency translation adjustment, primarily related to the strength of the euro. The Company declared and paid dividends totaling $39 million during 2004.

The Company also recorded an increase of $14 million to the minimum liability for the Company’s pension plans during 2004. This increase was primarily a result of the 40 basis point decrease in the discount rate used to calculate present value of the obligations as of January 29, 2005, offset, in part, by an increase in the plans’ asset performance. The Company contributed $44 million and $6 million to the Company’s U.S. and Canadian qualified pension plans, respectively, in February 2004 and an additional $56 million to the Company’s U.S. qualified pension plan in September 2004, in advance of ERISA requirements.

As of January 31, 2004, the Company’s cash, net of debt and capital lease obligations, increased to $112 million. In 2003, the Company repurchased $19 million of the 8.50 percent debentures due in 2022. The Company declared and paid dividends totaling $21 million during 2003. The Company’s revolving credit facility was amended in 2003 to increase the available line of credit by $10 million to $200 million and extended the term to July 2006. The amended agreement includes various restrictive financial covenants with which the Company was in compliance on January 31, 2004. The Company made a $50 million contribution to its U.S. qualified retirement plan in February 2003, in advance of ERISA requirements.

Contractual Obligations and Commitments

The following tables represent the scheduled maturities of the Company’s contractual cash obligations and other commercial commitments as of January 29, 2005:

			Payments Due by Period
Contractual Cash Obligations	Total		Less than 1 Year		2 – 3 Years		4 – 5 Years		After 5 Years
	(in millions)
Long-term debt	$	351	$	18	$	44	$	113	$	176
Operating leases		2,723		449		806		578		890
Capital lease obligations		14		—		14		—		—
Other long-term liabilities ⁽¹⁾		—		—		—		—		—
Total contractual cash obligations	$	3,088	$	467	$	864	$	691	$	1,066

(1)

The Company’s other liabilities in the Consolidated Balance Sheet as of January 29, 2005 primarily comprise pension and postretirement benefits, deferred rent liability, income taxes, workers’ compensation and general liability reserves and various other accruals. These liabilities have been excluded from the above table as the timing and/or amount of any cash payment is uncertain. The timing of the remaining amounts that are known have not been included as they are minimal and not useful to the presentation. Additional information on the balance sheet caption is included in the “Other Liabilities” footnote under “Item 8. Consolidated Financial Statements and Supplementary Data.”

			Amount of Commitment Expiration by Period
Other Commercial Commitments	Total Amounts Committed		Less than 1 Year		2 – 3 Years		4 – 5 Years		After 5 Years
	(in millions)
Line of credit	$	175	$	—	$	—	$	175	$	—
Stand-by letters of credit		25		—		—		25		—
Purchase commitments ⁽²⁾		1,696		1,686		6		4		—
Other ⁽³⁾		131		41		58		28		4
Total commercial commitments	$	2,027	$	1,727	$	64	$	232	$	4

(2)

Represents open purchase orders, as well as minimum required purchases under merchandise contractual agreements at January 29, 2005. The Company is obligated under the terms of purchase orders; however, the Company is generally able to renegotiate the timing and quantity of these orders with certain vendors in response to shifts in consumer preferences.

(3)

Represents payments required by non-merchandise purchase agreements and minimum royalty requirements.

The Company does not have any off-balance sheet financing, other than operating leases entered into in the normal course of business as disclosed above, or unconsolidated special purpose entities. The Company does not participate in transactions that generate relationships with unconsolidated entities or financial partnerships, including variable interest entities. The Company’s policy prohibits the use of derivatives for which there is no underlying exposure.

In connection with the sale of various businesses and assets, the Company 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, management believes that the resolution of such contingencies will not significantly affect the Company’s consolidated financial position, liquidity, or results of operations. The Company is also operating 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

Management’s responsibility for integrity and objectivity in the preparation and presentation of the Company’s financial statements requires diligent application of appropriate accounting policies. Generally, the Company’s accounting policies and methods are those specifically required by U.S. generally accepted accounting principles (“GAAP”). Included in the “Summary of Significant Accounting Policies” footnote in “Item 8. Consolidated Financial Statements and Supplementary Data” is a summary of the Company’s most significant accounting policies. In some cases, management is required to calculate amounts based on estimates for matters that are inherently uncertain. The Company believes the following to be the most critical of those accounting policies that necessitate subjective judgments.

Business Combinations

The Company accounts for acquisitions of other businesses in accordance with SFAS No. 141, “Business Combinations” (“SFAS 141”). SFAS 141 requires that the Company record the net assets of acquired businesses at fair value, and make estimates and assumptions to determine the fair value of these acquired assets and liabilities. The Company allocates the purchase price of acquired businesses based, in part, upon internal estimates of cash flows, recoverability and independent appraisals. Changes to the assumptions used to estimate the fair value could impact the recorded amounts of the assets acquired and the resultant goodwill.

Merchandise Inventories

Merchandise inventories for the Company’s Athletic Stores are valued at the lower of cost or market using the retail inventory method. The retail inventory method (“RIM”) is commonly used by retail companies to value inventories at cost and calculate gross margins by applying a cost-to-retail percentage to the retail value of inventories. The RIM is a system of averages that requires management’s estimates and assumptions regarding markups, markdowns and shrink, among others, and as such, could result in distortions of inventory amounts. Judgment is required to differentiate between promotional and other markdowns that may be required to correctly reflect merchandise inventories at the lower of cost or market. Management believes this method and its related assumptions, which have been consistently applied, to be reasonable.

Vendor Reimbursements

In the normal course of business, the Company receives allowances from its vendors for markdowns previously taken. Vendor allowances are recognized as a reduction in cost of sales in the period in which the markdowns are taken. The effect of vendor allowances on gross margin, as a percentage of sales, as compared with the corresponding prior year period was not significant. The Company also has volume-related agreements with certain vendors, under which it receives rebates based on fixed percentages of cost purchases. These volume-related rebates are recorded in cost of sales when the product is sold and they contributed 20 basis points to the 2004 gross margin rate.

