Nordstrom - 10-K annual report

 

NORDSTROM, INC.
(Exact name of Registrant as specified in its charter)

Registrant’s telephone number, including area code: 206-628-2111

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

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

     Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
YES R NO £

     Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
YES £ NO R

     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 R NO £

     Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. £

     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act (Check one):

Large accelerated filer R                     Accelerated filer £                      Non-accelerated filer £

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). YES £ NO R

     As of July 29, 2005 the aggregate market value of the Registrant’s voting and non-voting stock held by non-affiliates of the Registrant was approximately $8.1 billion using the closing sales price on that day of $37.01. On March 10, 2006, 267,288 shares of common stock were outstanding (in thousands).

1. Portions of the Proxy Statement for the 2006 Annual Meeting of Shareholders scheduled to be held on May 23, 2006 are incorporated into Part III

 

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DESCRIPTION OF BUSINESS
Nordstrom incorporated in the state of Washington in 1946 as the successor to a retail shoe business that started in 1901. We are one of the nation’s leading fashion specialty retailers, with 156 U.S. stores located in 27 states. The west coast and east coast are the areas in which we have the largest presence. Nordstrom is comprised of four segments: Retail Stores, Credit, Direct, and Other.

Retail Stores derives its revenues from sales of high-quality apparel, shoes, cosmetics and accessories. It includes our 99 Full-Line ‘Nordstrom’ stores, 49 discount ‘Nordstrom Rack’ stores, one free-standing shoe store, and two clearance stores that operate under the name ‘Last Chance.’ The Nordstrom Rack stores serve as outlets for clearance merchandise from our Full-Line stores and purchase merchandise directly from manufacturers.

In 2005, we opened four Full-Line stores (Atlanta, Georgia; San Antonio, Texas; Irvine, California; and Dallas, Texas) and relocated one Rack store (Portland, Oregon). In March 2006, we opened one Full-Line store in Palm Beach Gardens, Florida. We are scheduled to relocate our Topanga Full-Line store in Canoga Park, California and open one Rack store in San Marcos, California in the fall of 2006. In 2007, we are scheduled to open four Full-Line stores.

Through our wholly-owned federal savings bank, Nordstrom fsb, we offer a private label card, two co-branded Nordstrom VISA credit cards and a debit card for Nordstrom purchases. The credit and debit cards feature a shopping based loyalty program designed to increase customer visits and spending in our Retail Stores and Direct segments. Our Credit segment generates earnings through finance charges and securitization-related gains on these cards.

Direct generates revenues from sales of high-quality apparel, shoes, cosmetics and accessories by serving our customers on the Web at www.nordstrom.com and through our catalogs. Most of the Direct segment’s sales are shipped via third-party carriers from our fulfillment center in Cedar Rapids, Iowa.

Our Other segment includes our five U.S. based ‘Façonnable’ boutiques and the 32 Façonnable boutiques located in France, Portugal and Belgium. Façonnable is a wholesaler and retailer of high quality men’s and women’s apparel and accessories with distribution to over 45 countries. Façonnable has licensee and franchisee agreements with others who operate wholesale distribution and/or boutique locations in Spain, Switzerland, Turkey, Greece, the Middle East, Taiwan, Canada and Latin America. The Other segment also includes our product development team, called Nordstrom Product Group, which coordinates the design and production of private label merchandise sold in our retail stores. In addition, this segment includes our corporate center operations.

For more information about our business and our reportable segments, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operation” on page 14 and Note 15 of the Notes to Consolidated Financial Statements in Item 8 on page 45.

FISCAL YEAR END
Our fiscal year ends on the Saturday closest to January 31st. References to 2005, 2004 and 2003 relate to the 52 week fiscal years ended January 28, 2006, January 29, 2005 and January 31, 2004. References to 2006 relate to the 53 weeks ending February 3, 2007.

STOCK SPLIT
On May 24, 2005, our Board of Directors approved a two-for-one stock split of our outstanding common stock and a proportional increase in the number of common shares authorized from 500 million to 1 billion. Additional shares issued as a result of the stock split were distributed on June 30, 2005 to shareholders of record as of June 13, 2005. Reference to our shares and per share information have been adjusted to reflect this stock split.

TRADEMARKS
We have approximately 150 registered trademarks or trademark applications. Our most notable trademarks include Nordstrom, Nordstrom Rack, Façonnable, Caslon, John W. Nordstrom, and Classiques Entier. Each of our trademarks is renewable indefinitely provided that it is still used in commerce at the time of the renewal.

RETURN POLICY
We offer our customers a fair and liberal return policy at our Full-Line stores. Our Nordstrom Rack stores accept returns up to 30 days from the date of purchase. In general, our return policy is somewhat more generous than industry standards. We utilize historical return patterns to estimate our expected returns.

SEASONALITY
Due to our anniversary sale in July and the holidays in December, sales are higher for our Retail Stores in the second and fourth quarters of the fiscal year than in the first and third quarters.

INVENTORY
We plan our merchandise purchases and receipts to coincide with the selling patterns that we expect. For instance, we purchase and receive a larger amount of merchandise in the fall as we prepare for the holiday shopping season (from late November through early January). Also, our merchandise purchases and receipts increase prior to our Anniversary Sale, which extends over the last two weeks of July. We pay for our merchandise purchases under the terms established with our vendors, which is usually within 30 days of the date that the merchandise was shipped to us.

In order to offer merchandise that our customer will desire, we purchase merchandise from a wide variety of high-quality suppliers. In 2005, our ten largest suppliers accounted for approximately 21% of our merchandise purchases. We also have arrangements with agents and contract manufacturers to produce our private label merchandise. We do not have long-term purchase commitments or arrangements with any of our merchandise suppliers. Our suppliers include domestic and foreign businesses. We expect our suppliers to meet our “Nordstrom Partnership: Standards and Business Practice Guidelines,” which address our standards for matters such as law, labor, health and safety, and environment.

