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. The Direct-to-Customers segment reflects Footlocker.com, Inc., which sells athletic footwear, apparel, and equipment, through its affiliates, including Eastbay, Inc., and CCS, which sells skateboard and snowboard equipment, apparel, footwear, and accessories. The Direct-to-Customer segment sells to customers through catalogs and Internet websites.

STORE COUNT

At August 1, 2009, the Company operated 3,615 stores as compared with 3,641 and 3,728 stores at January 31, 2009 and August 2, 2008, respectively. During the twenty-six weeks ended August 1, 2009, the Company opened 26 stores, remodeled or relocated 89 stores and closed 52 stores.

A total of 19 franchised stores were operational at August 1, 2009. Revenue from the franchised stores was not significant for the thirteen and twenty-six weeks ended August 1, 2009 or August 2, 2008. These stores are not included in the Company's operating store count above.

SALES AND OPERATING RESULTS

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. Accordingly, stores opened and closed during the period are not included. Sales from the Direct-to-Customer segment, excluding CCS sales, are included in the calculation of comparable-store sales for all periods presented. Sales from acquired businesses that include the purchase of inventory are included in the computation of comparable-store sales after 15 months of operations. Accordingly, CCS sales have been excluded in the computation of comparable-store sales. Division profit reflects (loss) income from continuing operations before income taxes, corporate expense, non-operating income and net interest expense.

The following table summarizes results by segment:

                                     Sales
                                Thirteen weeks ended         Twenty-six weeks ended
                              August 1,      August 2,      August 1,        August 2,
       (in millions)            2009           2008            2009            2008
       Athletic Stores       $     1,018        $ 1,223      $     2,136        $ 2,440
       Direct-to-Customers            81             79              179            171
       Total sales           $     1,099        $ 1,302      $     2,315        $ 2,611



                               Operating Results
                                                 Thirteen weeks ended                Twenty-six weeks ended
                                            August 1,            August 2,        August 1,           August 2,
(in millions)                                  2009                 2008            2009                2008
Athletic Stores (1)                        $          5         $         39     $        66         $        79
Direct-to-Customers                                   5                    8              13                  18
Division profit (loss)                               10                   47              79                  97
Corporate expense, net (2)                           10                   19              29                  53
Operating profit                                      -                   28              50                  44
Other income (3)                                      1                    2               2                   2
Interest expense, net                                 3                    2               5                   3
(Loss) income from continuing operations
before income taxes                        $         (2 )       $         28     $        47         $        43

(1) Included in the results for the thirteen and twenty-six weeks ended August 2, 2008 are store closing costs of $1 million and $5 million, respectively, which primarily represent lease termination costs.

(2) Included in corporate expense for the twenty-six weeks ended August 2, 2008 is a $15 million impairment charge on the Northern Group note receivable.

(3) Included in other income for the twenty-six weeks ended August 1, 2009 are gains from insurance proceeds, gain on the purchase and retirement of bonds, and royalty income. The amount included in the prior year periods represented a lease termination gain related to the sale of a leasehold interest in Europe.

Sales of $1,099 million for the thirteen weeks ended August 1, 2009 decreased 15.6 percent from sales of $1,302 million for the thirteen weeks ended August 2, 2008. For the twenty-six weeks ended August 1, 2009 sales of $2,315 million decreased 11.3 percent from sales of $2,611 million for the twenty-six week period ended August 2, 2008. Excluding the effect of foreign currency fluctuations, total sales for the thirteen week and twenty-six week periods decreased 11.8 percent and 7.0 percent, respectively, as compared with the corresponding prior-year periods. Comparable-store sales decreased by 12.1 percent and 7.3 percent, for the thirteen and twenty-six weeks ended August 1, 2009, respectively.

Gross margin, as a percentage of sales, decreased to 25.5 percent for the thirteen weeks ended August 1, 2009 as compared with 27.7 percent in the corresponding prior-year period. Gross margin, as a percentage of sales, of 27.5 percent for the twenty-six weeks ended August 1, 2009 decreased as compared with 27.8 percent in the corresponding prior-year period. For the thirteen and twenty-six weeks ended August 1, 2009, the occupancy and buyers' salary expense rate increased by 190 and 80 basis points, respectively, as a percentage of sales, as compared with the corresponding prior-year period due to lower sales. The merchandise margin rate for the thirteen weeks ended August 1, 2009 declined by 30 basis points reflecting a mix shift towards inventory purchases with a lower initial markup. The merchandise margin rate for the twenty-six weeks improved by 50 basis points primarily reflecting lower markdowns taken as the Company was less promotional in the first half of 2009. The effect of vendor allowances was not significant for any of the periods presented.