The Company receives support from some of its vendors in the form of reimbursements for cooperative advertising and catalog costs for the launch and promotion of certain products. The reimbursements are agreed upon with vendors for specific advertising campaigns and catalogs. Cooperative income, to the extent that they reimburse specific, incremental and identifiable costs incurred to date, are recorded in SG&A in the same period as the associated expenses are incurred. Reimbursements received that are in excess of specific, incremental and identifiable costs incurred to date are recognized as a reduction to the cost of merchandise and are reflected in cost of sales as the merchandise is sold. Cooperative reimbursements amounted to approximately 29 percent of total advertising costs in 2004 and approximately 8 percent of catalog costs in 2004.

Impairment of Long-Lived Assets

In accordance with SFAS No. 144, the Company recognizes an impairment loss when circumstances indicate that the carrying value of long-lived tangible and intangible assets with finite lives may not be recoverable. Management’s policy in determining whether an impairment indicator exists, a triggering event, comprises measurable operating performance criteria as well as qualitative measures. If an analysis is necessitated by the occurrence of a triggering event, the Company uses assumptions, which are predominately identified from the Company’s three-year strategic plans, in determining the impairment amount. The calculation of fair value of long-lived assets is based on estimated expected discounted future cash flows by store, which is generally measured by discounting the expected future cash flows at the Company’s weighted-average cost of capital. Management believes its policy is reasonable and is consistently applied. Future expected cash flows are based upon estimates that, if not achieved, may result in significantly different results. Long-lived tangible assets and intangible assets with finite lives primarily include property and equipment and intangible lease acquisition costs.

The Company is required to perform an impairment review of its goodwill, at least annually. The Company has chosen to perform this review at the beginning of each fiscal year, and it is done in a two-step approach. The initial step requires that the carrying value of each reporting unit be compared with its estimated fair value. The second step — to evaluate goodwill of a reporting unit for impairment — is only required if the carrying value of that reporting unit exceeds its estimated fair value. The fair value of each of the Company’s reporting units exceeded its carrying value as of February 1, 2004. The Company used a combination of a discounted cash flow approach and market-based approach to determine the

fair value of a reporting unit. The latter requires judgment and uses one or more methods to compare the reporting unit with similar businesses, business ownership interests or securities that have been sold.

Pension and Postretirement Liabilities

The Company determines its obligations for pension and postretirement liabilities based upon assumptions related to discount rates, expected long-term rates of return on invested plan assets, salary increases, age, mortality and health care cost trends, among others. Management reviews all assumptions annually with its independent actuaries, taking into consideration existing and future economic conditions and the Company’s intentions with regard to the plans. Management believes that its estimates for 2004, as disclosed in “Item 8. Consolidated Financial Statements and Supplementary Data,” to be reasonable. The expected long-term rate of return on invested plan assets is a component of pension expense and the rate is based on the plans’ weighted-average target asset allocation of 64 percent equity securities and 36 percent fixed income investments, as well as historical and future expected performance of those assets. The target asset allocation is selected to obtain an investment return that is sufficient to cover the expected benefit payments based on the timing of settlements and to reduce future contributions by the Company. The Company’s common stock represented approximately 2 percent of the total pension plans’ assets at January 29, 2005. A decrease of 50 basis points in the weighted-average expected long-term rate of return would have increased 2004 pension expense by approximately $3 million. The actual return on plan assets in a given year may differ from the expected long-term rate of return and the resulting gain or loss is deferred and amortized into the plans’ performance over time. An assumed discount rate is used to measure the present value of future cash flow obligations of the plans and the interest cost component of pension expense and postretirement income. The discount rate is selected with reference to the Aa long-term corporate bond yield. A decrease of 50 basis points in the weighted-average discount rate would have increased the accumulated benefit obligation as of January 29, 2005 of the pension and postretirement plans by approximately $30 million and approximately $1 million, respectively. Such a decrease would not have significantly changed 2004 pension expense or postretirement income. There is limited risk to the Company for increases in healthcare costs related to the postretirement plan as new retirees have assumed the full expected costs and existing retirees have assumed all increases in such costs since the beginning of fiscal year 2001. The additional minimum liability included in shareholders’ equity at January 29, 2005 for the pension plans represented the amount by which the accumulated benefit obligation exceeded the fair market value of the plan assets. The Company contributed $44 million to the U.S. qualified pension plan and contributed $6 million to the Canadian qualified pension plan in February 2004. In addition, $56 million was contributed to the U.S. qualified pension plan in September 2004.

The Company expects to record postretirement income of approximately $11 million and pension expense of approximately $13 million in 2005. Pension expense in 2005 reflects the Company’s expected contributions, of which $19 million was made on February 4, 2005. These contributions have reduced 2005 estimated pension expense by approximately $2 million.

Income Taxes

In accordance with GAAP, deferred tax assets are recognized for tax credit and net operating loss carryforwards, reduced by a valuation allowance, which is established when it is more likely than not that some portion or all of the deferred tax assets will not be realized. Management is required to estimate taxable income for future years by taxing jurisdiction and to use its judgment to determine whether or not to record a valuation allowance for part or all of a deferred tax asset. A one percent change in the Company’s overall statutory tax rate for 2004 would have resulted in a $6 million change in the carrying value of the net deferred tax asset and a corresponding charge or credit to income tax expense depending on whether such tax rate change was a decrease or increase.

The Company has operations in multiple taxing jurisdictions and is subject to audit in these jurisdictions. Tax audits by their nature are often complex and can require several years to resolve. Accruals of tax contingencies require management to make estimates and judgments with respect to the ultimate outcome of tax audits. Actual results could vary from these estimates.

The Company expects its 2005 effective tax rate to be approximately 36.5 percent.