COMPETITIVE CONDITIONS
All segments of our business are highly competitive. Each of our stores competes with other national, regional and local retail establishments that may carry similar lines of merchandise, including department stores, specialty stores, boutiques, mail order and Internet businesses. Our specific competitors vary from market to market. We believe the principal methods of competing in our industry include customer service, store environment, quality of product, fashion, depth of selection and location.

EMPLOYEES
During 2005, we regularly employed on a full or part-time basis an average of 51,400 employees. Due to the seasonal nature of our business, employment increased to approximately 55,400 employees in July 2005 and 56,000 in December 2005.

CAUTIONARY STATEMENT
Certain statements in this Annual Report on Form 10-K contain “forward-looking” statements (as defined in the Private Securities Litigation Reform Act of 1995) that involve risks and uncertainties, including anticipated results, store openings and trends in our operations. Actual future results and trends may differ materially from historical results or current expectations depending upon various factors including those discussed below and elsewhere in this Annual Report on Form 10-K, particularly in Item 1A under the heading “Risk Factors:” the impact of economic and competitive market forces, terrorist activity or war may impact our customers and the retail industry, our ability to predict fashion trends, consumer apparel buying patterns, trends in personal bankruptcies and bad debt write-offs, changes in interest rates, employee relations, our ability to continue and control our expansion, remodel and investment plans, changes in government or regulatory requirements, our ability to control costs, weather conditions and hazards of nature.

These and other factors could affect our financial results and cause actual results to differ materially from those contained in any forward-looking statements we may make. As a result, while we believe there is a reasonable basis for the forward-looking statements, you should not place undue reliance on those statements. We undertake no obligation to update or revise any forward-looking statements to reflect subsequent events, new information or future circumstances.

SEC FILINGS
We file annual, quarterly and current reports, proxy statements and other documents with the Securities and Exchange Commission (“SEC”). All material we file with the SEC is publicly available at the SEC’s Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an Internet Web site at www.sec.gov that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC.

WEB SITE ACCESS
Our Internet Web site address is www.nordstrom.com. We make available free of charge on or through our Internet Web site our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, statements of changes in beneficial ownership of securities on Form 4 and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after we electronically file the report with or furnish it to the SEC. Interested parties may also access a Webcast of quarterly earnings conference calls and other financial events over our Internet Web site.

CORPORATE GOVERNANCE
We have a long-standing commitment to upholding a high level of ethical standards. In addition, as required by the listing standards of the New York Stock Exchange (“NYSE”) and the rules of the SEC, we have adopted a Code of Business Conduct and Ethics (“Code of Ethics”) and Corporate Governance Guidelines. We have posted on our Web site our Code of Ethics, our Corporate Governance Guidelines, and our Committee Charters for the Audit, Compensation, Corporate Governance and Nominating, Executive, and Finance committees. These items are also available in print to any shareholder upon request to:

Nordstrom, Inc. Investor Relations
P.O. Box 2737
Seattle, Washington 98111
(206) 303-3200
invrelations@nordstrom.com

Our business faces many risks. We believe the risks described below outline the items of most concern to us. However, these risks may not be the only ones we face. Additional risks and uncertainties, not presently known to us or that we currently deem immaterial, may also impair our business operations.

ABILITY TO RESPOND TO THE BUSINESS ENVIRONMENT AND FASHION TRENDS
Our sales and operating results depend in part on our ability to predict or respond to changes in fashion trends and consumer preferences in a timely manner. Any sustained failure to identify and respond to emerging trends in lifestyle and consumer preferences could have a material adverse affect on our business. Consumer spending at our stores may be affected by many factors outside of our control, including consumer confidence, weather and other hazards of nature that affects consumer traffic, and general economic conditions.

INVENTORY MANAGEMENT
We strive to ensure the merchandise we offer remains fresh and compelling to our customers. If we are not successful at predicting our sales trends and adjusting our purchases, we may have excess inventory, which would result in additional markdowns and reduce our operating performance.

IMPACT OF COMPETITIVE MARKET FORCES
The recent retail industry consolidation changes the environment for many of our vendors and customers. In the future, our competition may partner more effectively with vendors to serve the market’s needs. If we do not effectively respond to changes in our environment, we may see a loss of market share to competitors, declining same-store sales, and declining profitability due to higher markdowns.

STORE GROWTH STRATEGY
As of March 2006, our plans for the next three years include opening 13 new stores and relocating or remodeling 18 existing stores. In the past, our expected opening dates have sometimes been delayed because of development plan delays. Our future growth could be negatively impacted by delays to our store opening, relocating or remodeling plans. In addition, our future net sales at new, relocated or remodeled stores may not meet our projections, which could reduce our operating performance. Performance in our new stores could also be impacted based on our ability to hire employees who are able to deliver the level of service customers have come to expect when shopping at our stores.

INFORMATION SECURITY AND PRIVACY
The protection of our customer, employee, and company data is critical to us. The regulatory environment surrounding information security and privacy is increasingly demanding, with the frequent imposition of new and constantly changing requirements across our business units. In addition, our customers have a high expectation that we will adequately protect their personal information. A significant breach of customer, employee, or company data could damage our reputation and result in lost sales, fines, or lawsuits.

LEADERSHIP DEVELOPMENT AND SUCCESSION PLANNING
The training and development of our future leaders is critical to our long-term growth. If we do not effectively implement our strategic and business planning processes to train and develop future leaders, our long-term growth may suffer. In addition, if unexpected leadership turnover occurs without established succession plans, our business may suffer.

BOARD SUCCESSION
A number of our long-standing Directors who were instrumental in leading our Company have retired or will soon retire from our Board. These Board members with extensive experience will no longer be actively involved in our business and development of our long-term strategy. We are welcoming a number of new members to our Board, and we expect to benefit from their vast business experience.