Segment Analysis

Athletic Stores

Athletic Stores sales decreased by 16.8 percent and 12.5 percent for the thirteen and twenty-six weeks ended August 1, 2009, respectively, as compared with the corresponding prior-year periods. Excluding the effect of foreign currency fluctuations, primarily related to the euro, sales from athletic stores decreased 12.7 percent and 7.8 percent for the thirteen and twenty-six weeks ended August 1, 2009, respectively, as compared with the corresponding prior-year periods. Comparable-store sales decreased by 12.1 percent and 7.1 percent for the thirteen and twenty-six weeks ended August 1, 2009, respectively. The decline in domestic operations sales for the thirteen and twenty-six weeks ended August 1, 2009 was principally as a result of the continued decline in mall traffic and consumer spending in general. The sales decline during the thirteen week period ended August 1, 2009 also reflected various tax-free calendar shifts in 2009 and the effect of the stimulus checks that the U.S. government provided last year. Excluding the effect of foreign currency fluctuations, primarily related to the euro, sales from international operations declined by 0.8 percent and increased by 0.6 percent for the thirteen and twenty-six weeks ended August 1, 2009, respectively, as compared with the corresponding prior-year periods. International results continued to benefit from improved apparel sales.

Athletic Stores division profit for the thirteen weeks ended August 1, 2009 decreased to $5 million, or 0.5 percent, as a percentage of sales, from a division profit of $39 million for the thirteen weeks ended August 2, 2008. Athletic Stores division profit for the twenty-six weeks ended August 1, 2009 decreased to $66 million, or 3.1 percent, as a percentage of sales, from a division profit of $79 million for the twenty-six weeks ended August 2, 2008. Included in division profit for the thirteen weeks and twenty-six weeks ended August 2, 2008 are $1 million and $5 million, respectively, in costs associated with the closure of underproductive stores, primarily lease termination costs. The second quarter 2009 results of the domestic operations were significantly lower than the prior year and management's expectations, while international operations were essentially equal to the prior-year periods.

Direct-to-Customers

Direct-to-Customers sales increased by 2.5 percent to $81 million and by 4.7 percent to $179 million for the thirteen and twenty-six weeks ended August 1, 2009, respectively, as compared with the corresponding prior-year periods of $79 million and $171 million. This reflects a comparable-sales decrease of 11.1 percent and 9.2 percent for the thirteen and twenty-six weeks ended August 1, 2009, respectively, as compared with the corresponding prior-year periods, offset by sales from CCS, which was acquired during the fourth quarter of 2008. Internet sales increased by 6.2 percent to $69 million and by 8.6 percent to $152 million for the thirteen and twenty-six weeks ended August 1, 2009, respectively, as compared with the corresponding prior-year periods. Increases in Internet sales were partially offset by a decline in catalog sales.

Direct-to-Customers division profit decreased 37.5 percent and 27.8 percent to $5 million and $13 million for thirteen and twenty-six weeks ended August 1, 2009, respectively, as compared with the corresponding prior-year periods. Division profit, as a percentage of sales, decreased to 6.2 percent and 7.3 percent for the thirteen and twenty-six weeks ended August 1, 2009, respectively, as compared with 10.1 percent and 10.5 percent, respectively, in the corresponding prior-year periods. The decrease relates primarily to a decline in gross margin due to the lack of close-out inventory purchases in the current period, which enhanced the prior-year gross margin rate. The effect of the CCS acquisition on division profit was not significant.

Corporate Expense

Corporate expense consists of unallocated general and administrative expenses as well as depreciation and amortization related to the Company's corporate headquarters, centrally managed departments, unallocated insurance and benefit programs, certain foreign exchange transaction gains and losses, and other items. Corporate expense for the thirteen weeks ended August 1, 2009 decreased by $9 million to $10 million from the corresponding prior-year period. Corporate expense for the twenty-six weeks ended August 1, 2009 decreased by $24 million to $29 million from the corresponding prior-year period. Included in the twenty-six weeks ended August 2, 2008 was the impairment charge of $15 million associated with a note receivable due from the purchaser of the Company's former Northern Group operation in Canada. The remaining decrease for both the thirteen and twenty-six weeks ended August 1, 2009 represents primarily decreased incentive compensation, offset, in part, by higher pension expense.