Discontinued, Repositioning and Restructuring Reserves

The Company exited four business segments as part of its discontinuation and restructuring programs. The final discontinued segment and disposition of the restructured businesses were completed in 2001. In order to identify and calculate the associated costs to exit these businesses, management made assumptions regarding estimates of future liabilities for operating leases and other contractual agreements, the net realizable value of assets held for sale or disposal and the fair value of non-cash consideration received. The Company has settled the majority of these liabilities and the remaining activity relates to the disposition of the residual lease liabilities.

As a result of achieving divestiture accounting in the fourth quarter of 2002, the Northern Group note was recorded at its fair value. The Company is required to review the collectibility of the note based upon various criteria such as the credit-worthiness of the issuer or a delay in payment of the principal or interest. Future adjustments, if any, to the carrying value of the note will be recorded pursuant to SEC Staff Accounting Bulletin Topic 5:Z:5, “Accounting and Disclosure Regarding Discontinued Operations,” which requires changes in the carrying value of assets received as consideration from the disposal of a discontinued operation to be classified within continuing operations. The purchaser has made all payments required under the terms of the Note, however the business sustained unexpected operating losses during the past fiscal year. The Company has evaluated the projected performance of the business and will continue to monitor its results during the coming year. At January 29, 2005, $9 million remains outstanding on the Note.

The remaining discontinued reserve balances at January 29, 2005 totaled $18 million of which $7 million is expected to be utilized within the next twelve months. The remaining repositioning and restructuring reserves totaled $4 million at January 29, 2005, whereby $1 million is expected to be utilized within the next twelve months.

Disclosure Regarding Forward-Looking Statements

This report, including the Shareholders’ Letter, contains forward-looking statements within the meaning of the federal securities laws. All statements, other than statements of historical facts, which address activities, events or developments that the Company expects or anticipates will or may occur in the future, including, but not limited to, such things as future capital expenditures, expansion, strategic plans, 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 detailed in the Company’s filings with the Securities and Exchange Commission, including the effects of currency fluctuations, customer demand, fashion trends, competitive market forces, uncertainties related to the effect of competitive products and pricing, customer acceptance of the Company’s merchandise mix and retail locations, the Company’s reliance on a few key vendors for a majority of its merchandise purchases (including a significant portion from one key vendor), unseasonable weather, risks associated with foreign global sourcing, including political instability, changes in import regulations, disruptions to transportation services and distribution, economic conditions worldwide, any changes in business, political and economic conditions due to the threat of future terrorist activities in the United States or in other parts of the world and related U.S. military action overseas and the ability of the Company to execute its business plans effectively with regard to each of its business units. 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.

Item 7A.

Quantitative and Qualitative Disclosures About Market Risk

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

Item 8.

Consolidated Financial Statements and Supplementary Data

MANAGEMENT’S REPORT

The integrity and objectivity of the financial statements and other financial information presented in this annual report are the responsibility of the management of the Company. The financial statements have been prepared in conformity with U.S. generally accepted accounting principles and include, when necessary, amounts based on the best estimates and judgments of management.

The Company maintains a system of internal controls designed to provide reasonable assurance, at appropriate cost, that assets are safeguarded, transactions are executed in accordance with management’s authorization and the accounting records provide a reliable basis for the preparation of the financial statements. The system of internal accounting controls is continually reviewed by management and improved and modified as necessary in response to changing business conditions. The Company also maintains an internal audit function to assist management in evaluating and formally reporting on the adequacy and effectiveness of internal accounting controls, policies and procedures.

The Company’s financial statements have been audited by KPMG LLP, the Company’s independent registered public accounting firm, whose report expresses their opinion with respect to the fairness of the presentation of these statements.

The Audit Committee of the Board of Directors, which comprises solely independent non-management directors who are not officers or employees of the Company, meets regularly with the Company’s management, internal auditors, legal counsel and KPMG LLP to review the activities of each group and to satisfy itself that each is properly discharging its responsibility. In addition, the Audit Committee meets on a periodic basis with KPMG LLP, without management’s presence, to discuss the audit of the financial statements as well as other auditing and financial reporting matters. The Company’s internal auditors and independent registered public accounting firm have direct access to the Audit Committee.


MATTHEW D. SERRA, Chairman of the Board, President and Chief Executive Officer								BRUCE L. HARTMAN, Executive Vice President and Chief Financial Officer

March 28, 2005

MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. The Company’s internal control over financial reporting includes those policies and procedures that: (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Management assessed the effectiveness of the Company’s internal control over financial reporting as of January 29, 2005. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework. Based on our assessment and those criteria, management believes that the Company maintained effective internal control over financial reporting as of January 29, 2005.

The Company’s independent registered public accounting firm has issued their attestation report on management’s assessment of the Company’s internal control over financial reporting. That report appears in the Company’s 2004 Annual Report on Form 10-K under the heading, Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting.


MATTHEW D. SERRA, Chairman of the Board, President and Chief Executive Officer								BRUCE L. HARTMAN, Executive Vice President and Chief Financial Officer

March 28, 2005

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Shareholders of
Foot Locker, Inc.

We have audited the accompanying consolidated balance sheets of Foot Locker, Inc. and subsidiaries as of January 29, 2005 and January 31, 2004, and the related consolidated statements of operations, comprehensive income, shareholders’ equity, and cash flows for each of the years in the three-year period ended January 29, 2005. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Foot Locker, Inc. and subsidiaries as of January 29, 2005 and January 31, 2004, and the results of their operations and their cash flows for each of the years in the three-year period ended January 29, 2005, 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), the effectiveness of Foot Locker, Inc.’s internal control over financial reporting as of January 29, 2005, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 28, 2005 expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting.

New York, New York
March 28, 2005

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON
INTERNAL CONTROL OVER FINANCIAL REPORTING

The Board of Directors and Shareholders of
Foot Locker, Inc.