MULTI-CHANNEL STRATEGY EXECUTION
In 2005, we started to make changes in our Direct business that better align our online shopping environment and catalog with the customer experience in our Full-Line stores. These changes include: aligning our Direct merchandise offering with our Full-Line stores to create a seamless experience for our customers between our stores, catalogs and Web site; integrating our Full-Line stores and Direct merchandise organization; recommending that our Full-Line store salespeople utilize our Direct inventory to fulfill customer requests when merchandise is not available at the store; reducing the number and frequency of our Direct catalog mailings; and transitioning our Direct inventory system onto our Full-Line store platform, all while dealing with changes in the Internet market in general. If we made decisions that prove to not be embraced by our customers, our sales could decline. In addition, the cost of integrating these businesses may be greater than expected, which would impact our future operating performance.

BRAND AND REPUTATION
We have a well-recognized brand that is synonymous with the highest level of customer service. Any significant damage to our brand or reputation may negatively impact same-store sales, lower employee morale and productivity, and diminish customer trust, resulting in a reduction in shareholder value.

CAPITAL EFFICIENCY AND PROPER ALLOCATION
Our goal is to invest capital to maximize our overall returns. This includes spending on inventory, capital projects and expenses, managing debt levels, managing accounts receivable through our credit business, and using our assets efficiently to return value to our shareholders. To a large degree, capital efficiency reflects how well we manage the other key risks to our Company. The actions taken to address other specific risks may affect how well we manage the more general risk of capital efficiency. Our recent operating results have raised expectations about our performance. If we do not properly allocate our capital to maximize returns, we may fail to continue to produce similar financial results and we may experience a reduction in shareholder value.

HUMAN RESOURCE REGULATIONS
Our policies and procedures are designed to comply with human resource laws such as wage and hour, meal and rest period, and commissions. Federal and state wage and hour laws are complex, and the related enforcement is increasingly aggressive, particularly in the state of California. Failure to comply with these laws could result in damage to our reputation, class action lawsuits, and dissatisfied employees.

EMPLOYMENT AND DISCRIMINATION LAWS
State and federal employment and discrimination laws and the related case law continue to evolve, making ongoing compliance in this area a challenge. Failure to comply with these laws may result in damage to our reputation, legal and settlement costs, disruption of our business, and loss of customers and employees, which would result in a loss of net sales and increased employment costs, low employee morale and attendant harm to our business and results of operations.

TECHNOLOGY STRATEGY
We make investments in information technology to sustain our competitive position. We spend on average approximately $150 million each year on information technology operations and system development, and this spending is key to our growth strategy. We must monitor and choose the right investments and implement them at the right pace. Targeting the wrong opportunities, failing to make the best investment, or making an investment commitment significantly above or below the requirements of the business opportunity may result in the loss of our competitive position. In addition, an inadequate investment in maintaining our current systems may result in a loss of system functionality and increased future costs to bring our systems up to date.

We may implement too much technology, or change too fast, which could result in failure to adopt the new technology if the business is not ready or capable of accepting it. Excessive technological change affects the effectiveness of adoption, and could adversely affect the realization of benefits from the technology. However, not implementing enough technology could compromise our competitive position.

REGULATORY COMPLIANCE
Our policies and procedures are designed to comply with all applicable laws and regulations, including those imposed by the SEC, NYSE, the banking industry, and foreign countries. With recent high profile business failures on accounting-related issues, additional legal and regulatory requirements such as the Sarbanes-Oxley Act have increased the complexity of the regulatory environment. In addition, foreign laws may conflict with domestic laws. Failure to comply with the various regulations may result in damage to our reputation, civil and criminal liability, fines and penalties, increased cost of regulatory compliance, and restatements of financial statements.

ANTI-TAKEOVER PROVISIONS
We are incorporated in the state of Washington and subject to Washington state law. Some provisions of Washington state law could interfere with or restrict takeover bids or other change in control events affecting us. For example, one statutory provision prohibits us, except under specified circumstances, from engaging in any significant business transaction with any shareholder who owns 10% or more of our common stock (which shareholder, under the statute, would be considered an “acquiring person”) for a period of five years following the time that such shareholder became an acquiring person.

None.

The following table summarizes the number of retail stores owned or leased by us, and the percentage of total store square footage represented by each listed category at January 28, 2006:

We also own six merchandise distribution centers located in Portland, Oregon; Dubuque, Iowa; Ontario, California; Newark, California; Upper Marlboro, Maryland; and Gainesville, Florida, which are utilized by the Retail Stores segment. The Direct segment utilizes one fulfillment center in Cedar Rapids, Iowa, which is owned on leased land. Our administrative offices in Seattle, Washington are a combination of leased and owned space. For one of our corporate office buildings in Seattle, we own a 49% interest in a limited partnership which constructed the office building in which we are the primary tenant. During 2002, the limited partnership refinanced its construction loan obligation with a mortgage secured by the property. This mortgage is included in our long-term debt and is amortized as we make rental payments to the limited partnership over the life of the mortgage. We also lease an office building in the Denver, Colorado metropolitan area that serves as an office of Nordstrom fsb and Nordstrom Credit, Inc.

The following table lists our retail store facilities as of January 28, 2006:

(a) We are scheduled to relocate our Full-Line store in Canoga Park, CA in 2006, increasing the square footage to approximately 200,000.

In March 2006, we opened one Full-Line store in Palm Beach Gardens, FL and we plan to open one Rack store in San Marcos, CA in the fall of 2006. In 2007, we are scheduled to open four Full-Line stores.