Selling, General and Administrative

Selling, general and administrative expenses ("SG&A") of $252 million decreased by $47 million, or 15.7 percent, for the thirteen weeks ended August 1, 2009 as compared with the corresponding prior-year period. SG&A of $530 million decreased by $68 million, or 11.4 percent, for the twenty-six weeks ended August 1, 2009 as compared with the corresponding prior-year period. SG&A, as a percentage of sales, decreased to 22.9 percent for the thirteen weeks ended August 1, 2009 as compared with 23.0 percent in the corresponding prior-year period. SG&A, as a percentage of sales, was 22.9 percent for both the twenty-six weeks ended August 1, 2009 and August 2, 2008. Excluding the effect of foreign currency fluctuations, SG&A decreased $37 million and $44 million for the thirteen and twenty-six weeks ended August 1, 2009, respectively, as compared with the corresponding prior-year periods. The decrease in the thirteen and twenty-six weeks ended August 1, 2009 primarily reflects reduced store costs and lower corporate expense offset, in part, by an increase in pension expense as compared with the corresponding prior-year periods. The decrease in store costs principally reflects reduced store variable costs, primarily wages, related to operating fewer stores and better expense management. Pension expense increased by $3 million and $7 million for the thirteen and twenty-six weeks ended August 1, 2009, respectively. The inclusion of CCS, which was acquired during the fourth quarter of 2008, did not significantly affect SG&A.

Depreciation and Amortization

Depreciation and amortization decreased by $5 million in the second quarter of 2009 to $28 million as compared with $33 million for the second quarter of 2008. Depreciation and amortization decreased by $9 million for the twenty-six weeks ended August 1, 2009 to $56 million as compared with $65 million for the twenty-six weeks ended August 2, 2008. Excluding the effect of foreign currency fluctuations, primarily related to the euro, depreciation and amortization decreased by $3 million and $6 million for the thirteen and twenty-six weeks ended August 1, 2009, respectively, as compared with the corresponding prior-year periods. The decrease for the quarter and the year-to-date periods primarily reflects reduced depreciation and amortization of approximately $4 million and $8 million, respectively, associated with the impairment charges recorded during the fourth quarter of 2008, offset by the effect of prior-year capital spending and the amortization expense associated with the CCS customer list intangible asset.

Interest Expense

                                                       Thirteen weeks ended                       Twenty-six weeks ended
                                               August 1,                 August 2,           August 1,               August 2,
(in millions)                                    2009                       2008               2009                    2008
Interest expense                             $           3             $            4       $         6             $         9
Interest income                                          -                         (2 )              (1 )                    (6 )
Interest expense, net                        $           3             $            2       $         5             $         3

Interest expense decreased as a result of lower debt balances as the Company repaid its term loan during the second quarter of 2008, coupled with the fact that during the past 12 months the Company repurchased and retired a portion of its 2022 debentures. The decrease in interest income was primarily the result of lower interest rates on cash, cash equivalents, and short-term investments.

Other Income/Expense

Other income of $1 million and $2 million for the thirteen and twenty-six week periods ended August 1, 2009, respectively, is primarily related to gains from insurance proceeds, gain on the purchase and retirement of bonds, and royalty income. Other income of $2 million for the thirteen and twenty-six week periods ended August 2, 2008 is primarily related to a lease termination gain.

Income Taxes

The Company's effective tax rate for the thirteen and twenty-six weeks ended August 1, 2009 was 72.2 percent and 35.4 percent as compared with 36.8 percent and 51.3 percent for the corresponding prior-year periods. The income tax benefit for the second quarter of 2009 primarily reflects favorable settlements of tax examinations and a reduced tax rate in a foreign jurisdiction. The decrease in the rate for the twenty-six weeks is primarily attributable to the establishment in the prior year of a valuation allowance related to the tax benefit associated with the impairment of the Northern Group note receivable. Excluding the effect of the valuation allowance, the effective rate for the twenty-six weeks ended August 2, 2008 would have been 38.0 percent. If certain Canadian provincial tax rate reductions are enacted as proposed, the Company will record a charge of $4 million to $5 million to write-down the value of its net deferred tax assets. Excluding this charge, the Company expects its effective rate to range from 36 to 37 percent for the full year of 2009. The actual rate will also depend in significant part on the proportion of the Company's worldwide income that is earned in the U.S.