We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that Foot Locker, Inc. maintained effective internal control over financial reporting as of January 29, 2005, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Foot Locker, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

In our opinion, management’s assessment that Foot Locker, Inc. maintained effective internal control over financial reporting as of January 29, 2005, is fairly stated, in all material respects, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, Foot Locker, Inc. maintained, in all material respects, effective internal control over financial reporting as of January 29, 2005, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Foot Locker, Inc. and subsidiaries as of January 29, 2005 and January 31, 2004, and the related consolidated statements of operations, comprehensive income, shareholders’ equity, and cash flows for each of the years in the three-year period ended January 29, 2005, and our report dated March 28, 2005 expressed an unqualified opinion on those consolidated financial statements.

New York, New York
March 28, 2005

CONSOLIDATED STATEMENTS OF OPERATIONS

	2004		2003			2002
	(in millions, except per share amounts)

Sales	$	5,355	$	4,779		$	4,509
Costs and expenses
Cost of sales		3,722		3,297			3,161
Selling, general and administrative expenses		1,088		987			928
Depreciation and amortization		154		152			153
Restructuring charges (income)		2		1			(2	)
Interest expense, net		15		18			26
		4,981		4,455			4,266
Other income (expense)		—		—			(3	)
		4,981		4,455			4,263
Income from continuing operations before income taxes		374		324			246
Income tax expense		119		115			84
Income from continuing operations		255		209			162

Income (loss) on disposal of discontinued operations, net of income tax benefit of $37, $4, and $2, respectively		38		(1	)		(9	)
Cumulative effect of accounting change, net of income tax benefit of $ —		—		(1	)		—
Net income	$	293	$	207		$	153

Basic earnings per share:
Income from continuing operations	$	1.69	$	1.47		$	1.15
Income (loss) from discontinued operations		0.25		(0.01	)		(0.06	)
Cumulative effect of accounting change		—		—			—
Net income	$	1.94	$	1.46		$	1.09
Diluted earnings per share:
Income from continuing operations	$	1.64	$	1.40		$	1.10
Income (loss) from discontinued operations		0.24		(0.01	)		(0.05	)
Cumulative effect of accounting change		—		—			—
Net income	$	1.88	$	1.39		$	1.05

See Accompanying Notes to Consolidated Financial Statements.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

	2004			2003			2002
	(in millions)
Net income	$	293		$	207		$	153
Other comprehensive income, net of tax

Foreign currency translation adjustment:
Translation adjustment arising during the period		19			31			38

Cash flow hedges:
Change in fair value of derivatives, net of income tax		(1	)		—			—
Reclassification adjustments, net of income tax expense (benefit) of $1, ($1), and $—, respectively		1			(1	)		—
Net change in cash flow hedges		—			(1	)		—

Minimum pension liability adjustment:
Minimum pension liability adjustment, net of deferred tax expense (benefit) of $(9), $10 and $(56), respectively		(14	)		16			(83	)

Comprehensive income	$	298		$	253		$	108

See Accompanying Notes to Consolidated Financial Statements.

CONSOLIDATED BALANCE SHEETS

	2004		2003
	(in millions)
ASSETS

Current assets
Cash and cash equivalents	$	225	$	190
Short-term investments		267		258
Total cash, cash equivalents and short-term investments		492		448
Merchandise inventories		1,151		920
Assets of discontinued operations		1		2
Other current assets		188		149
		1,832		1,519
Property and equipment, net		715		668
Deferred taxes		180		194
Goodwill		271		136
Intangible assets, net		135		96
Other assets		104		100
	$	3,237	$	2,713

LIABILITIES AND SHAREHOLDERS’ EQUITY

Current liabilities
Accounts payable	$	381	$	234
Accrued liabilities		275		300
Liabilities of discontinued operations		2		2
Current portion of repositioning and restructuring reserves		1		1
Current portion of reserve for discontinued operations		7		8
Current portion of long-term debt and obligations under capital leases		18		—
		684		545

Long-term debt and obligations under capital leases		347		335
Other liabilities		376		458
Total liabilities		1,407		1,338

Shareholders’ equity		1,830		1,375
	$	3,237	$	2,713

See Accompanying Notes to Consolidated Financial Statements.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

	2004						2003						2002
	Shares			Amount			Shares			Amount			Shares			Amount
	(shares in thousands, amounts in millions)
Common Stock and Paid-In Capital
Par value $0.01 per share, 500 million shares authorized
Issued at beginning of year		144,009		$	411			141,180		$	378			139,981		$	363
Restricted stock issued under stock option and award plans		400			—			845			—			60			—
Forfeitures of restricted stock		—			2			—			1			—			1
Amortization of stock issued under restricted stock option plans		—			8			—			4			—			2
Conversion of convertible debt		9,490			150			—			—			—			—
Reclassification of convertible debt issuance costs		—			(3	)		—			—			—			—
Issued under director and employee stock plans, net of tax		2,256			40			1,984			28			1,139			12
Issued at end of year		156,155			608			144,009			411			141,180			378
Common stock in treasury at beginning of year		(57	)		(1	)		(105	)		(1	)		(70	)		—
Reissued under employee stock plans		260			5			152			1			—			—
Restricted stock issued under stock option and award plans		—			—			—			—			30			—
Forfeitures/cancellations of restricted stock		(100	)		(2	)		(80	)		(1	)		(60	)		(1	)
Shares of common stock used to satisfy tax withholding obligations		(137	)		(3	)		—			—			—			—
Exchange of options		(30	)		(1	)		(24	)		—			(5	)		—
Common stock in treasury at end of year		(64	)		(2	)		(57	)		(1	)		(105	)		(1	)
		156,091			606			143,952			410			141,075			377
Retained Earnings
Balance at beginning of year					1,132						946						797
Net income					293						207						153
Cash dividends declared on common stock $0.26, $0.15 and $0.03 per share, respectively					(39	)					(21	)					(4	)
Balance at end of year					1,386						1,132						946
Accumulated Other Comprehensive Loss
Foreign Currency Translation Adjustment
Balance at beginning of year					16						(15	)					(53	)
Translation adjustment arising during the period					19						31						38
Balance at end of year					35						16						(15	)
Cash Flow Hedges
Balance at beginning of year					(1	)					—						—
Change during year, net of tax					—						(1	)					—
Balance at end of year					(1	)					(1	)					—
Minimum Pension Liability Adjustment
Balance at beginning of year					(182	)					(198	)					(115	)
Change during year, net of tax					(14	)					16						(83	)
Balance at end of year					(196	)					(182	)					(198	)
Total Accumulated Other Comprehensive Loss					(162	)					(167	)					(213	)
Total Shareholders’ Equity				$	1,830					$	1,375					$	1,110

See Accompanying Notes to Consolidated Financial Statements.