COSMETICS
We were originally named as a defendant along with other department store and specialty retailers in nine separate but virtually identical class action lawsuits filed in various Superior Courts of the State of California in May, June and July 1998 that were consolidated in Marin County Superior Court. In May 2000, plaintiffs filed an amended complaint naming a number of manufacturers of cosmetics and fragrances and two other retailers as additional defendants. Plaintiffs’ amended complaint alleges that the retail price of the “prestige” or “Department Store” cosmetics and fragrances sold in department and specialty stores was collusively controlled by the retailer and manufacturer defendants in violation of the Cartwright Act and the California Unfair Competition Act.

Plaintiffs seek treble damages and restitution in an unspecified amount, attorneys’ fees and prejudgment interest, on behalf of a class of all California residents who purchased cosmetics and fragrances for personal use from any of the defendants during the four years prior to the filing of the original complaints.

We entered into a settlement agreement with the plaintiffs and the other defendants on July 13, 2003. In furtherance of the settlement agreement, the case was re-filed in the United States District Court for the Northern District of California on behalf of a class of all persons who currently reside in the United States and who purchased “Department Store” cosmetics and fragrances from the defendants during the period May 29, 1994 through July 16, 2003. The Court gave preliminary approval to the settlement, and a summary notice of class certification and the terms of the settlement were disseminated to class members. On March 30, 2005, the Court entered a final judgment approving the settlement and dismissing the plaintiffs’ claims and the claims of all class members with prejudice, in their entirety. On April 29, 2005, two class members who had objected to the settlement filed notices of appeal from the Court’s final judgment to the United States Court of Appeals for the Ninth Circuit. The objectors’ appellate brief is due on March 24, 2006, and plaintiffs’ and defendants’ briefs are due in late April or early May, 2006. It is uncertain when the appeals will be resolved, but the appeal process could take as much as another year or more. If the Court’s final judgment approving the settlement is affirmed on appeal, or the appeals are dismissed, the defendants will provide class members with certain free products with an estimated retail value of $175 million and pay the plaintiffs’ attorneys’ fees, awarded by the Court, of $24 million. Our share of the cost of the settlement will not have a material adverse effect on our financial condition, results of operations or cash flows.

OTHER
We are involved in routine claims, proceedings, and litigation arising from the normal course of our business. We do not believe any such claim, proceeding or litigation, either alone or in aggregate, will have a material impact on our results of operations, financial position, or liquidity.

None.

Our Common Stock, without par value, is traded on the New York Stock Exchange under the symbol “JWN.” The approximate number of holders of Common Stock as of March 10, 2006 was 133,876, based upon the number of registered and beneficial shareholders, as well as the number of employee shareholders in the Nordstrom 401(k) Plan and Profit Sharing.

On May 24, 2005, our Board of Directors approved a two-for-one stock split of our outstanding common stock and a proportional increase in the number of common shares authorized from 500 million to 1 billion. Additional shares issued as a result of the stock split were distributed on June 30, 2005 to shareholders of record as of June 13, 2005. Reference to our shares and per share information have been adjusted to reflect this stock split.

The high and low sales prices of our common stock and dividends declared for each quarter of 2005 and 2004 are presented in the table below:

REPURCHASES
(Dollars in millions except per share amounts)

A summary of our fourth quarter share repurchases are as follows:

(1) In February 2005, the Board of Directors authorized $500.0 of share repurchases. The actual number and timing of share repurchases will be subject to market conditions and applicable SEC rules. In 2005, we purchased 8,493,887 shares for $287.1 at an average price of $33.80 per share.

Item 6. Selected Financial Data.
(Dollars in thousands except sales per square foot and per share amounts)

The following selected financial data are derived from the audited Consolidated Financial Statements and should be read in conjunction with Item 1A “Risk Factors,” Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operation,” and the Consolidated Financial Statements and the related notes included in Item 8 of this Annual Report on Form10-K.

(Dollars in thousands except sales per square foot and per share amounts)

¹ Same-stores include stores that have been open at least one full year at the beginning of the year.

² Gross profit rate is calculated as the gross profit as a percentage of net sales.

³ Selling, general, and administrative rate is calculated as the selling, general, and administrative expenses as a percentage of net sales.

⁴ 1999 — The item below amounted to a net $10,000 charge ($6,111, net of tax, or $0.02 per diluted share):

Nordstrom is a fashion specialty retailer offering high-quality apparel, shoes, cosmetics and accessories for women, men and children. We offer a wide selection of brand name and private label merchandise. We offer our products through multiple retail channels including our Full-Line ‘Nordstrom’ stores, our discount ‘Nordstrom Rack’ stores, our ‘Façonnable’ boutiques, our catalogs and on the Internet at www.nordstrom.com. Our stores are located throughout the United States and we have 32 Façonnable boutiques located in France, Portugal, and Belgium. In addition, we offer our customers a variety of payment products and services including our loyalty program.

STRATEGIC INITIATIVES FOR 2006
Our long-term goal is to deliver industry-leading performance, and we continue to focus on driving top-line growth, gaining operational efficiencies and developing leaders for future growth. This mindset has served us well over the last few years as we have generated same-store sales growth and improved our gross profit and selling, general, and administrative rates. Our 2006 initiatives maintain the same focus but also recognize the developments in our business and the marketplace.

Drive Top-Line Growth
Our top priority is to gain market share through existing stores and channels, as well as from new Full-Line stores. Our success in accomplishing this goal starts and ends with the experience each customer has in our stores. We believe the essence of this experience is desirable products coupled with personalized service. Our ongoing focus revolves around these two key elements of our business as we believe they are an integral part of long-term success. For 2006, we have identified three specific areas of focus to drive top-line growth: re-energizing women’s apparel, multi-channel integration and enhancing our designer business.

Women’s Apparel — Women’s apparel represents about one-third of our total sales and serves a wide range of individual tastes and styles. In 2005, we started to develop more targeted merchandising strategies for our women’s departments. A thorough analysis of objective customer information combined with the feedback from our selling floor has helped us to better understand our customers’ needs and shopping priorities in terms of style, price, fit and occasion. We have carefully reorganized our merchant teams and are in the process of fine-tuning our offerings to better serve our customers.