Net Income (Loss)

For the thirteen weeks ended August 1, 2009, net income decreased by $18 million, or $0.11 per diluted share as compared with the thirteen weeks ended August 2, 2008. Net income for the twenty-six weeks ended August 1, 2009 was $31 million, or $0.20 per diluted share. This compares to net income of $21 million, or $0.13 per diluted share for the twenty-six weeks ended August 2, 2008. Included in the thirteen weeks ended August 1, 2009, is income from discontinued operations of $1 million, as a result of a favorable state tax examination attributable to the Company's former Canadian businesses. Included in the twenty-six weeks ended August 2, 2008 are charges totaling $20 million (pre-tax), or $0.12 per share, representing an impairment charge of $15 million related to the Northern Group note receivable and expenses of $5 million related to the store closing program.

Management is in the process of developing various merchandising and expense initiatives in an effort to improve performance, as well as evaluating the effect of macroeconomic trends on the Company's projected future earnings. In the third quarter, once developed, the Company intends to analyze the effect of these initiatives and trends on the projected performance of its operations, which may include an analysis of recoverability of store long-lived assets, goodwill, and other intangible assets pursuant to SFAS No. 144 and SFAS No. 142.

LIQUIDITY AND CAPITAL RESOURCES

Generally, the Company's primary source of cash has been from operations. The Company generally 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, information systems, and other support facilities, retirement plan contributions, quarterly dividend payments, interest payments, other cash requirements to support the development of its short-term and long-term operating strategies, and to fund other working capital requirements. Management believes its cash, cash equivalents, future operating cash flow from operations, and the Company's current revolving credit facility will be adequate to fund these requirements. The Company may also from time to time repurchase its common stock or seek to retire or purchase outstanding debt through open market purchases, privately negotiated transactions or otherwise. Such repurchases, if any, will depend on prevailing market conditions, liquidity requirements, contractual restrictions and other factors. The amounts involved may be material.

On March 20, 2009, the Company entered into a new credit agreement with its banks, providing for a $200 million revolving credit facility maturing on March 20, 2013 which replaced the prior credit agreement. The new credit agreement also provides an incremental facility of up to $100 million under certain circumstances. The new credit agreement provides for a security interest in certain of the Company's domestic assets, including certain inventory assets. No material covenants or payment restrictions exist unless the Company is borrowing under the agreement and, in that event, the restrictions vary depending upon the level of borrowings.

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 and risks associated with foreign global sourcing or economic conditions worldwide, as well as other factors listed under the heading "Disclosure Regarding Forward-Looking Statements," could affect the ability of the Company to continue to fund its needs from business operations.

Net cash provided by operating activities was $83 million and $159 million for the twenty-six weeks ended August 1, 2009 and August 2, 2008, respectively. These amounts reflect net income adjusted for non-cash items and working capital changes. The non-cash charge for the twenty-six weeks ended August 2, 2008 represents a $15 million impairment charge related to the Northern Group note receivable. The change in merchandise inventories represents the normal seasonal increase related to the back-to-school selling season. The change in other accruals primarily represents incentive compensation payments. During the twenty-six weeks ended August 1, 2009, the Company terminated its interest rate swaps for a gain of $19 million. Additionally, during the twenty-six weeks ended August 1, 2009, the Company contributed $11 million to its U.S. and Canadian qualified pension plans as compared with a $6 million contribution to the Canadian qualified pension plan in the corresponding prior-year period. Due to the negative pension asset performance experienced in 2008, the Company made an additional contribution of $29 million during August 2009 to its U.S. qualified pension plan. No further pension contributions are planned for the balance of the year.