CONSOLIDATED STATEMENTS OF CASH FLOWS

	2004			2003			2002
	(in millions)
From Operating Activities
Net income	$	293		$	207		$	153
Adjustments to reconcile net income to net cash provided by operating activities of continuing operations:
(Income) loss on disposal of discontinued operations, net of tax		(38	)		1			9
Restructuring charges (income)		2			1			(2	)
Cumulative effect of accounting change, net of tax		—			1			—
Depreciation and amortization		154			152			153
Impairment of long-lived assets		—			—			7
Restricted stock compensation expense		8			4			2
Tax benefit on stock compensation		10			2			2
Gains on sales of real estate and assets		—			—			(3	)
Deferred income taxes		50			(5	)		38
Change in assets and liabilities, net of dispositions:
Merchandise inventories		(183	)		(63	)		(22	)
Accounts payable and other accruals		157			(17	)		(22	)
Repositioning and restructuring reserves		(1	)		(1	)		(3	)
Pension contribution		(106	)		(50	)		—
Income taxes		—			9			42
Other, net		(57	)		23			(7	)
Net cash provided by operating activities of continuing operations		289			264			347

From Investing Activities
Acquisitions		(242	)		—			—
Purchases of short-term investments		(2,884	)		(1,546	)		(536	)
Sales of short-term investments		2,875			1,440			384
Lease acquisition costs		(17	)		(15	)		(18	)
Capital expenditures		(156	)		(144	)		(150	)
Proceeds from sales of real estate and assets		—			—			6
Net cash used in investing activities of continuing operations		(424	)		(265	)		(314	)

From Financing Activities
Debt issuance costs		(2	)		—			—
Increase (reduction) in long-term debt		175			(19	)		(41	)
Reduction in capital lease obligations		—			—			(1	)
Dividends paid on common stock		(39	)		(21	)		(4	)
Issuance of common stock		33			27			10
Net cash provided by (used in) financing activities of continuing operations		167			(13	)		(36	)

Net Cash Provided by (Used in) Discontinued Operations		1			7			(10	)

Effect of Exchange Rate Fluctuations on Cash and Cash Equivalents		2			(8	)		3

Net Change in Cash and Cash Equivalents		35			(15	)		(10	)
Cash and Cash Equivalents at Beginning of Year		190			205			215
Cash and Cash Equivalents at End of Year	$	225		$	190		$	205

Cash Paid During the Year:
Interest	$	23		$	25		$	27
Income taxes	$	121		$	77		$	39
Non-cash Financing Activities:
Common stock issued upon conversion of convertible debt	$	150		$	—		$	—
Debt issuance costs reclassified to equity upon conversion of convertible debt	$	3		$	—		$	—

See Accompanying Notes to Consolidated Financial Statements.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Summary of Significant Accounting Policies

Basis of Presentation

The consolidated financial statements include the accounts of Foot Locker, Inc. and its domestic and international subsidiaries (the “Company”), all of which are wholly owned. All significant intercompany amounts have been eliminated. The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results may differ from those estimates.

Reporting Year

The reporting period for the Company is the Saturday closest to the last day in January. Fiscal years 2004, 2003 and 2002 represented the 52 weeks ended January 29, 2005, January 31, 2004 and February 1, 2003, respectively. References to years in this annual report relate to fiscal years rather than calendar years.

Revenue Recognition

Revenue from retail store sales is recognized when the product is delivered to customers. Retail sales include merchandise, net of returns and exclude all taxes. The Company recognizes revenue, including layaway sales, in accordance with SEC Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements,” as amended by SAB No. 104, “Revenue Recognition.” Revenue from layaway sales is recognized when the customer receives the product, rather than when the initial deposit is paid. Revenue from Internet and catalog sales is recognized when the product is shipped to customers. Sales include shipping and handling fees for all periods presented.

Store Pre-Opening and Closing Costs

Store pre-opening costs are charged to expense as incurred. In the event a store is closed before its lease has expired, the estimated post-closing lease exit costs, less the fair market value of sublease rental income, is provided for once the store ceases to be used, in accordance with SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.”

Advertising Costs

Advertising and sales promotion costs are expensed at the time the advertising or promotion takes place, net of reimbursements for cooperative advertising. Cooperative advertising reimbursements earned for the launch and promotion of certain products is agreed upon with vendors and is recorded in the same period as the associated expense is incurred. In accordance with EITF 02-16 “Accounting by a Reseller for Cash Consideration from a Vendor,” the Company accounts for reimbursements received in excess of expenses incurred related to specific, incremental advertising, as a reduction to the cost of merchandise and is reflected in cost of sales as the merchandise is sold.

Advertising costs, which are included as a component of selling, general and administrative expenses, net of reimbursements for cooperative advertising, were as follows:

	2004			2003			2002
	(in millions)
Advertising expenses	$	102.5		$	97.5		$	89.2
Cooperative advertising reimbursements		(24.8	)		(23.4	)		(15.4	)
Net advertising expense	$	77.7		$	74.1		$	73.8

Catalog Costs

Catalog costs, which primarily comprise paper, printing, and postage, are capitalized and amortized over the expected customer response period to each catalog, generally 90 days. Cooperative reimbursements earned for the promotion of certain products is agreed upon with vendors and is recorded in the same period as the associated catalog expenses are amortized. Prepaid catalog costs totaled $3.5 million and $2.9 million at January 29, 2005 and January 31, 2004, respectively.