Multi-Channel Integration — Our goal is to create a more integrated, consistent merchandise offering for our customers, whether they choose to shop in our Full-Line stores, on the Internet or through our catalogs. As described in “Multi-Channel Strategy Execution” on page 6, we initiated the integration in 2005. In 2006 we will begin migrating the Direct inventory system onto our Full-Line store platform, creating a “one-company view” of inventory resulting in a more seamless merchandise offering and experience for our customer. This process is expected to continue through 2008.

Designer — Our women’s designer category has been a strong performer and contributes significantly to the aspirational nature of our brand. Our goal is to have a complete designer offering in at least one store for every major market we serve. In addition, we are focused on enhancing and aligning our designer offering across all major merchandise categories. In August 2005, we purchased a majority interest in Jeffrey, a luxury specialty store business with stores in New York City and Atlanta, and named the founder, President and CEO of Jeffrey, Mr. Jeffrey Kalinsky, Director of Designer Merchandising at Nordstrom. Along with our merchant team, we’re utilizing Mr. Kalinsky’s expertise and creativity in the designer business to further our current designer strategies. Additionally, we launched a designer Web site in February 2006, which offers designer apparel, footwear
and accessories.

Continue to Gain Operational Efficiencies
As we ‘drive top-line growth,’ we seek to expand our gross profit and reduce our selling, general and administrative rates by minimizing the increases to our buying, occupancy, general and administrative costs. This approach has been successful over the past three years, as we have controlled these costs while we supported our same-store sales growth. We are committed to keeping our technology investments current and relevant to our business needs. This includes investing in ongoing maintenance and system enhancements as well as replacing older applications as the opportunities present themselves. This is an ongoing part of our overall technology investment strategy. We anticipate additional rate improvement from our buying and corporate organization as we enhance our processes and expand the use of our systems to support our future sales growth.

Leadership Development and Succession Planning
At Nordstrom, we are committed to developing the best talent in retail. The training and development of our future leaders is critical to our long-term growth. To that end, we have identified potential successors for all major leadership roles. We have also piloted with 35 executives a leadership development program designed to increase specifically identified leadership skills. This program includes identifying each leader’s development needs and includes personal coaching as well as interactive group learning. This program will be rolled out to approximately 90 leaders by the end of 2006 with plans to train more individuals over the next few years.

OVERVIEW
In 2005, our same-store sales increased 6.0% on top of our 8.5% increase in 2004. These increases are our two highest annual same-store sales growth results in the past 10 years. Some other retailers who combine an offering of compelling merchandise and customer service have also experienced positive sales growth. Our merchandise and selling costs increased in-line with our same-store sales, but our other costs, including buying and occupancy costs and non-selling labor, remained relatively consistent with last year. As a result of our same-store sales growth and expense performance, we experienced a significant increase in our operating income. Our earnings before income tax expense as a percentage of net sales was 11.5% in 2005, the first year that it exceeded 10.0% since we first issued stock to the public in 1971. In addition, our diluted earnings per share increased 43.5% to $1.98.

2005 VS 2004 NET SALES
In our Full-Line stores, our accessories, cosmetics and men’s apparel merchandise categories experienced the largest same-store sales increases. Our shoe divisions had same-store sales increases. Our women’s apparel merchandise category had mixed same-store sales performance; women’s intimate, junior and contemporary apparel were the leaders in the women’s category, while women’s special sizes, better and bridge apparel had same-store sales decreases in 2005.

Our Rack same-store sales increased 14.8% in 2005, on top of last year’s 13.2% increase. Our sales increase was driven by the Rack’s merchandise mix, especially our ability to offer customers branded merchandise.

Nordstrom Direct’s 2005 sales, including shipping revenue, decreased by 2.5%. Internet sales increased 40.7%. In February 2005, we reduced our shipping fees, which drove additional Internet sales but reduced our overall shipping revenue. Nordstrom Direct’s 2005 sales, excluding shipping revenue, improved by 2.4% compared to 2004. As part of the multi-channel strategy (see page 6), we reduced our Direct catalog mailings significantly beginning in July 2005 and we shifted the merchandise offering to be more aligned with the Full-Line stores. The decrease in the number of Direct catalog mailings, along with a continuing shift of catalog customers to the Internet, resulted in a drop in catalog sales in 2005.

Total net sales increased as a result of our same-store sales increases as well as from the six Full-Line stores opened since February 2004.

2004 VS 2003 NET SALES
Our net sales increased as our customers responded positively to our merchandise offerings. Both our Full-Line and Rack stores had overall and same-store sales increases. All of our geographic regions and major merchandise categories also reported overall and same-store sales increases. The strongest performing areas were accessories, women’s shoes and women’s better apparel, followed by women’s designer and men’s apparel.

Total net sales also benefited from the six Full-Line stores and two Rack stores opened since February 2003, increasing our retail square footage 5% during the last two years.

Sales at Nordstrom Direct increased 30.9% due to Internet-customer order growth and an improved customer order fulfillment rate. Internet sales increased 53.1% due to an increase in the rate of Web site visits that result in sales and increased Internet advertising. Catalog net sales decreased in 2004 by 3%, which is consistent with our strategy to shift catalog customers to the Internet.

2006 FORECAST OF SAME-STORE SALES
In March 2006, we opened one Full-Line store; later in 2006, we plan to open one Rack store and relocate one existing Full-Line store, increasing retail square footage by approximately 1%. We expect 2006 same-store sales to increase 1% to 3%.

2005 VS 2004 GROSS PROFIT
While we showed growth in our same-store sales, we held buying and occupancy costs relatively consistent with last year. In addition, our merchandise costs increased in-line with our sales increases. As a result, we drove a gross profit rate improvement of 60 basis points.