Net cash used in investing activities was $36 million and $77 million for the twenty-six weeks ended August 1, 2009 and August 2, 2008, respectively. Included in investing activities for the twenty-six weeks ended August 1, 2009 is a $1 million gain from insurance recoveries. Additionally, during the second quarter of 2009, the Company received $10 million, representing further liquidation of the Reserve International Liquidity Fund. The remaining investment of $13 million is classified as a short-term investment in the Condensed Consolidated Balance Sheet at August 1, 2009. Capital expenditures were $47 million for the twenty-six weeks ended August 1, 2009 as compared with $79 million in the corresponding prior-year period reflecting the Company's strategic decision to reduce its capital plan for 2009 due to the uncertain external environment. Capital expenditures for the full-year of 2009 are expected to total approximately $103 million, of which $79 million relates to modernizations of existing stores and new store openings, and $24 million reflects the development of information systems and other support facilities. The Company has the ability to revise and reschedule the anticipated capital expenditure program should the Company's financial position require it.

Net cash used in financing activities was $49 million and $139 million for the twenty-six weeks ended August 1, 2009 and August 2, 2008, respectively. During the twenty-six weeks ended August 1, 2009 and August 2, 2008, the Company purchased and retired $3 million and $6 million, respectively, of its 8.50 percent debentures payable in 2022. Additionally, during the twenty-six weeks ended August 2, 2008 the Company made payments of $88 million, which fully repaid its 5-year term loan. The Company declared and paid dividends totaling $47 million for both the twenty-six weeks ended August 1, 2009 and August 2, 2008, representing a rate of $0.15 per share. The Company received proceeds from the issuance of common stock in connection with employee stock programs of $1 million and $2 million for the twenty-six weeks ended August 1, 2009 and August 2, 2008, respectively.

Recent Accounting Pronouncements

In April 2009, the FASB issued FSP No. FAS 157-4, "Determining Fair Value When the Volume and Level of Activity for the Asset or the Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly," ("FSP No. 157-4"). FSP No. FAS 157-4 amends Statement No. 157 to provide additional guidance on (i) estimating fair value when the volume and level of activity for an asset or liability have significantly decreased in relation to normal market activity for the asset or liability, and (ii) circumstances that may indicate that a transaction is not orderly. FSP No. FAS 157-4 also requires additional disclosures about fair value measurements in interim and annual reporting periods. FSP No. FAS 157-4 is effective for interim and annual reporting periods ending after June 15, 2009. The adoption of FSP No. FAS 157-4 did not have a material effect on the Company's consolidated financial statements.

In April 2009, the FASB issued FSP No. FAS 115-2 and FAS 124-2, "Recognition and Presentation of Other-Than-Temporary Impairments." FSP No. FAS 115-2 and FAS 124-2 amends the other-than-temporary impairment guidance for debt securities to make the guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities in the financial statements. This guidance does not amend existing recognition and measurement guidance related to other-than-temporary impairments of equity securities. The provisions of FSP No. FAS 115-2 and FAS 124-2 are effective for interim and annual reporting periods ending after June 15, 2009. The adoption of FSP No. FAS 115-2 and FAS 124-2 did not have a material effect on the Company's consolidated financial statements.

In April 2009, the FASB issued FSP No. FAS 107-1 and APB No. 28-1, "Interim Disclosures about Fair Value of Financial Instruments" which amends SFAS No. 107, "Disclosures about Fair Value of Financial Instruments," to require disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies, as well as in annual financial statements. This FSP also amends APB Opinion No. 28, "Interim Financial Reporting," to require those disclosures in summarized financial information at interim reporting periods. FSP FAS 107-1 and APB 28-1 are effective for interim reporting periods ending after June 15, 2009. The disclosures required as a result of the adoption of FSP FAS 107-1 and APB 28-1 are included herein.

In May 2009, the FASB issued SFAS No. 165, "Subsequent Events," ("SFAS No. 165") which establishes the accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. SFAS No. 165 is effective for interim and annual reporting periods ending after June 15, 2009. The Company adopted SFAS No. 165 during the second quarter of 2009. See Note 1, Basis of Presentation, for the disclosure required under SFAS No. 165.

In June 2009, the FASB issued SFAS No. 167, "Amendments to FASB Interpretation No. 46(R)," ("SFAS No. 167") which changes various aspects of accounting for and disclosures of interests in variable interest entities. SFAS No. 167 will be effective for interim and annual reporting periods beginning after November 15, 2009. The adoption of SFAS No. 167 is not expected to have a material effect on the Company's consolidated financial statements.

In June 2009, the FASB issued SFAS No. 168, "The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles," ("SFAS No. 168") which establishes the FASB Accounting Standards . . .