Catalog costs, which are included as a component of selling, general and administrative expenses, net of reimbursements for cooperative reimbursements, were as follows:

	2004			2003			2002
	(in millions)
Catalog costs	$	50.3		$	42.4		$	41.9
Cooperative reimbursements		(2.9	)		(3.5	)		(2.9	)
Net catalog expense	$	47.4		$	38.9		$	39.0

Earnings Per Share

Basic earnings per share is computed as net income divided by the weighted-average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur from common shares issuable through stock-based compensation including stock options and the conversion of convertible long-term debt. The following table reconciles the numerator and denominator used to compute basic and diluted earnings per share for continuing operations.

	2004		2003		2002
	(in millions)
Income from continuing operations	$	255	$	209	$	162
Effect of Dilution:
Convertible debt		2		5		5
Income from continuing operations assuming dilution	$	257	$	214	$	167

Weighted-average common shares outstanding		150.9		141.6		140.7
Effect of Dilution:
Stock options and awards		3.0		1.8		0.6
Convertible debt		3.2		9.5		9.5
Weighted-average common shares outstanding assuming dilution		157.1		152.9		150.8

Options to purchase 1.5 million, 3.6 million and 6.8 million shares of common stock as of January 29, 2005, January 31, 2004 and February 1, 2003, respectively, were not included in the computations because the exercise price of the options was greater than the average market price of the common shares and, therefore, the effect of their inclusion would be antidilutive.

Stock-Based Compensation

The Company accounts for stock-based compensation plans in accordance with the intrinsic-value based method permitted by SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”) which has not resulted in compensation cost for stock options and shares purchased under employee stock purchase plans. No compensation expense for employee stock options is reflected in net income, as all stock options granted under those plans had an exercise price not less than the quoted market price at the date of grant. The market value at date of grant of restricted stock is recorded as compensation expense over the period of vesting.

The following table illustrates the effect on net income and earnings per share as if the Company had applied the fair value recognition provisions of SFAS No. 123 to measure stock-based compensation expense during the three-year period ended January 29, 2005.

	2004			2003			2002
	(in millions, except per share amounts)
Net income:
As reported	$	293		$	207		$	153
Compensation expense included in reported net income, net of income tax benefit		5			2			1
Total compensation expense under fair value method for all awards, net of income tax benefit		(13	)		(7	)		(6	)
Pro forma	$	285		$	202		$	148
Basic earnings per share:
As reported	$	1.94		$	1.46		$	1.09
Pro forma	$	1.89		$	1.43		$	1.05
Diluted earnings per share:
As reported	$	1.88		$	1.39		$	1.05
Pro forma	$	1.83		$	1.36		$	1.02

On December 15, 2004, the FASB issued SFAS No. 123R, “Share-Based Payment” (“SFAS No. 123R”). SFAS No. 123R requires companies to measure compensation cost for share-based payments at fair value. The Statement is effective as of the beginning of the first interim or annual reporting period that begins after June 15, 2005. The Company has not yet determined the effect of this statement on its consolidated financial position, results of operations or cash flows.

Cash and Cash Equivalents

The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents. Cash equivalents at January 29, 2005 and January 31, 2004 were $140 million and $130 million, respectively.

Short-Term Investments

The Company accounts for its short-term investments in accordance with SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” At January 29, 2005, all of the Company’s investments were classified as available for sale, and accordingly are reported at fair value. Short-term investments comprise auction rate securities. Auction rate securities are perpetual preferred or long-dated securities whose dividend/coupon resets periodically through a Dutch auction process. A Dutch auction is a competitive bidding process designed to determine a rate for the next term, such that all sellers sell at par and all buyers buy at par. Accordingly, there were no realized or unrealized gains or losses for any of the periods presented.

Merchandise Inventories and Cost of Sales

Merchandise inventories for the Company’s Athletic Stores are valued at the lower of cost or market using the retail inventory method. Cost for retail stores is determined on the last-in, first-out (LIFO) basis for domestic inventories and on the first-in, first-out (FIFO) basis for international inventories. Merchandise inventories of the Direct-to-Customers business are valued at the lower of cost or market using weighted-average cost, which approximates FIFO. Transportation, distribution center and sourcing costs are capitalized in merchandise inventories.

Cost of sales is comprised of the cost of merchandise, occupancy, buyers’ compensation and shipping and handling costs. The cost of merchandise is recorded net of amounts received from vendors for damaged product returns, markdown allowances and volume rebates as well as cooperative advertising reimbursements received in excess of specific, incremental advertising expenses. Occupancy reflects the amortization of amounts received from landlords for tenant improvements.

Property and Equipment

Property and equipment are recorded at cost, less accumulated depreciation and amortization. Significant additions and improvements to property and equipment are capitalized. Maintenance and repairs are charged to current operations as incurred. Major renewals or replacements that substantially extend the useful life of an asset are capitalized and depreciated. Owned property and equipment is depreciated on a straight-line basis over the estimated useful lives of the assets: maximum of 50 years for buildings and 3 to 10 years for furniture, fixtures and equipment. Property and equipment

	2004			2003
	(in millions)

Land	$	3		$	3
Buildings:
Owned		31			32
Furniture, fixtures and equipment:
Owned		1,072			1,015
Leased		14			14
		1,120			1,064
Less: accumulated depreciation		(755	)		(706	)
		365			358
Alterations to leased and owned buildings, net of accumulated amortization		350			310
	$	715		$	668

	(in millions)
Inventory	$	39
Property and equipment		45
Intangible assets — amortizing		29
Goodwill		122
Total assets		235