We continue our efforts to improve inventory management while providing fresh and compelling merchandise to our customers. We utilized existing and new technology to gain greater visibility into our sales trends and inventory position. Our merchant teams used these tools to expand their analysis of our sales and on-hand content to drive sales growth and increase our inventory turnover rate.

2004 VS 2003 GROSS PROFIT
In 2004, the improvement in our gross profit rate was primarily a result of meeting our customers’ desire for fresh, compelling merchandise, which increased the sales of regular priced merchandise. In addition, gross profit benefited from our ongoing improvement in managing inventory and by holding buying costs and the fixed portion of occupancy expenses flat.

Contributing to our gross profit rate improvement was the continuous improvement we are making utilizing our perpetual inventory system investment, which we made in 2003. We have better visibility into sales trends and on-hand content, allowing us to more effectively manage our merchandise; the result was a significant improvement in our inventory turnover rate. Increased sell-through of regular-priced merchandise reduced the markdowns necessary to sell slow moving goods. We maintained our inventory at levels consistent with the prior year, even though our sales and square footage grew in 2004. The overall improvements in merchandise management have generated higher margins on our inventory investments.

2006 FORECAST OF GROSS PROFIT
In 2006, if we achieve our planned same-store sales growth, we expect a net 10 to 20 basis point improvement in our gross profit rate from continued sales leverage on buying and occupancy costs. This includes an estimated 15 basis point decrease to our 2006 gross profit rate when we adopt SFAS No. 123(R), “Share-Based Payment.”

2005 VS 2004 SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
The primary component of our selling, general and administrative expenses that varies with our same-store sales is our selling costs. Most of our other expenses do not fluctuate with changes in our same-store sales. In 2005, as our same-store sales increased 6.0%, we held our general and administrative expenses essentially in-line with 2004, which resulted in a 110 basis point decrease in our selling, general and administrative rate. This is our second year in a row that the combination of our net sales increases and control of our general and administrative costs has given us an improvement in the selling, general and administrative rate of over 100 basis points.

2004 VS 2003 SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
We continued to use our infrastructure to support increased sales. In 2004, our selling, general and administrative rate improved 110 basis points. We were able to control and leverage our fixed general and administrative expenses, especially non-selling labor. While selling expense increased in 2004, primarily from higher costs linked to increased sales, we experienced a slight rate improvement in selling expense as a percentage of net sales.

2006 FORECAST OF SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
In 2006, our selling, general and administrative rate is expected to improve overall by 10 to 20 basis points, primarily from continued sales leverage on general and administrative expenses. This includes an estimated 20 basis point increase to our 2006 selling, general and administrative rate when we adopt SFAS No. 123(R), “Share-Based Payment.”

2005 VS 2004 INTEREST EXPENSE, NET
Interest expense, net decreased $32.1 million in 2005 compared to 2004. The decrease is primarily due to debt prepayment costs of $20.9 million incurred in 2004 in connection with a $198.2 million debt buyback. We did not incur similar costs in 2005.

2004 VS 2003 INTEREST EXPENSE, NET
We prepaid debt of $198.2 million in 2004 and $105.7 million in 2003. We incurred debt prepayment costs of $20.9 million in 2004 and $14.3 million in 2003. The decrease in our interest expense, net in 2004 was due to the reduction in our 2004 average outstanding debt, partially offset by the increase in the prepayment costs.

2006 FORECAST OF INTEREST EXPENSE, NET
We expect a reduction in interest expense, net of approximately $8 to $10 million due to higher interest income. This forecasted interest expense can vary based upon the rate of our share repurchases, which affects our cash on hand and the related interest income, and the variable portion of our long-term debt. Although the majority of our debt has fixed interest rates, we currently hold an interest rate swap agreement on our $250.0 million 5.625% senior notes due in January 2009, where we receive a fixed rate of 5.625% and pay a variable rate based on LIBOR plus a margin of 2.3% set at six-month intervals (7.09% at January 28, 2006).

2005 VS 2004 OTHER INCOME INCLUDING FINANCE CHARGES, NET
Other income including finance charges, net increased $23.4 million, due to earnings growth in the Nordstrom fsb co-branded VISA credit card program and our gift card breakage income of $8.0 million. The principal balances of receivables in the VISA credit card, which are held by a separate trust in which we hold a certificated interest, increased 20.6% during 2005. The receivables growth increase, which is mostly funded by our operating cash flows, produces an increase in the trust’s earnings. Our income from the program increased primarily because of this growth in the co-branded receivables program.

Gift card breakage income is a new component of income in 2005. Unclaimed property legislation changed in 2004 to allow us to retain unused balances on gift cards. We analyzed the experience of our program since it was introduced in 1999, and we determined that balances remaining on cards issued five years ago are unlikely to be redeemed. The breakage income recognized in 2005 includes $2.6 million and $5.4 million for cards issued in 1999 and 2000; in both cases, the breakage income is 3.4% of the amount issued as gift cards in those years.

2004 VS 2003 OTHER INCOME INCLUDING FINANCE CHARGES, NET
Our overall other income including finance charges, net increased $17.9 million, primarily from our co-branded VISA credit card program growth. Since 2002, we marketed this credit card to our in-store customers and the inactive Nordstrom private label credit card holders. These marketing efforts showed success in 2004, as the co-branded VISA credit card holders used the cards more extensively in 2004, resulting in a 45.7% volume increase.

2006 FORECAST OF OTHER INCOME INCLUDING FINANCE CHARGES, NET
In 2006, other income including finance charges, net is expected to increase approximately $25 to $30 million as we continue to see growth in our VISA credit card program and corresponding income.

2005 VS 2004 INCOME TAX EXPENSE
Our expected effective tax rate, considering the federal tax rate of 35.0% and the net effect of state income taxes, is 38.5%. In 2005, our actual effective tax rate was below this rate because our 2004 tax expense, which was finalized in the third quarter of 2005, was less than we expected; we reduced our reserve when the audits of our 2000 and 2001 federal tax returns were completed; and, we utilized a larger than previously estimated amount of our capital loss carryforward.