Accounts payable and accrued liabilities ⁽¹⁾		5
Other liabilities ⁽²⁾		4
Total liabilities		9
Total purchase price	$	226

	(in millions)
Intangible assets — amortizing	$	2
Intangible assets — non-amortizing		3
Goodwill		12
Total assets		17
Other amounts due and payable ⁽¹⁾		(1	)
Cash paid as of January 29, 2005	$	16

	2004		2003
	(in millions)
Intangible assets not subject to amortization	$	4	$	2
Intangible assets subject to amortization (net of accumulated amortization of $70 and $51, respectively)		131		94
	$	135	$	96

	2003		Acquisitions ⁽¹⁾		Additions		Amortization / Other ⁽²⁾			2004
	(in millions)
Finite life intangible assets
Lease acquisition costs	$	94	$	—	$	17	$	(9	)	$	102	12.2
Trademark		—		21		—		(1	)		20	20.0
Loyalty program		—		1		—		—			1	2.0
Favorable leases		—		9		—		(1	)		8	4.1
Total	$	94	$	31	$	17	$	(11	)	$	131	12.6

	2004			2003			2002
	(in millions)
Athletic Stores ⁽¹⁾	$	420		$	363		$	280
Direct-to-Customers		45			53			40
		465			416			320
All Other ⁽²⁾		(2	)		(1	)		1
Division profit		463			415			321
Corporate expense ⁽³⁾		(74	)		(73	)		(52	)
Operating profit		389			342			269
Non-operating income ⁽⁴⁾		—			—			3
Interest expense, net		(15	)		(18	)		(26	)
Income from continuing operations before income taxes	$	374		$	324		$	246

	Depreciation and Amortization						Capital Expenditures						Total Assets
	2004		2003		2002		2004		2003		2002		2004		2003		2002
	(in millions)
Athletic Stores	$	126	$	123	$	123	$	139	$	126	$	124	$	2,335	$	1,739	$	1,591
Direct-to-Customers		5		4		4		8		6		8		190		183		177
		131		127		127		147		132		132		2,525		1,922		1,768
Corporate		23		25		26		9		12		18		711		789		744
Discontinued operations														1		2		2
Total Company	$	154	$	152	$	153	$	156	$	144	$	150	$	3,237	$	2,713	$	2,514

	2004		2003		2002
	(in millions)
United States	$	3,982	$	3,597	$	3,639
International		1,373		1,182		870
Total sales	$	5,355	$	4,779	$	4,509

	2004		2003
	(in millions)
Tax exempt municipal bonds	$	50	$	44
Taxable bonds		40		—
Equity securities		177		214
	$	267	$	258

	2004		2003
	(in millions)
LIFO inventories	$	856	$	651
FIFO inventories		295		269
Total merchandise inventories	$	1,151	$	920

	2004		2003
	(in millions)
Net receivables	$	47	$	41
Prepaid expenses and other current assets		47		45
Prepaid income taxes		40		—
Deferred taxes		53		60
Current portion of Northern Group note receivable		1		2
Fair value of derivative contracts		—		1
	$	188	$	149

	2004		2003
	(in millions)
Deferred tax costs	$	25	$	35
Investments and notes receivable		22		23
Northern Group note receivable, net of current portion		8		6
Income taxes receivable		—		1
Fair value of derivative contracts		2		—
Other		47		35
	$	104	$	100

	2004		2003
	(in millions)
Pension and postretirement benefits	$	30	$	57
Incentive bonuses		34		38
Other payroll and payroll related costs, excluding taxes		51		44
Taxes other than income taxes		45		44
Property and equipment		22		32
Gift cards and certificates		22		16
Income taxes payable		9		9
Fair value of derivative contracts		3		3
Current deferred tax liabilities		1		—
Other operating costs		58		57
	$	275	$	300

	2004		2003
	(in millions)
8.50% debentures payable 2022	$	176	$	171
$175 million term loan		175		—
5.50% convertible notes		—		150
Total long-term debt		351		321
Obligations under capital leases		14		14
		365		335
Less: Current portion		18		—
	$	347	$	335

	Long-Term Debt		Capital Leases		Total
	(in millions)
2005	$	18	$	—	$	18
2006		18		—		18
2007		26		14		40
2008		26		—		26
2009		87		—		87
Thereafter		176		—		176
		351		14		365
Less: Current portion		18		—		18
	$	333	$	14	$	347

	2004			2003			2002
	(in millions)
Rent	$	605		$	532		$	491
Contingent rent based on sales		11			11			11
Sublease income		(1	)		(1	)		(1	)
Total rent expense	$	615		$	542		$	501

	2004		2003
	(in millions)
Pension benefits	$	130	$	175
Postretirement benefits		95		113
Straight-line rent liability		77		67
Income taxes		29		62
Workers’ compensation / general liability reserves		11		12
Reserve for discontinued operations		11		11
Repositioning and restructuring reserves		3		2
Fair value of derivatives		—		1
Unfavorable leases		3		—
Other		17		15
	$	376	$	458

	2001		2002							2003							2004
	Balance		Charge/ (Income)		Net Usage*			Balance		Charge/ (Income)		Net Usage*			Balance		Charge/ (Income)		Net Usage*		Balance
	(in millions)
Asset write-offs & impairments	$	—	$	18	$	(18)		$	—	$	—	$	—		$	—	$	—	$	—	$	—
Recognition of note receivable		—		(10)		10			—		—		—			—		—		—		—
Real estate & lease liabilities		6		1		(1	)		6		1		(7	)		—		—		—		—
Severance & personnel		2		—		(2	)		—		—		—			—		—		—		—
Operating losses & other costs		3		—		(2	)		1		—		1			2		—		1		3
Total	$	11	$	9	$	(13	)	$	7	$	1	$	(6	)	$	2	$	—	$	1	$	3