2004 VS 2003 INCOME TAX EXPENSE
Our effective tax rate in 2004 increased from the 2003 rate because we recorded a valuation allowance for a portion of a capital loss carryforward which we deemed to be unrealizable.

2006 FORECAST OF INCOME TAX EXPENSE
In 2006, we expect our effective tax rate to be 38.5%.

2005 VS 2004 NET EARNINGS AND DILUTED EARNINGS PER SHARE
In 2005, net earnings increased 40.1% and diluted earnings per share increased 43.5% as a result of our same-store sales growth and sales leverage on buying and occupancy and general and administrative expenses. In 2004, we incurred prepayment costs and wrote off deferred debt costs totaling $20.9 million, or $0.05 per diluted share, upon prepayment of $198.2 million of long-term debt. We did not incur similar costs in 2005.

2004 VS 2003 NET EARNINGS AND DILUTED EARNINGS PER SHARE
In 2004, earnings per share increased to $1.38 from $0.88 in 2003. This increase was driven by a strong increase in overall and same-store sales, improvements in gross profit through better inventory management, and sales leverage on buying and occupancy and selling, general and administrative expenses.

2006 FORECAST OF DILUTED EARNINGS PER SHARE
We expect our diluted earnings per share to be in the range of $2.15 to $2.23 in 2006, which includes an estimated annual expense of $0.06 per diluted share from the adoption of SFAS No. 123(R), “Share-Based Payment” in the first quarter of 2006.

Fourth Quarter Results
Net earnings for the fourth quarter of 2005 were $190.4 million compared with $140.0 million in 2004. Total sales for the quarter increased 9.3% to $2.3 billion and same-store sales increased by 5.8%. Our cosmetics, accessories and men’s apparel merchandise categories experienced the largest same-store sales increases. Our shoe divisions had same-store sales increases. Our women’s apparel merchandise categories had mixed same-store sales performance. Women’s intimate and contemporary apparel were the leaders in the women’s category, while women’s special sizes, bridge and better apparel had same-store sales decreases in 2005.

Our gross profit rate increased to 37.5% from 36.6% last year. Our women’s apparel category experienced a reduction in gross profit rate, but this was offset by improvement in the men’s apparel and accessories categories. The quarterly improvement in our gross profit rate resulted from leverage on our buying and occupancy expenses.

Our selling, general and administrative rate improved 70 basis points from 26.9% to 26.2%, primarily from leverage on our general and administrative expenses.

LIQUIDITY AND CAPITAL RESOURCES
Overall, cash increased by $102.0 million to $462.7 million as of January 28, 2006 due primarily to the increase in our net earnings in 2005. We utilized our cash flow from operations for capital expenditures, to repay debt and to return capital to our shareholders through dividends and repurchases of our common stock.

2005 VS 2004 OPERATING ACTIVITIES
Net cash flow from operating activities increased from $606.3 million to $776.2 million, an increase of $169.9 million primarily due to the growth in our net earnings. We continue to see growth in our co-branded VISA credit card program, and as a result we have increased the capital we allocate to fund this program. Under our co-branded VISA program, we earn interchange and finance charge income and we offer card holders merchandise certificates, which can be redeemed in our stores, similar to a gift certificate. Our operating cash flows have been sufficient over the past three years to support the annual growth of this program, and we expect additional growth in 2006 also will be funded from our operations.

A key tool that we use to manage our inventory is our perpetual inventory system. In 2005, we reduced our average inventory per square foot by 2.3%. We use our perpetual inventory system to identify sales trends quickly, so we can enhance additional sales opportunities and increase inventory turnover.

In the course of negotiating for store locations, some developers offer up-front cash payments to defray our capital expenditures in exchange for our commitment to operate a store in their development. In 2005, we received $49.5 million of these incentives, which is a $29.6 million increase over 2004. Property incentive receipts vary year to year, depending on the number of our store openings and remodels and the arrangements we negotiate with developers.

2004 VS 2003 OPERATING ACTIVITIES
In 2004, net cash flow from operating activities increased to $606.3 million, a $7.1 million increase. Higher net earnings was offset by our merchandise purchase and payment flow changes in 2004 as compared to 2003 and the timing of income tax payments. Toward the end of 2003 and into 2004, we achieved a more even flow of merchandise purchases in relation to our sales trends. Our 2004 inventory turns have improved over the prior year; the payables leverage we achieved in 2004 is consistent with our merchandise purchase plan. Income tax payments have increased in 2004 as a result of our earnings growth.

2006 FORECAST FOR OPERATING ACTIVITIES
In 2006, cash flows provided by operating activities are expected to increase slightly as a result of increased net earnings.

Investing Activities
In the past three years, we have had two principal types of investing activities: capital expenditures and short-term investments.

CAPITAL EXPENDITURES
The changes in the level of our capital expenditures from year to year partially correlate to the number of stores opened in each year:

In 2005, we opened four Full-Line stores: at Phipps Plaza in Atlanta, Georgia; at The Shops at La Cantera in San Antonio, Texas; at the Irvine Spectrum Center in Irvine, California; and at the NorthPark Center in Dallas, Texas. Gross square footage for the year increased approximately 3.5%, from 19,397,000 to 20,070,000. In 2005, 40% of our capital expenditures was for new stores and 30% was for remodels. In addition, 15% of our capital expenditures was for information technology and 15% for other routine projects.

Our capital expenditures over the last three years totaled $776.8 million. These capital expenditures were offset by property incentives of $115.3 million. With these capital expenditures, we added stores, enhanced existing facilities and improved our information systems. More than 1.6 million square feet of retail store space have been added during this period, representing an increase of 9% since January 31, 2003.