	2001		2002								2003							2004
	Balance		Charge/ (Income)			Net Usage			Balance		Charge/ (Income)		Net Usage			Balance		Charge/ (Income)			Net Usage		Balance
	(in millions)
Lease liabilities	$	7	$	(4)		$	(1)		$	2	$	—	$	—		$	2	$	—		$	—	$	2
Operating losses & other costs		2		—			(1	)		1		—		(1	)		—		(1	)		1		—
Total	$	9	$	(4	)	$	(2	)	$	3	$	—	$	(1	)	$	2	$	(1	)	$	1	$	2

	2004		2003		2002
	(in millions)
Domestic	$	222	$	186	$	160
International		152		138		86
Total pre-tax income	$	374	$	324	$	246

	2004			2003			2002
	(in millions)
Current:
Federal	$	11		$	48		$	16
State and local		6			14			5
International		52			58			25
Total current tax provision		69			120			46
Deferred:
Federal		43			11			31
State and local		8			(6	)		—
International		(1	)		(10	)		7
Total deferred tax provision		50			(5	)		38
Total income tax provision	$	119		$	115		$	84


Federal statutory income tax rate	35.0	%	35.0	%	35.0	%
State and local income taxes, net of federal tax benefit	2.3		2.4		2.0
International income taxed at varying rates	(0.6	)	0.5		1.0
Foreign tax credit utilization	(2.5	)	(1.0	)	(1.2	)
Increase (decrease) in valuation allowance	0.1		(1.5	)	(2.0	)
Federal/foreign tax settlements	(3.3	)	—		—
State and local tax settlements	—		(0.2	)	(0.3	)
Tax exempt obligations	(0.2	)	(0.2	)	(0.1	)
Work opportunity tax credit	(0.2	)	(0.1	)	(0.3	)
Other, net	1.1		0.6		0.1
Effective income tax rate	31.7	%	35.5	%	34.2	%

	2004			2003
	(in millions)
Deferred tax assets:
Tax loss/credit carryforwards	$	89		$	99
Employee benefits		116			135
Reserve for discontinued operations		5			8
Repositioning and restructuring reserves		3			2
Property and equipment		89			81
Allowance for returns and doubtful accounts		7			10
Straight-line rent		19			17
Goodwill		—			1
Other		17			22
Total deferred tax assets		345			375
Valuation allowance		(124	)		(122	)
Total deferred tax assets, net	$	221		$	253

	2004			2003
	(in millions)
Deferred tax liabilities:
Inventories	$	8		$	13
Goodwill		2			—
Other		1			1
Total deferred tax liabilities		11			14
Net deferred tax asset	$	210		$	239
Balance Sheet caption reported in:
Deferred taxes	$	180		$	194
Other current assets		53			60
Other current liabilities		(1	)		—
Other liabilities		(22	)		(15	)
	$	210		$	239

	Fair Value (US in millions)			Contract Value (US in millions)
Inventory

Buy €/Sell British £	$	—		$	59	0.6996

Intercompany

Buy €/Sell $US	$	—		$	6	1.2290
Buy $US/Sell €		(3	)		69	1.2432
Buy €/Sell British £		—			17	0.7187
	$	(3	)	$	151

	2004			2003			2002
	($ in millions)
Interest Rate Swaps:
Fixed to Variable ($US)	$	100		$	100		$	50
Average pay rate		6.46	%		5.07	%		4.53	%
Average receive rate		8.50	%		8.50	%		8.50	%
Variable to variable ($US)	$	100		$	—		$	—
Average pay rate		2.73	%		—	%		—	%
Average receive rate		3.25	%		—	%		—	%

	2005													Jan. 29, 2005 Total		Jan. 31, 2004 Total
	($ in millions)
Long-term debt	$	18		18		26		26		87		193		$	368	$	435
Weighted-average interest rate		5.2	%	5.3	%	5.4	%	5.6	%	6.6	%	6.9	%


Asset Category
Equity securities	63	%	63	%
Foot Locker, Inc. common stock	2	%	2	%
Debt securities	33	%	33	%
Real estate	1	%	1	%
Other	1	%	1	%
Total	100	%	100	%

	2004				2003				2002
	Number of Shares		Weighted- Average Exercise Price		Number of Shares		Weighted- Average Exercise Price		Number of Shares		Weighted- Average Exercise Price
	(in thousands, except prices per share)
Options outstanding at beginning of year		6,886	$	14.73		7,676	$	15.18		7,557	$	14.63
Granted		1,183	$	25.20		1,439	$	10.81		1,640	$	15.72
Exercised		1,853	$	14.43		1,830	$	12.50		783	$	6.67
Expired or canceled		307	$	19.13		399	$	19.55		738	$	19.80
Options outstanding at end of year		5,909	$	16.69		6,886	$	14.73		7,676	$	15.18
Options exercisable at end of year		3,441	$	15.34		4,075	$	15.99		4,481	$	15.94
Options available for future grant at end of year		7,464				8,780				6,739

	Options Outstanding						Options Exercisable
Range of Exercise Prices	Shares		Weighted- Average Remaining Contractual Life		Weighted- Average Exercise Price		Shares		Weighted- Average Exercise Price
	(in thousands, except prices per share)
$ 4.53 to $10.75		1,230		7.7	$	9.85		483	$	9.25
$10.78 to $15.75		1,529		5.9		12.53		1,487		12.51
$15.85 to $21.88		1,318		7.0		16.55		772		16.70
$22.19 to $28.13		1,832		6.7		24.84		699		24.09
$ 4.53 to $28.13		5,909		6.8	$	16.69		3,441	$	15.34

	2004				2003
	High		Low		High		Low
Common Stock
Quarter
1^st Q	$	27.59	$	21.75	$	11.40	$	9.28
2^nd Q		25.03		19.97		15.20		10.10
3^rd Q		24.80		19.98		18.20		13.85
4^th Q		27.26		22.75		25.97		18.01