We expect that our capital expenditures will be $1.5 billion over the next three years, with $319 million planned for 2006. These future capital expenditures are expected to be offset partially by property incentives of $230 million. We plan to use 50% of this investment to build new stores, 25% on remodels, 10% on information technology and 15% for smaller, store-related improvements. Compared to the previous three years, capital expenditures will increase 94%, with increased spending allocated to new stores. The estimated capital project spending does not include potential investments in new stores resulting from the current industry consolidation. We believe we have the capacity to address additional capital investments should opportunities arise.

As of January 28, 2006, we were contractually committed to spend $567.5 million for constructing new stores, remodeling existing stores, and other capital projects.

SHORT-TERM INVESTMENTS
We reduced our holdings of our short-term investments in 2004 when we repurchased $198.2 million of long-term debt. In 2005, our short-term investment balances have been more consistent. We evaluate a number of short-term investment options, with a variety of yields and liquidity restrictions. Consistent with our investment policy, we invest our excess cash in high quality short-term investments. Some of these investments are classified as cash equivalents while others are classified as short-term investments; changes in the investment mix, while not significant to our overall short-term investing activities, can impact our net cash flows from investing activities.

Financing Activities
Over the past three years, our net operating cash flows have exceeded our net investing activities, and we used this excess cash flow to repay long-term debt, pay dividends, and to repurchase our common stock in 2004 and 2005. Over this three-year period, the price of our common stock has increased, which spurred stock option exercises that also increased our net cash. We have not utilized our short-term borrowing facilities during the past three years.

DEBT REPURCHASE
The following table outlines our debt retirement activity (in millions):

We repaid the remaining $96.0 million of our 6.7% medium-term notes when they matured in 2005. The cash payments in 2004 and 2003 that exceeded the principal retired represent early prepayment premiums.

In October 2006, our $300.0 million 4.82% Private Label Securitization will mature. We intend to borrow the funds necessary to repay the Securitization with a combination of our existing borrowing capacity and additional borrowing capacity that we expect to put in place before October 2006. In the first quarter of 2007, we intend to establish a new securitization program that includes the private label and co-branded Visa cards.

SHARE REPURCHASE
In August 2004, our Board of Directors authorized $300.0 million of share repurchases, replacing a previous share repurchase authorization. By the end of 2004, we purchased 13.8 million shares in the open market for the entire authorized amount of $300.0 million at an average price of $21.71 per share.

In February 2005, our Board of Directors authorized an additional $500.0 million of share repurchases. The actual number and timing of share repurchases will be subject to market conditions and applicable SEC rules. We entered into an accelerated share repurchase agreement with Goldman, Sachs & Co. in September 2005 to repurchase shares of our common stock for an aggregate purchase price of $100.0 million. We purchased 2.6 million shares of our common stock on September 8, 2005 at $38.77 per share. Under the terms of the agreement, we received 0.1 million additional shares in March 2006 based on the volume weighted average price of our common stock from September 8, 2005 to March 3, 2006. Overall for 2005, we purchased 8.5 million shares for $287.1 million at an average price of $33.80 per share. We expect to utilize the remaining authorization of $212.9 million in the first half of 2006.

Debt-to-Capital Ratio
Our recent favorable operating results increased our shareholders’ equity and allowed us to reduce our long-term debt, which contributed to a decrease in our debt-to-capital ratio from 43.0% at the end of 2003 to 30.9% at the end of 2005. We believe that a debt-to-capital ratio in the range of 25% to 40% results in favorable debt ratings and provides appropriate flexibility and a reasonable cost of capital.

Off-Balance Sheet Financing
We transfer our Nordstrom co-branded VISA credit card receivables to a third-party trust that issued $200 million of VISA receivable backed securities to third parties in 2002; those securities mature in April 2007. The outstanding balance of the co-branded VISA credit card receivables exceeds the receivable backed securities balance. As a result, we hold securities that represent our beneficial interests in the trust, recorded as investment in asset backed securities in our consolidated balance sheets. We do not record the $200.0 million of VISA receivable backed securities or the co-branded Nordstrom VISA credit card receivables transferred to the trust on our consolidated balance sheets.

In the past, this off-balance sheet financing provided us a cost-effective source of capital. See Note 8 for a further description of our off-balance sheet financing activities, including the amounts of income and cash flows arising from the arrangement and the amounts of our beneficial interests.

Interest Rate Swaps
To manage our interest rate risk, we entered into an interest rate swap agreement in 2003, which had a $250.0 million notional amount expiring in January 2009. Under the agreement, we receive a fixed rate of 5.63% and pay a variable rate based on LIBOR plus a margin of 2.3% set at six-month intervals (7.09% at January 28, 2006). The interest rate swap agreement had a fair value of $(11.1) million and $(7.8) million at the end of 2005 and 2004.

Contractual Obligations (Dollars in Millions)
The following table summarizes our contractual obligations and the expected effect on our liquidity and cash flows. We expect to fund these commitments primarily with operating cash flows generated in the normal course of business and credit available to us under existing and potential future facilities.

Long-term debt includes financing related to the $200.0 million off-balance sheet receivable backed securities due in April 2007. In addition to the required debt repayments disclosed above, we estimate total interest payments of approximately $576.6 million as of January 28, 2006, payable over the remaining life of the debts.

Purchase obligations primarily consist of purchase orders for unreceived goods or services and capital expenditure commitments.

Other long-term liabilities consist of workers’ compensation and general liability insurance reserves and postretirement benefits. The repayment amounts presented above were determined based on historical payment trends. Other long-term liabilities not requiring cash payments, such as deferred property incentives, were excluded from the table above.

This table also excludes the short-term liabilities, other than the current portion of long-term debt, disclosed on our 2005 balance sheet as the amounts recorded for these items will be paid in the next year.

Credit Capacity and Commitments
The following table summarizes our amount of commitment expiration per period (in millions):